Gratuity Rules in India: Eligibility, Calculation and Tax Exemption Explained

Gratuity is one of those retirement benefits many employees don't think about until they're resigning, retiring, or being asked to sign a full-and-final settlement form — and by then, it's easy to feel unsure whether the amount offered is correct. This guide breaks down exactly who is eligible, how the amount is calculated, and how much of it is actually tax-free.

What is Gratuity?

Gratuity is a lump-sum monetary benefit paid by an employer to an employee as a token of appreciation for continuous service. It is governed primarily by the Payment of Gratuity Act, 1972, and is paid on top of your salary, provident fund, and any leave encashment — it is not a substitute for any of these.

Who is Eligible for Gratuity?

Under the Act, an employee becomes eligible for gratuity once they complete 5 years of continuous service with the same employer. This applies whether you resign, retire, or are terminated (for reasons other than serious misconduct).

• Standard rule: Minimum 5 years of continuous service is required.
• Exception – death: If an employee dies while in service, the 5-year rule is waived entirely, and gratuity is paid to the nominee or legal heir regardless of tenure.
• Exception – disablement: If the employee becomes permanently disabled due to accident or disease during service, the 5-year condition is also waived.
• "Continuous service" nuance: Courts and labour authorities have held that an employee who has worked 240 days or more in the 5th year may, in certain interpretations, be treated as having completed continuous service — though employers vary in how strictly they apply this, so it's worth checking your specific case with HR.

How Gratuity is Calculated

For employees covered under the Payment of Gratuity Act, the formula is fixed by law:

Here, "last drawn salary" means basic salary plus dearness allowance (DA) — not your full CTC or gross salary. The number 26 represents the working days in a month (excluding 4 Sundays), and 15 represents 15 days' wages for every completed year of service.

If your service period includes a part-year beyond a completed year, any period of 6 months or more is rounded up to the next full year for the purpose of this calculation.

Worked Example

Suppose an employee's last drawn basic salary + DA is ₹45,000, and they have completed 12 years and 7 months of continuous service. Since 7 months is more than 6 months, it rounds up to 13 years.

So this employee would be entitled to approximately ₹4,38,750 in gratuity, subject to the maximum ceiling discussed below.

Covered vs Non-Covered Establishments

Not every organisation falls under the Payment of Gratuity Act in the same way, and this affects the exact formula used:

• Covered establishments: Factories, mines, plantations, ports, railway companies, shops, and establishments employing 10 or more people on any day in the preceding 12 months. These follow the standard "15/26" formula shown above.
• Non-covered establishments: Employers not covered under the Act (smaller organisations that fall below the employee threshold) may still choose to pay gratuity voluntarily, but the formula used is often slightly different: (15 × last drawn salary × years of service) ÷ 30, using 30 days per month instead of 26. This generally results in a marginally lower payout for the same tenure and salary.

It's worth confirming with your HR team which category your employer falls under, since this directly affects your final payout.

Tax Exemption on Gratuity

Gratuity received is exempt from income tax up to certain limits under Section 10(10) of the Income Tax Act, and the limit depends on your employment type:

• Government employees: Gratuity received is fully exempt from tax, with no upper ceiling.
• Non-government employees covered under the Gratuity Act: Exempt up to the least of (a) actual gratuity received, (b) ₹20,00,000 (the current statutory ceiling), or (c) the amount calculated using the 15/26 formula above.
• Non-government employees not covered under the Act: Exempt up to the least of (a) actual gratuity received, (b) ₹20,00,000, or (c) half a month's average salary (last 10 months) for each completed year of service.

Any amount received above these limits is added to your taxable salary income and taxed as per your applicable slab rate in that financial year.

Frequently Asked Questions

Q: Can an employer refuse to pay gratuity even after 5 years of service?
A: Generally no, except in specific cases of proven misconduct involving moral turpitude or acts causing loss to the employer, where the Act allows forfeiture of gratuity (wholly or partially) after due process.

Q: Is gratuity paid on basic salary or full CTC?
A: It is calculated only on basic salary plus dearness allowance, not on your full cost-to-company figure, which usually also includes HRA, special allowances, and other components.

Q: What happens to gratuity if I switch jobs before completing 5 years?
A: In most cases, you forfeit eligibility entirely — the 5-year continuous service requirement is not transferable between employers, so job-hoppers frequently miss out on gratuity altogether.

Q: Is there a maximum gratuity amount an employer must pay?
A: Yes, the statutory ceiling is currently ₹20,00,000 across your entire career for tax-exemption purposes, though some employers voluntarily pay higher amounts as per internal policy — any excess above the exempt limit becomes taxable.

Q: Does gratuity apply to contract or temporary employees?
A: If a contract or temporary employee completes 5 years of continuous service with the same employer (through the principal employer, in many contract-labour arrangements), they are generally entitled to gratuity just like permanent employees, subject to the specific terms of their engagement.

Calculate Your Gratuity Instantly

Rather than doing the maths by hand, use our free Gratuity Calculator to enter your last drawn salary and years of service and instantly see your estimated gratuity amount along with the tax-exempt portion.