Gratuity is a lump sum an employer pays when an employee leaves after long service. Since the four Labour Codes came into force on 21 November 2025, gratuity is governed by the Code on Social Security, 2020 (replacing the Payment of Gratuity Act, 1972) — and two changes matter for most employers: a new definition of wages, and eligibility after one year for fixed-term employees.
The gratuity formula
- 15 days’ wages per year — the monthly wage is divided by 26 (working days) and multiplied by 15.
- Years of service — every completed year, plus one more for a part-year of more than six months.
- Last drawn wages — the wages at the time the employee leaves, not an average.
- Cap — ₹20 lakh for private-sector employees; an employer can choose to pay more.
What counts as “wages” now
Under the Labour Codes, wages mean basic pay + dearness allowance + retaining allowance. Allowances such as HRA, conveyance and statutory bonus are excluded — but if the excluded parts add up to more than 50% of total remuneration, the excess is added back into wages. In practice, wages for gratuity are at least half of total pay.
The Labour Ministry has clarified that gratuity on the revised wage definition applies from 21.11.2025, and that annual performance incentives are not part of wages.
Example of the 50% rule
| Monthly pay | Amount |
|---|---|
| Basic + DA | ₹30,000 |
| HRA and other allowances | ₹70,000 |
| Total remuneration | ₹1,00,000 |
| Excluded parts above 50% (₹70,000 − ₹50,000), added back | ₹20,000 |
| Wages for gratuity | ₹50,000 |
For 10 years of service, gratuity would be ₹50,000 × 15 ÷ 26 × 10 = ₹2,88,462, against ₹1,73,077 if it were worked out on Basic + DA of ₹30,000 alone. That is why many employers are reviewing salary structures.
Worked example
An employee leaves after 7 years and 8 months with last drawn wages of ₹40,000 a month. The 8 months are more than six, so service counts as 8 years:
₹40,000 × 15 ÷ 26 × 8 = ₹1,84,615
Gratuity calculator
Who is eligible
- Permanent employees — after five years of continuous service.
- On death or disablement — the five-year condition does not apply.
- Fixed-term employees — after one year of service under their contract, paid pro rata. This applies to people employed directly, not contract labour through a contractor.
- Contract labour — the contractor, as their employer, pays gratuity after five years of continuous service.
Tax on gratuity
For private-sector employees, gratuity is tax-free up to ₹20 lakh over their working life. Anything above that is taxable as salary. Leave encashment at retirement or resignation has its own, separate limit of ₹25 lakh.
Gratuity is usually paid as part of the full and final settlement, along with unpaid salary and leave encashment.
Sources
- Ministry of Labour & Employment — Additional FAQs on Labour Codes (as on 16.03.2026)
- Code on Social Security, 2020 — Section 53 (Indian Kanoon)
- KPMG — Implementation of the Labour Codes
- Fisher Phillips — India’s new Labour Codes expand gratuity rules
This guide is general information to help HR and payroll teams, not legal or tax advice. Rules change and can depend on your circumstances — confirm with the official source or your consultant before acting on it.