Gratuity Rules in India: Eligibility, Formula and Tax

To qualify for gratuity, an employee must have completed at least 5 continuous years of service with the same employer. This applies when the employee:

• Resigns or retires
• Is retrenched
• Dies or becomes permanently disabled (the 5-year rule is waived in these two cases)

The 5-year threshold is calculated from the date of joining, not from any probation end date. Breaks in service due to illness, accident, authorized leave, or a legal strike do not break continuity.

One important practical nuance: if an employee completes 4 years and 240 days or more in the fifth year, courts and many employers treat this as completing 5 years — because 240 days equals a full working year for establishments operating 6 days a week. For 5-day-a-week establishments, the threshold is 190 days in the fifth year. This interpretation has been upheld in several High Court rulings, though it is not explicitly stated in the Act itself.

The standard formula under the Payment of Gratuity Act is:

Gratuity = (Last drawn monthly salary × 15 × Years of service) ÷ 26

Here, 15 represents 15 days of salary per completed year of service, and 26 is the number of working days assumed in a month (a 4-week month minus 4 Sundays). The salary figure used is basic pay plus dearness allowance (DA) — not gross salary. HRA, bonuses, overtime, and other allowances are excluded.

Years of service are rounded to the nearest completed year. A tenure of 7 years and 7 months rounds up to 8; a tenure of 7 years and 4 months rounds down to 7.

Worked Example

Suppose Priya has worked at a manufacturing company for 12 years and 8 months (rounds to 13 years). Her last drawn basic salary + DA is ₹55,000 per month.

Gratuity = (55,000 × 15 × 13) ÷ 26

= (55,000 × 195) ÷ 26

= 1,07,25,000 ÷ 26

= ₹4,12,500

Priya's employer must pay her ₹4,12,500 as gratuity. This falls well below the statutory ceiling of ₹20 lakh. Any amount an employer voluntarily pays above ₹20 lakh is treated as ex-gratia, not statutory gratuity.

Employees not covered by the Act (e.g., those in organizations with fewer than 10 employees) but who receive gratuity under a separate scheme use a slightly different formula: (Last salary × 15 × Years) ÷ 30 — dividing by 30 instead of 26.

The tax treatment depends on the type of employee:

The ₹20 lakh ceiling was revised from ₹10 lakh in March 2018. It applies to the aggregate gratuity received across all employers in a lifetime, not per job.

In Priya's example, her ₹4,12,500 falls well below ₹20 lakh and equals the Act formula amount, so the entire ₹4,12,500 is tax-free. She pays zero income tax on it.

If a senior employee with long tenure received ₹24 lakh in gratuity, the ₹4 lakh above the ₹20 lakh ceiling would be added to her taxable income for that year and taxed at her applicable slab rate.

Gratuity is not unconditional. The Act provides two grounds on which an employer can forfeit all or part of the amount:

1. Termination for misconduct causing damage or loss: If an employee is dismissed for willful misconduct that results in financial loss to the employer, gratuity can be forfeited to the extent of the damage proved. The employer may deduct for the proven loss but cannot withhold the remainder.
2. Termination for moral turpitude or violence: If the dismissal is for an offense involving moral turpitude (theft, fraud, dishonesty, or assault on coworkers or supervisors), the entire gratuity can be forfeited.

A few important guard-rails apply. Forfeiture requires a formal dismissal order — a voluntary resignation or retrenchment cannot trigger forfeiture. The misconduct must be proved through a proper domestic inquiry following natural justice principles. Courts have consistently held that employers cannot use forfeiture to punish minor infractions; the offense must be serious and directly connected to employment.

Resignation by an employee — regardless of circumstances — does not amount to forfeiture. If Priya resigns after 12 years, her employer cannot withhold gratuity on the grounds that her departure is inconvenient or poorly timed.

Once gratuity becomes payable, the employer must:

• Pay within 30 days of the date it becomes due
• Pay simple interest (typically around 10% per annum as notified) on amounts delayed beyond 30 days, if the delay is the employer's fault
• Accept a written application from the employee (Form I under the Gratuity Rules) — though the obligation exists even without a written claim

If the employer disputes the amount, they must deposit the undisputed portion and refer the contested amount to the Controlling Authority (typically the Labor Commissioner). Employees can independently approach the Controlling Authority if the employer refuses to pay. Gratuity must be paid as a single lump sum — installments are not permitted under the Act.