Gratuity in India: Eligibility, Calculation Formula & Tax Rules Explained
Gratuity is a lump-sum benefit paid by an employer to an employee as a token of gratitude for long service. Governed by the Payment of Gratuity Act, 1972, it is one of the most misunderstood employee benefits in India. Many employees lose their gratuity due to simple eligibility misunderstandings. This guide clarifies every rule.
Eligibility: The 5-Year Rule
Gratuity is payable when: (1) employee resigns/retires after completing 5 years of continuous service, (2) employee is terminated (gratuity is still payable — the 5-year rule applies), (3) employee dies or becomes disabled — payable to nominee regardless of service years.
The 5-year rule has one important exception: if an employee dies or becomes disabled, gratuity is paid to the nominee/family even for 1 day of service.
Continuous service: Even if the company changed ownership or was acquired, service years count continuously. Contract workers and fixed-term employees may not be covered depending on the terms.
Applicable to: Organizations with 10 or more employees. Once an organization is covered, it remains covered even if headcount falls below 10.
4 years 240 days = 5 years for gratuity purposes. The Supreme Court has held that 240 working days in the 5th year constitutes completion of 5 years. Do not resign in month 59 — wait for 240 days in year 5.
Gratuity Calculation Formula
Formula: Gratuity = (Last Drawn Salary × 15 × Years of Service) ÷ 26
Last drawn salary = Basic salary + Dearness Allowance (DA). HRA, LTA, bonus, incentives are NOT included.
Example: Last basic salary ₹60,000/month, 8 years of service. Gratuity = (60,000 × 15 × 8) ÷ 26 = ₹2,76,923.
Partial year of service: Gratuity is calculated for years completed. If total service is 8 years 7 months, the 7 months round up to 1 year (if ≥ 6 months), making it 9 years for calculation. If less than 6 months in the last partial year, it is dropped.
Maximum gratuity under the Act: ₹20 lakh. Employers can pay more voluntarily.
Tax on Gratuity
Government employees (central/state/defence): Entire gratuity is fully tax-exempt. No limit.
Private sector employees (covered under Gratuity Act): Exempt up to the least of — (a) ₹20 lakh, (b) actual gratuity received, (c) 15 days salary × years of service. Amount above the exemption is taxable at slab rate.
Private sector employees (not covered under Act): Exempt up to the least of — (a) ₹10 lakh, (b) actual gratuity, (c) half-month average salary × years of service.
For most middle-class employees, gratuity after 10-15 years will be ₹4-8 lakh — entirely within the ₹20L exemption and thus tax-free.
When Is Gratuity Paid?
Employer must pay within 30 days of the gratuity becoming payable (resignation date, retirement date, etc.).
If not paid within 30 days, employer owes interest at the rate notified by the government from the due date.
How to claim: Submit Form I (application for gratuity) to employer. Employer must determine and communicate amount within 15 days via Form L. Employer must pay within 30 days.
Dispute: If employer disputes the gratuity amount, approach the Controlling Authority (typically the Deputy Labour Commissioner) under the Payment of Gratuity Act. Filing is simple and free.
Planning Your Gratuity Payout
Gratuity is a windfall of sorts — typically received at retirement or major job transition. Having a deployment plan before receipt is important.
If received at retirement: Deploy into FDs, SCSS (Senior Citizens Savings Scheme), or Pradhan Mantri Vaya Vandana Yojana for regular income.
If received at mid-career transition: Consider NPS Tier 1 (for tax-saving + retirement corpus), index funds (for long-term growth), or partial prepayment of home loan.
Use our Gratuity Calculator to know exactly how much you are owed, and our FD/RD Calculator to plan where to park it.
Related Calculators
Frequently Asked Questions
What if I resign before 5 years?
No gratuity is payable under the Gratuity Act if you resign before completing 5 years of continuous service (except death/disability). Some employers voluntarily pay a pro-rated amount — check your offer letter or HR policy.
Is gratuity payable on termination?
Yes. If the employer terminates your employment for any reason other than proven misconduct, full gratuity (based on years of service) is payable even if service is less than 5 years. For misconduct, gratuity can be forfeited partially or fully.
Does gratuity count toward PF?
No. Gratuity and PF are separate benefits. PF is contributed monthly; gratuity is a one-time payment at exit after qualifying period.
Can gratuity be forfeited?
Yes, in case of willful omission or negligence causing damage/loss to employer, or termination for proven disorderly conduct/moral turpitude. Partial or full forfeiture is possible but must go through the Controlling Authority process.