A gratuity cheque often arrives at one of the hardest moments of a working life: retirement, a redundancy letter, a bereavement, the quiet end of a contract. Most working professionals in India will see at least one of these payouts, but few are shown how they are calculated.
Fixed-term workers at firms like Infosys, HCLTech and Flipkart suddenly qualified for gratuity after one year of service instead of five. And a shift in how “wages” is defined has, for most salaried employees, lifted employer gratuity liability without a single rupee of CTC changing.
What follows unpacks the gratuity position as it stands for Indian employees and employers in 2026.
What is Gratuity?
Gratuity is a lump-sum payment an employer makes to an employee at the end of a sustained period of service, as a statutory recognition of that service. It is neither a bonus nor a pension. It is a defined-benefit entitlement payable once, at exit.
Industry practice in Indian textile mills and tea plantations seeded the benefit in the mid-20th century. Parliament codified it in the Payment of Gratuity Act, 1972, making it a legal right for employees of factories, mines, oilfields, plantations, ports, railway companies, shops and establishments with 10 or more employees.
From 21 November 2025, that Act stands repealed. Gratuity provisions now sit in Chapter V (Sections 53 to 58) of the Code on Social Security, 2020, which the Government of India brought into force on that date alongside the other three Labour Codes.
Once an employee is eligible, the employer owes gratuity on retirement, resignation, superannuation, death or permanent disablement, and now on expiry of a fixed-term contract. The sum rewards tenure. It also, in effect, backstops families when a wage-earner dies in service.
New Gratuity Rules 2026 Under the Code on Social Security
The Code on Social Security reshapes gratuity exposure for Indian employers from 21 November 2025 through structural changes to who qualifies, what counts as wages, and how pay must be structured. The formula is untouched. What feeds into it is not.
Fixed-term employees now qualify after one year
Section 53(2) of the CoSS entitles a fixed-term worker to pro-rata gratuity on completion or expiry of the contract, once one year of continuous service is behind them. The old five-year wall is gone for this cohort, as the Ministry of Labour and Employment’s own Labour Codes briefing sets out. Indian IT services, where TCS, Infosys and Wipro collectively employ hundreds of thousands of fixed-term and project-based engineers, now face a material change to severance accounting.
The definition of “wages” is now uniform across social security
Section 2(88) of the CoSS sets a single definition of wages that applies to EPF, ESI, gratuity, maternity benefit and employee compensation. The three included components are basic pay, dearness allowance and retaining allowance (if any). Eleven heads are excluded, including bonus, HRA, conveyance, overtime and commission.
The 50% wage rule caps allowance-heavy CTC structures
The second proviso to Section 2(88) deems “wages” to be at least 50% of total remuneration for the purposes of the Code. If an employer structures CTC with basic + DA at 30% and the rest in allowances, the excess allowance over the 50% ceiling is added back into wages for calculating gratuity, PF and ESI.
A gratuity formula multiplied by a bigger wage base produces a bigger payout. On a ₹1 lakh/month CTC that used to show basic pay of ₹30,000, “wages” for gratuity now float up toward ₹50,000, and the resulting liability can rise by roughly 67% without a single pay revision. HR teams working through the fine print of these shifts can map them against our handbook on the new Labour Codes.
Who is Eligible for Gratuity?
Eligibility turns on two things: whether the establishment is covered by the gratuity provisions, and whether the employee has completed the qualifying period of continuous service. The Code applies to every factory, mine, oilfield, plantation, port, railway company, shop and establishment with 10 or more employees on any day in the preceding 12 months.
The qualifying service period for permanent employees stays at five years. Fixed-term staff cross the threshold at one year of continuous service, with payment on a pro-rata basis. The five-year rule is waived entirely in case of death or disablement, and gratuity is then payable to the nominee or legal heir.
A quick view of who qualifies and when:
| Employee category | Qualifying service | Trigger event | Payment basis |
| Permanent employee | 5 years continuous | Retirement, resignation, superannuation | Full |
| Fixed-term employee | 1 year continuous | Expiry or termination of contract | Pro-rata |
| Any employee (death) | None | Death in service | Full, to nominee |
| Any employee (disablement) | None | Permanent disablement | Full |
A long-running judicial interpretation adds a wrinkle for permanent employees. In a six-day work-week establishment, 240 working days in the fifth year have been treated by High Courts as a full year of continuous service, making employees with 4 years and 8 months generally eligible. The Social Security (Central) Rules, 2026 carry a complementary rounding rule, treating any part-year over six months as a whole year.
Fixed-term employment itself is a formal category under the Industrial Relations Code, 2020, with the same wages, allowances and benefits as a permanent employee on a pro-rata basis. The parallel definitions across the Codes aim to protect contract and project staff from being used to sidestep statutory benefits, a loophole that was common in IT services, GCCs and e-commerce. For a quick view of how the Codes now define each worker category, the type-of-employment framework matters as much as the formula.
Salary Components Included in Gratuity Calculation
Only three salary components count as “wages” for gratuity under Section 2(88) of the CoSS: basic pay, dearness allowance, and any retaining allowance the employer pays. Nothing else goes into the formula at face value.
Exclusions are long and specific. The Code expressly keeps out:
- Bonus and incentive payments
- House rent allowance (HRA)
- Conveyance allowance
- Overtime pay
- Commission
- Employer contributions to PF, pension or insurance
- Gratuity itself paid on exit
- Travel concessions and reimbursements
- Retrenchment compensation
- Ex-gratia payments
- Payment in kind beyond specified limits
What makes the definition bite is the 50% ceiling in the second proviso. If the sum of the excluded allowances exceeds half of total remuneration, the surplus is added back to wages. In practice, an employer paying ₹1 lakh/month cannot keep basic pay at ₹30,000 and route ₹70,000 through allowances to shrink gratuity exposure. ₹20,000 (the excess over 50% of ₹1 lakh) flows back into wages, lifting the gratuity base to ₹50,000.
A deeper look at how the new wage definition rewrites compensation planning sits alongside this one and matters most for CTCs in the ₹8 lakh to ₹25 lakh LPA bracket, where allowance-heavy structures used to dominate.
Gratuity Calculation Formula
In establishments covered by the Code,
Gratuity for an eligible employee = (last drawn wages × 15 × completed years of service) ÷ 26
That one line carries most of India’s gratuity liability.
Each number inside the formula earns its place. 15 stands for 15 days of wages payable for each completed year of service. 26 is the number of working days in a calendar month after deducting four Sundays. The multiplier set, in effect, produces about half a month’s wages for every year worked. “Last drawn wages” is the pay in the final month before exit, now defined per Section 2(88).
Outside the Code’s statutory gratuity provisions (a shrinking category, since the 10-employee threshold is wide), many employers still pay gratuity contractually, using a different divisor:
- Covered under the Code: Gratuity = (Last drawn wages × 15 × Years of service) ÷ 26
- Not covered under the Code: Gratuity = (Average salary of last 10 months × 15 × Years of service) ÷ 30
A key subtlety on tenure: part-years of six months or more are rounded up to the next whole year. So 10 years and 7 months counts as 11 years. 10 years and 5 months counts as 10. That single rounding rule can move the final cheque by a full year’s slice of wages, which is why exit timing is a sensitive negotiation at many Indian firms.
Gratuity Calculation Examples
The formula lands differently on different Indian pay structures. The worked illustrations below use realistic 2026 pay bands and apply the CoSS wage definition.
Example 1: A permanent employee in Indian IT services
Ananya worked at an IT services firm in Bengaluru for 11 years and 8 months. Her last drawn basic pay plus DA was ₹60,000/month. Rounded tenure: 12 years. Gratuity = (60,000 × 15 × 12) ÷ 26 = ₹4,15,384.
Example 2: A manufacturing employee at the five-year threshold
Suresh completed exactly 5 years as a floor supervisor at a Pune auto-component plant. His last drawn wages were ₹32,000/month. Gratuity = (32,000 × 15 × 5) ÷ 26 = ₹92,307.
Example 3: A fixed-term employee under the new one-year rule
Rohit joined a Hyderabad GCC on a two-year fixed-term contract with wages of ₹45,000/month (basic + DA). The contract ends at the full term. Under Section 53(2) of the CoSS, he qualifies after one year, and the two-year tenure gives: Gratuity = (45,000 × 15 × 2) ÷ 26 = ₹51,923.
Rohit’s entitlement did not exist under the 1972 Act. The reform is modest in individual rupees for a two-year stint, but at sector scale it changes how companies price fixed-term and project engagements. A workforce running into millions across IT services, BFSI, retail and GCCs is now accruing gratuity from the end of year one.
Maximum Gratuity Limit and Tax Treatment
Statutory gratuity for private-sector employees is capped at ₹20 lakh per employee, and the same ceiling applies for income tax exemption under Section 10(10) of the Income Tax Act, 1961. Anything above that is paid at the employer’s discretion and taxed in the employee’s hands.
The current tax treatment splits into three tiers:
| Employee category | Governing provision | Tax-exempt limit |
| Central and state government employees | Section 10(10)(i) | Fully exempt, no monetary cap |
| Private-sector employees covered under the Act | Section 10(10)(ii) | Least of actual gratuity, calculated amount, or ₹20 lakh |
| Private-sector employees not covered under the Act | Section 10(10)(iii) | Least of actual gratuity, calculated amount, or ₹20 lakh |
The ₹20 lakh ceiling was last raised in March 2018 for employees covered under the Act, and a matching Ministry of Finance notification in March 2019 brought the Section 10(10)(iii) exemption for other employees in line. The Income Tax Department’s clarification on the effective dates of both notifications sets out the current position.
Important caveat: the ₹20 lakh exemption is a lifetime limit applied across every employer in a working life. An employee who used ₹8 lakh of exemption at a previous employer has ₹12 lakh left for the rest of their career. At senior levels in TCS, Infosys, Reliance and the large private banks, that lifetime ceiling now routinely binds, with the surplus taxed as salary.
Government employees sit outside this cap, and the central-government ceiling itself was lifted to ₹25 lakh in 2024 following dearness allowance revisions. The private-sector statutory ceiling of ₹20 lakh has not moved to match.
When Must Employers Pay Gratuity?
Under Section 56(3) of the Code on Social Security, 2020, an employer must pay gratuity within 30 days of the date it becomes payable. The clock starts on the date of exit, retirement, death or contract expiry.
Delay beyond 30 days triggers mandatory simple interest on the unpaid amount, at the rate notified by the Central Government (currently 10% per annum). The employer bears the interest from Day 31 to the date of actual payment. The only recognised exception is a delay caused by the employee’s own default, and even that needs the employer to seek written permission from the competent authority.
Employees are expected to apply for payment in the prescribed form, now revised under the Social Security (Central) Rules, 2026. Absence of an application does not, however, extinguish the employer’s duty to pay. Case law has consistently held that payment is an automatic obligation and the application is a formality.
In the Jet Airways insolvency, the National Company Law Appellate Tribunal ordered the full payout of provident fund and gratuity dues to Jet staff ahead of other creditor claims, underscoring gratuity’s statutory ring-fence.
Can an Employer Withhold or Forfeit Gratuity?
Forfeiture is permitted only in narrow, codified circumstances under Section 53(6) of the Code on Social Security. An employer cannot withhold gratuity as leverage during a dispute, to recover an outstanding advance, or because the employee did not serve notice.
Two grounds for forfeiture exist in the Code:
- Property damage or loss (Section 53(6)(a)): Where an employee’s wilful act, omission or negligence has caused damage, loss or destruction of the employer’s property, gratuity can be forfeited only to the extent of that loss. The language is a proportionality limit. An employer cannot pocket the whole gratuity for a small loss.
- Riotous or disorderly conduct, including moral turpitude (Section 53(6)(b)): Where services were terminated for riotous or violent conduct, or for an offence involving moral turpitude committed during employment, the whole gratuity may be forfeited.
Courts have read these grounds strictly. In a widely tracked recent case, a Chennai labour court directed TCS to pay full gratuity to an employee who challenged a layoff, finding the stated grounds insufficient to withhold the statutory amount.
The evidentiary bar sits even higher once money has moved. The Gauhati High Court in a separate matter held that excess gratuity already paid cannot be recovered later without proof of fraud by the employee. Pending notice periods, outstanding loans, an unreturned laptop, or a pending internal inquiry are not, by themselves, grounds to withhold the statutory amount.
Common Gratuity Calculation Mistakes
Payroll teams and employees regularly miss the same handful of things, and most of these mistakes are becoming more expensive under the Code on Social Security. Each one sits at the intersection of the formula, the new wage definition, and the 30-day payment clock.
Treating gross CTC as “wages”
Only basic + DA + retaining allowance count. Teams that still plug in gross monthly pay inflate the entitlement and risk disputes at audit.
Ignoring the 50% rule
Employers running allowance-heavy CTC structures from the pre-Code era are now understating gratuity liability. The excess over 50% has to be added back under Section 2(88).
Dropping the fifth-year rounding
4 years and 8 months in a six-day-week establishment is eligible for gratuity under the 240-day interpretation. Payroll systems that round down lose employees a statutory right.
Using 30 instead of 26 for covered employees
The divisor 26 is a statutory choice reflecting working days after Sundays. 30 only applies to employees whose employer is not covered by the Code.
Forgetting fixed-term employees post-Code
Fixed-term staff who finish their contract after one year now qualify. Many finance teams still provision gratuity only for permanent employees past the five-year mark.
Missing the 30-day interest clock
Any delay past 30 days from the exit date accrues 10% simple interest, taxable in the employee’s hands as income from other sources even where the principal gratuity is exempt.
Taking the ₹20 lakh ceiling as per job
It’s a lifetime limit across all employers for private-sector employees. Senior professionals who have changed jobs several times often find their remaining exemption much lower than they assumed.
In the End…
Gratuity sits in an unusual place in Indian payroll: a statutory promise most employees ignore until the week it matters, and most employers under-provision until an actuarial valuation forces the question. The Code on Social Security, 2020 has not changed the arithmetic. It has changed who the arithmetic applies to and how big the “wages” number inside the formula will be, which is enough to shift balance-sheet obligations across sectors from IT services to manufacturing to GCCs.
Practical next steps, before the next quarterly actuarial valuation lands:
- Employees: request a one-time gratuity statement from HR against current wages, with the Section 2(88) definition applied. Keep it in the exit file alongside the PF passbook and nomination form.
- HR and finance leaders: re-run gratuity liability for the full workforce, including fixed-term staff, under the new wage definition, and reconcile against the FY26 actuarial report.
- Business owners and founders: check whether the gratuity trust or insurance arrangement under Section 57 of the Code covers the lifted liability, or whether a top-up is overdue.
The reform is less a rewrite of gratuity than a tightening of its grip. The formula survived. The loopholes did not.
FAQs
What is gratuity and when is it payable?
Gratuity is a lump-sum statutory payment for sustained service. It is payable on retirement, resignation, death, permanent disablement, or expiry of a fixed-term contract.
Who is eligible for gratuity in India in 2026?
Permanent employees qualify after 5 years of continuous service. Fixed-term employees now qualify after just 1 year, on a pro-rata basis. The service rule is waived in case of death or disablement.
What is the gratuity calculation formula?
Gratuity = (Last drawn wages × 15 × Completed years of service) ÷ 26. “Wages” means basic pay plus DA. Any part-year of 6 months or more rounds up to the next whole year.
How has the definition of “wages” changed under the Labour Codes?
Wages must now be at least 50% of total remuneration. If allowances exceed that ceiling, the surplus is added back into wages, lifting gratuity liability without any pay revision.
What is the maximum tax-exempt gratuity limit?
₹20 lakh for private-sector employees under Section 10(10) of the Income Tax Act. This is a lifetime cap across all employers, not a per-job limit. Government employees are fully exempt.
When must an employer pay gratuity?
Within 30 days of the date it becomes payable. Any delay beyond that attracts 10% simple interest per annum, borne by the employer until payment is made.
Can an employer withhold or forfeit gratuity?
Only for property damage caused by the employee’s wilful act (up to the loss amount) or termination for riotous conduct or moral turpitude. Unreturned assets, pending notice, or loans are not valid grounds.
