Gratuity Calculation & Eligibility Rules Explained in Simple Terms

Gratuity is a gift of money given by an employer to an employee in recognition of the employee's services over a specified period. The Payment of Gratuity Act, 1972, regulates gratuity; thus, firms with 10 or more workers must pay this benefit to eligible employees upon completion of their employment. The Act is designed to be a farewell financial gift to the employees who have been faithful and loyal.

The purpose of gratuity is to acknowledge and reward employees who have provided long-term service to an organization. It reflects the employer's gratitude and helps employees secure a financial cushion after leaving the company.

Gratuity becomes payable when an employee:

• Resigns after completing the minimum eligibility period (usually 5 years).
• Retires from active service.
• Is terminated after serving for the qualifying period.
• Passes away or suffers from permanent disablement (in such cases, the 5-year condition is waived).

It's important to note that gratuity is different from the provident fund (PF). While PF is a retirement savings contribution made jointly by the employer and the employee throughout the service period, gratuity is a one-time lump-sum payment made solely by the employer as a gesture of appreciation for long-term service.

Gratuity is determined based on a formula that is set out in the Payment of Gratuity Act, 1972. The formula involves the employee's last salary and the number of years of service. To figure out the exact amount of gratuity, one must first realise that the calculation differs a bit between employees who the Act covers and those who are not.

1. For Employees Covered Under the Gratuity Act

The formula used is:

👉 Gratuity = (Last drawn salary × 15 × Number of completed years of service) / 26

Breakdown of the formula:

• Last drawn salary = Basic Salary + Dearness Allowance (DA).
• 15 = The Act considers 15 days' wages for each completed year of service.
• 26 = Represents the average number of working days in a month (excluding Sundays).

Hence, the 15/26 ratio means the employee is entitled to 15 days' salary for every completed year of service, based on a 26-day working month. This "15/26" in the gratuity calculation essentially converts monthly wages into a per-day equivalent, then multiplies by 15 to compute half a month's salary for each service year.

2. For Employees Not Covered Under the Gratuity Act

The calculation formula slightly changes to:

👉 Gratuity = (15 × Last drawn salary × Number of years of service) / 30

Here, the divisor 30 represents all calendar days in a month, not just working days. Only the Basic + DA portion is considered as the salary for gratuity calculation, making the last drawn salary a crucial factor in determining the final gratuity amount.

Gratuity Calculation After 5 Years

To better understand how much gratuity you receive after 5 years, let's look at a few simple examples using the standard formula under the Payment of Gratuity Act, 1972.

Formula: Gratuity = (Last drawn salary × 15 × Number of completed years of service) / 26

Example 1:

• Basic + DA (Last Drawn Salary): ₹30,000
• Years of Service: 5
• Calculation: (30,000 × 15 × 5) / 26 = ₹86,538 (approx.)

So, if an employee has worked for 5 years and their last drawn Basic + DA is ₹30,000, their gratuity amount will be around ₹86,538.

Example 2:

• Basic + DA: ₹50,000
• Years of Service: 10
• Calculation: (50,000 × 15 × 10) / 26 = ₹2,88,462 (approx.)

Thus, with 10 years of service and a last drawn salary of ₹50,000, the gratuity amount would be approximately ₹2.88 lakh.

These gratuity calculation examples show how the gratuity amount increases with both salary and years of service. Knowing what your gratuity amount could be after 5, 10, or more years helps you plan better for your financial future.

When figuring out a gratuity, knowing which parts of your wage are going to be counted and which will be left out is very important. According to the Payment of Gratuity Act, 1972, only some aspects of your salary are taken into account for the calculation of the gratuity amount.

The "last drawn salary" used in the formula is your Basic Salary plus Dearness Allowance (DA) for the last month of employment before the resignation, retirement, or termination. Of these two, Basic and DA, the latter serves as the basis for all gratuity calculations, as it is a fixed, regular income directly linked to long-term benefits.

Excluded components include all variable or performance-based payments, such as:

• House Rent Allowance (HRA)
• Bonus or Incentives
• Overtime Pay
• Conveyance or Travel Allowance
• Medical or Special Allowances

While computing the gross salary for gratuity calculation, only Basic + DA from your last drawn salary is taken into account. Knowing this distinction helps employees accurately estimate their gratuity amount and avoid confusion over which salary elements influence the final payout.

Here are the latest updates and essential changes in the gratuity regime in India—especially relevant for private-sector employees. These reflect the evolving law and practice regarding gratuity.

Key Changes & Highlights

• The tax-exempt gratuity ceiling remains at ₹20 lakh for private-sector employees.
  Despite some media reports, the tax-free limit for private employees covered under the Payment of Gratuity Act, 1972 remains ₹20 lakh. More detail: CMA Knowledge – 2025 Gratuity Updates By contrast, for certain central government employees, the ceiling has been revised (more on that later). More: PDICAI – Latest News
• Coverage extended to fixed-term employees / contractual staff.
  Under the revised Code on Social Security, 2020, and evolving interpretations, fixed-term employees are increasingly covered for gratuity. They may become eligible even if their employment ends before the traditional five years. Example: The rule now states that fixed-term contract employees may receive gratuity proportionate to their tenure. More: Corrida Legal – Social Security Code & Gratuity Guide
• Continuous service / eligibility definitions clarified.
  The definitions of "continuous service" and how breaks such as medical leave, temporary layoffs, etc., count are gaining greater clarity under recent guidance. More: CMA Knowledge – 2025 Gratuity Updates
• Companies' compliance & timelines matter.
  Private companies should ensure they calculate gratuity correctly, apply the correct formula, maintain records of salary components, service years, and last drawn salary, and process payment within the statutory timeline (typically within 30 days of becoming payable). Incorrect calculations or delays may result in interest and penalties. More practical discussion: CiteHR – Thread on Gratuity Eligibility & Service

Employers must confirm whether their establishment is covered under the Payment of Gratuity Act, 1972 (i.e., 10 or more employees on any day in the past 12 months). Refer to guidance from the Chief Labour Commissioner.

When Processing Gratuity:

• Use the formula for covered employees: (Last drawn Basic + DA) × 15 × Years of Service ÷ 26.
• If not covered under the Act (or for different contract types), follow the alternate calculation (÷30) or company policy.
• For fixed-term and contract staff: Review the employment contract, confirm whether gratuity is applicable, record the "last drawn salary" correctly, and compute the service period (even if less than 5 years), where appropriate.
• Maintain documentation: payslips (Basic + DA), service records, contract copies (especially for fixed-term staff), gratuity calculation sheet, employer's payments, and nominee details.
• Pay within the statutory timeframe (typically 30 days) after the event making gratuity payable (retirement, resignation, termination, death, or disablement) to avoid liability for interest.

Special Notes on Private Sector & Government Differences

• For private-sector employees, the gratuity tax exemption remains up to ₹20 lakh.
• For certain Central Government regular civil servants, the ceiling has been increased to ₹25 lakh. (PDICAI)
• The rules for fixed-term employees and contract workers continue to evolve, and organisations must stay updated on labour law amendments and state-specific notifications.

Tax-Free Limit: Gratuity received by an employee is exempt from income tax up to ₹20,00,000 in a lifetime, as per Section 10(10) of the Income Tax Act, 1961. This means any gratuity amount within ₹20 lakh is entirely tax-free.

For Government Employees: For employees of the Central Government, State Government, or local authorities, the entire gratuity amount is tax-free, regardless of the amount received. There is no upper ceiling on exemption for government employees.

For Private Sector Employees: Private-sector employees are eligible for tax exemption up to ₹20,00,000. Any amount received beyond ₹20 lakh is treated as "Income from Salary" and taxed according to the individual's income tax slab rate.

Lifetime Limit: The ₹20 lakh exemption is a one-time cumulative limit over your entire working life. If you receive gratuity from more than one employer, the total tax-free gratuity across all employers cannot exceed ₹20,00,000.

Applicability Under the Act: The rule applies to employees covered under the Payment of Gratuity Act, 1972, as well as to those not covered but who voluntarily receive gratuity from employers.

Tax Deduction and Filing: If the gratuity amount exceeds the exemption limit, the employer may deduct TDS (Tax Deducted at Source) on the taxable portion. Employees must include the taxable amount under the head "Income from Salary" while filing their income tax return.

Important Tip: Keep track of all gratuity payments received during your career to ensure you do not exceed the ₹20 lakh lifetime exemption limit and face unexpected tax liability.