Gratuity is a lump-sum reward an employer pays a long-serving employee for continuous service, governed by the Payment of Gratuity Act, 1972. It is a statutory right, not a bonus at the employer's discretion, and applies to every factory, mine, plantation, port, railway, and to shops or establishments employing 10 or more persons on any day in the preceding 12 months. Once the Act applies, it continues to apply even if the headcount later drops below 10.
Who is eligible
An employee earns gratuity after completing five years of continuous service with the same employer. It becomes payable on:
- Retirement or superannuation
- Resignation after five years
- Death or disablement due to accident or disease — here the five-year condition is waived, and the amount goes to the nominee or legal heir
A part of a year beyond six months in the final year counts as a full year. Some High Courts have held that 4 years and 240 days satisfies the "five years" test where the fifth year is substantially complete, but this remains fact-specific.
How gratuity is calculated
For employees covered by the Act, the formula is:
Gratuity = (Last drawn salary × 15 ÷ 26) × Years of service
"Salary" means basic pay plus dearness allowance (DA) only — HRA, bonus, and other allowances are excluded. The 26 represents the assumed working days in a month, and 15 is half a month's wages for each completed year.
| Particular | Example |
|---|---|
| Last drawn basic + DA | ₹52,000 |
| Completed years of service | 18 |
| Calculation | (52,000 × 15 ÷ 26) × 18 |
| Gratuity payable | ₹5,40,000 |
Employees not covered by the Act use the average of the last 10 months' salary and a 15/30 basis, with no rounding up of part-years.
Maximum limit and tax treatment
The maximum gratuity payable under the Act is capped at ₹20 lakh (Section 4(3)). For tax, Section 10(10) of the Income-tax Act exempts the least of: the actual gratuity received, ₹20 lakh, or the amount from the statutory formula. Anything above the exempt figure is taxed as salary income. Gratuity received by a nominee on the employee's death is treated separately and is generally exempt.
Payment timeline and common mistakes
Gratuity must be paid within 30 days of it becoming due. Delay attracts simple interest at the rate notified by the government from the due date until payment. Watch for these errors:
- Assuming gratuity is forfeited on resignation — it is not; five years of service is enough
- Not filing Form F (nomination) at the start of employment, which complicates payment to heirs
- Employers withholding gratuity for reasons other than proven misconduct causing loss — forfeiture is narrowly restricted under Section 4(6)
- Including allowances beyond basic and DA, which inflates the figure incorrectly
If an employer refuses or delays, the employee can apply to the Controlling Authority under the Labour Department, which can order payment with interest and penalties.