Gratuity rules in India: eligibility, formula, risks

Most gratuity disputes start when an otherwise clean full-and-final hits a snag on eligibility or the last drawn wage figure. Here is how to get it right the first time.

Gratuity in India: what matters for HR today

Gratuity is a statutory benefit payable by employers to employees for long and continuous service. It is not a goodwill gesture. It is a legal obligation under the Payment of Gratuity Act, 1972, and it can trigger interest and penalties if you delay or miscalculate.

For Indian SMBs, the operational challenges are consistent: deciding eligibility around the 5-year mark, using the correct wage definition, handling resignations versus terminations, and documenting nominations. Court orders keep reinforcing that gratuity is a statutory right and cannot be contracted away, which is why clean process matters.

Until the labour codes are brought into force, the 1972 Act continues to apply. HR teams should align policies and payroll configurations with the Act as it stands in 2026.

Coverage: which establishments and employees

The Act applies to establishments employing 10 or more persons on any day in the preceding 12 months. Once it applies, it continues to apply even if headcount falls below 10 later.

There is no wage ceiling for employee eligibility. The Act covers workers, staff, and managers in factories, mines, oilfields, plantations, ports, railways, and shops and establishments with the required headcount. Apprentices engaged under the Apprentices Act are excluded. Trainees not under the Apprentices Act may still be treated as employees based on actual work and control.

When gratuity becomes payable

Events that trigger payment

• Resignation or termination after completing the qualifying service
• Retirement or superannuation
• Death or disablement due to accident or disease

In cases of death or disablement, the 5-year service condition does not apply. Payment goes to the nominee or legal heirs as per the Act and nomination on record.

The 5-year rule and what counts as continuous service

Eligibility is five years of continuous service with the employer. Continuous service means the employee was not absent without leave for long stretches and includes days not actually worked but paid for, such as approved leave with wages, layoff, strike, lockout, and closure not due to employee fault.

The Act deems continuous service met if the employee actually worked for a minimum number of days in the preceding period:

• For one year: 240 days of actual work in the preceding 12 months
• For six months: 120 days of actual work in the preceding 6 months
• For employees working below ground in a mine or in establishments that work less than six days in a week: 190 days and 95 days respectively for one year and six months

Maternity leave counts as continuous service. Probationary periods count. Unpaid leave that is not approved and days beyond sanctioned leave typically do not count as days worked.

Courts have repeatedly underscored that gratuity is a statutory right and cannot be defeated by contract wording. For a practical view of recent jurisprudence and HR actions, see this explainer on the Supreme Court ruling on gratuity liability and what HR must do.

How to calculate gratuity correctly

Wage components to use

Use last drawn wages consisting of Basic plus Dearness Allowance for the calculation. Do not include HRA, overtime, bonus, and most allowances. Variable pay that is truly commission-like and not part of wages is normally excluded.

Be consistent with your payroll definitions and keep documentary proof of the last drawn Basic and DA in the exit month, since this is the most common audit and litigation question.

The standard formula for monthly-rated employees

For monthly-rated non-seasonal employees covered by the Act:

Gratuity = Last drawn (Basic + DA) x 15/26 x completed years of service

• 15 is the number of days’ wages payable per completed year
• 26 is the number of working days considered in a month under the Act
• Service is rounded to the nearest year by the Act’s rule: ignore any service up to 6 months, and count service in excess of 6 months as one full year

Examples

Example 1: Resignation after 7 years 5 months
Last drawn Basic + DA = Rs 30,000. Service counted = 7 years.
Gratuity = 30,000 x 15/26 x 7 = Rs 121,153.85, typically rounded as per company policy.

Example 2: Retirement after 7 years 7 months
Last drawn Basic + DA = Rs 30,000. Service counted = 8 years.
Gratuity = 30,000 x 15/26 x 8 = Rs 138,461.54.

Piece-rated and daily-rated employees: Compute average daily wages based on the preceding three months excluding overtime, then apply 15 days for each completed year. For seasonal establishments, pay is 7 days’ wages for each season worked.

Service rounding and the 4y-10m problem

HR often faces exits at 4 years 8 months, 4 years 10 months, or 4 years 11 months. The Act’s text requires five years of continuous service, but the deeming provisions for continuous service count 240 days of actual work for a year.

Risk-aware approach many SMBs adopt:

• At 4 years 11 months: pay gratuity, documenting 240 days of work in the last year
• At 4 years 10 months: consider facts such as weekly schedule and actual days worked; take a documented decision
• Under 4 years 8 months: usually not paid unless there are special facts

Document the decision, because the same pattern should apply across cases to avoid discrimination allegations.

Common calculation mistakes to avoid

Caps, tax, and how to show it in payroll

Statutory ceiling

The central government notifies a maximum gratuity amount payable under the Act. The current statutory ceiling is Rs 20 lakh. Employers can choose to pay more under company policy, but the legal minimum stops at the notified cap.

Track lifetime payouts per employee to apply the cap correctly across multiple stints with the same employer group. Maintain a central register so branches do not exceed the cap by mistake.

Income tax treatment and TDS

• Government employees: gratuity is fully exempt from income tax
• Employees covered by the Act: exemption up to the statutory limit; any excess is taxable
• Employees not covered by the Act: exemption calculation differs, subject to the same notified limit

Under HR ops, your job is to compute the exempt portion, include any taxable gratuity in the exit payroll, and deduct TDS where applicable. Reflect the amount and exemption in Form 16 Part B for the year of payment.

Accounting and funding

Accrue gratuity liability annually in your books, based on actuarial valuation where required by accounting standards. SMBs often either:

• Keep an internal gratuity provision and pay from operating cash at exit dates
• Buy a group gratuity policy with an insurer and fund it gradually to smooth cash flow

Whichever approach you take, ensure your HRIS captures the correct last drawn wage and service tenure to avoid overfunding or underfunding.

Fixed term employees and the labour codes: where we stand in 2026

The Code on Social Security, 2020 includes a provision for fixed term employees to receive gratuity on a pro-rata basis without completing five years. However, as of 2026, full implementation depends on notification by the central government and corresponding state rules. Many states have not yet operationalized all labour code rules.

Until notified, continue applying the Payment of Gratuity Act, 1972. Track the implementation status in your states. For context on staggered notifications and what HR should do in the interim, see this update on states delaying labour code rules and steps for HR.

Forfeiture and set-off: when you can withhold gratuity

Gratuity can be forfeited only in narrow circumstances:

• To the extent of loss or damage caused by an employee’s willful act, negligence, or default in the course of employment
• Wholly or partially for riotous or disorderly conduct, acts of violence, or an offense involving moral turpitude committed in the course of employment

Poor performance or ordinary misconduct does not by itself justify forfeiture. If you intend to forfeit, record clear findings in the domestic enquiry and termination order that link the misconduct to the statutory grounds. Keep evidence ready for the controlling authority.

You may adjust recoverable dues against the gratuity payable only in line with the Act and after applying the forfeiture rules. Avoid blanket set-offs that can be struck down.

Nominations, forms, timelines, interest

Have every employee complete a nomination after one year of service and update it on marriage, addition of dependents, or changes in family status. Keep nominations accessible and digitized along with KYC.

Operational timelines under the Act:

• Employee or nominee should apply in the prescribed form after termination or triggering event
• Employer must determine the amount, issue a notice of determination, and pay within 30 days from the date it becomes payable
• Delays attract simple interest at the government notified rate unless the delay is due to the employee’s fault and the employer has obtained written permission from the controlling authority

Failure to pay can invite directions from the controlling authority and prosecution. Build calendar reminders and SLA tracking in HR ops.

Contract labour, interns, and apprentices

Contract labour: The contractor, as the direct employer, is responsible for paying gratuity to contract staff. In practice, if the contractor vanishes or is insolvent, controlling authorities can draw the principal employer into proceedings. Protect yourself by writing gratuity obligations and indemnities into contracts, seeking proof of funding or insurance, and doing periodic audits of contractor compliances.

Interns and trainees: Apprentices engaged under the Apprentices Act are excluded. Trainees on stipends who perform regular work under supervision may be held to be employees based on facts. If you run long trainee programs, decide upfront whether they accrue gratuity and document it.

Exit checklist: how HR should process gratuity cleanly

1. Verify coverage: confirm the establishment is covered and the employee is not an excluded apprentice
2. Determine eligibility: compute continuous service and the five-year test, applying the 240 or 190 day deeming provisions where relevant
3. Confirm last drawn wage: Basic plus DA for the exit month, cross-check with the payslip and HRIS
4. Calculate gratuity: apply 15/26 x completed years, round service as per the six-month rule, apply the statutory cap
5. Check forfeiture: review any domestic enquiry findings for statutory grounds, and decide on partial or full forfeiture only if justified
6. Handle tax: compute exempt portion, include any taxable excess in FFS, and apply TDS where applicable
7. Issue notices: send determination notice to the employee or nominee, with calculation sheet and payment date
8. Pay within 30 days: remit through traceable mode, collect receipt, and record in the gratuity register
9. Update records: store calculation, approval, and payment proof; adjust lifetime cap tracker for the employee
10. Reconcile funding: post the accounting entry, update provision or insurer fund balance

Treat this sequence as part of your broader FFS workflow. If you are redesigning payroll handoffs, this operator guide to the payroll processing steps in India can help you stage responsibilities and checks between HR and payroll.

Documentation that prevents disputes

Most controlling authority cases turn on documents. Keep these current and easy to retrieve:

• Appointment letters and any transfer or absorption orders that prove continuity of service
• Attendance and leave records to establish 240 or 190 days of work in relevant periods
• Payroll proofs for last drawn Basic and DA, including the final payslip
• Domestic enquiry records if forfeiture is considered
• Signed nominations and family details

Use consistent templates for calculation notes. Date-stamp every decision and have a maker-checker sign-off to show diligence.

Edge cases you will see in SMB operations

Death during service

Pay gratuity up to the date of death, without the five-year requirement. Pay the nominee. If the nominee is a minor, follow the Rules for deposit and guardianship. Keep the family informed and set a short internal SLA for these cases.

Disablement

Disablement due to accident or disease triggers gratuity even if service is under five years. Collect medical certificates and process swiftly.

Resignation with break in service

If there was a break and a fresh appointment with no continuity, service periods are not added. If the break was a transfer inside the group with continuity recorded, add periods for gratuity. Your paperwork decides the outcome.

Change in ownership

On a transfer of undertaking where employment continues seamlessly, gratuity is not immediately payable. Liability travels with the undertaking and service continuity is preserved. Map and allocate the liability in the business transfer agreement.

Part-time schedules and weekly offs

Weekly offs and paid holidays count toward continuous service. For part-time employees, courts look at the real employment relationship and days actually worked. Maintain clear schedules and timesheets.

Maternity leave

Maternity leave counts as continuous service. Do not penalize tenure or gratuity for lawful maternity absence.

Unauthorized leave and absconding

Unauthorized leave generally does not count as days worked for deeming continuous service. If an employee absconds and you terminate for abandonment, calculate tenure carefully and document attempts to contact.

Policy choices that reduce risk

Two policy areas shape most gratuity outcomes: wage structure and eligibility stance near five years.

• Wage structure: Keep a rational Basic that reflects the employment terms. Avoid sudden Basic cuts near exit months. For a clean wage design reference, see this guide on how to define CTC in Indian salary structures.
• Eligibility stance: Publish a clear internal stance on near-5-year exits. For example, pay at 4 years 11 months on proof of 240 days, case-by-case at 4 years 10 months, and not below that unless there are special facts. Apply consistently.

Whenever you update payroll rules due to statutory changes in one area, check gratuity settings too. For instance, if you already reviewed payroll for the EPF wage ceiling change in 2026, do a parallel hygiene check for gratuity wage definitions, caps, and forms in the same sprint.

Process design: prevent errors with simple controls

HR and payroll teams can prevent most gratuity mistakes with three lightweight controls:

• Data lock: Lock the last drawn Basic and DA in the HRIS the day the resignation is accepted, so it is not changed downstream without approval
• Service calculator: Auto-calculate tenure and 240 or 190 day thresholds using attendance and paid leave data, then show HR a clear yes or no flag on eligibility
• Maker-checker: Have a second reviewer validate the wage figure and the service rounding before the determination notice goes out

These controls are simple to pilot. If you already track field attendance or shift rosters, tie that data into the eligibility calculator so your 240 day logic is evidence-backed. If you want to think through attendance data quality, this practical note on employee tracking and location signals can help you design collection without being intrusive.

Frequently asked operational questions

Q: Should we pay interest if the employee delayed filing the application?
A: Interest applies if you do not pay within 30 days from when gratuity became payable, unless the delay is due to the employee’s fault and you have written approval from the controlling authority. If the employee delayed filing but you still had enough information to compute and pay, do not rely solely on the delay. Take a practical, documented decision.

Q: Can we pay gratuity in advance installments?
A: The Act expects payment when it becomes payable. Some employers pay an ex gratia during long medical emergencies, then adjust at exit. If you do this, document it as an advance and reconcile against the final gratuity, keeping the statutory cap and tax in mind.

Q: Is forfeiture possible for data theft without a criminal conviction?
A: The Act allows forfeiture for offenses involving moral turpitude committed in the course of employment. While a conviction makes it stronger, controlling authorities have considered well-evidenced findings from domestic enquiries. Get legal review before forfeiture in such cases.

Q: Do we need to display any notice?
A: The Rules require a notice with gratuity information to be displayed in a conspicuous place. Many SMBs include the essentials in the employee handbook and intranet as well. Keep both aligned.

Real-world scenarios and how to handle them

Scenario 1: 4 years 9 months, 6-day week, long approved medical leave
Pull attendance and leave data. Count paid medical leave toward continuous service. If the last 12 months show 240 days of work including paid leave days that qualify, consider paying. Document the calculation and your policy stance.

Scenario 2: Termination for financial loss due to negligence
Get a quantified loss figure supported by finance, ensure a properly conducted enquiry, and forfeit only to the extent of the proven loss. Pay the balance gratuity within 30 days and record the set-off basis.

Scenario 3: Contractor shuts shop, long-serving guard claims gratuity
Direct the claim to the contractor as the employer. If the controlling authority involves you as principal employer, share contracts, proof of payments to the contractor inclusive of service charges, and insist on the contractor’s primary liability. Consider a commercial settlement only after legal review.

Scenario 4: Death in service with no nomination
Identify legal heirs as per the Act’s family definition. Obtain required affidavits and proofs. If minors are involved, follow deposit and guardianship rules. Pay within the statutory timeline to avoid interest.

What to do this week

• Audit 10 random closed FFS files to check wage definition, tenure rounding, and payment timelines
• Publish a one-pager on your internal stance for near-5-year exits and share it with HRBPs
• Digitize nominations and add a reminder to update after marriage or childbirth
• Set a 30-day payment SLA with clear owners and escalations
• Review contractor MSAs and add gratuity indemnities and proof requirements

Key takeaway

Gratuity compliance is won in the details: define wages correctly, count service carefully, document every decision, and pay on time. With a clear policy stance near the five-year mark and tight exit controls, Indian SMBs can reduce disputes and protect both employees and the company.

For wider context on statutory shifts that affect payroll operations alongside gratuity, you may also find this briefing on Gujarat Labour Code Rules 2025-26 and this explainer on two Income-tax Acts in one year useful as you plan compliance updates and sequencing.