An employee walks into your cabin, hands in her resignation, and asks one question before she even talks about her notice period: “Bhaiya, gratuity kitni banegi?” You open Excel, pull up the CTC sheet, and realise the basic salary field she was hired on in 2021 doesn’t match what the new wage rules say her “wages” should be for gratuity purposes. Now you’re not just calculating a number — you’re second-guessing whether your formula itself is still correct.
This happens in almost every HR office in India right now. The gratuity calculator math itself hasn’t changed, but what counts as “salary” for that math has — and most payroll teams haven’t updated their sheets to reflect it. This guide walks you through the gratuity formula, the new wage-definition twist under the labour codes, nomination and forfeiture rules that rarely get talked about, and the mistakes that get HR managers into trouble.
TL;DR
- Gratuity = (15 × Last Drawn Wages × Completed Years of Service) ÷ 26, capped at ₹20 lakh under the Payment of Gratuity Act, 1972.
- Under the new labour codes (effective 21 November 2025), if allowances exceed 50% of total remuneration, the excess is added back to “wages” — which can push your gratuity liability up.
- Fixed-term employees now qualify for pro-rata gratuity after just 1 year, not the usual 5.
- Gratuity can be forfeited under Section 4(6) only for specific misconduct — and only after a show-cause notice, never automatically.
What Is Gratuity, Exactly?
Gratuity is a lump-sum, statutory reward an employer pays an employee for continuous service, governed in India by the Payment of Gratuity Act, 1972 (now folded into the Code on Social Security, 2020). It isn’t a bonus, and it isn’t optional — if your establishment employs 10 or more people, you’re covered whether you like it or not. Think of it as the law’s way of saying “thank you for sticking around,” paid out on resignation, retirement, superannuation, death, or disablement.
Most HR teams run this number manually once or twice a year, get it slightly wrong, and only find out during a full and final settlement dispute. Using a free gratuity calculator removes that guesswork — but only if you feed it the correct inputs, which is where this article earns its keep.
The Gratuity Formula, With a Worked Example
For employees covered under the Act, the formula is:
Gratuity = (15 × Last Drawn Wages × Completed Years of Service) ÷ 26
Here, “last drawn wages” means basic salary plus dearness allowance — nothing else, in the traditional reading. “26” represents working days in a month (Saturdays excluded), and “15” is the number of days’ wages paid per year of service.
Example
Suppose Meena worked for 7 years and 8 months, with a last drawn basic + DA of ₹42,000/month. Since she crossed 6 months in her final year, it rounds up to 8 years of service.
Gratuity = (15 × 42,000 × 8) ÷ 26 = ₹1,93,846
Run the same numbers through the EZHRM gratuity calculator and you get the answer in seconds, with the rounding rule applied automatically — no argument with the employee over whether 7 years 8 months counts as 7 or 8.
Eligibility: The 5-Year Rule (and Its Exceptions)
An employee becomes eligible for gratuity after completing 5 years of continuous service with the same employer. But there are three situations where this rule doesn’t apply:
- Death of the employee — gratuity is paid to the nominee or legal heir regardless of tenure.
- Disablement due to accident or disease — full gratuity is payable even if service is less than 5 years.
- Fixed-term employees under the new labour codes — eligible for pro-rata gratuity after just 1 year of continuous service under the contract, a genuinely new provision that most SMEs haven’t updated their contracts for yet.
“Continuous service” also has its own definition — an employee doesn’t lose eligibility just because they took approved leave, were on strike (lawfully), or were laid off temporarily. If your attendance and leave records aren’t clean, this is exactly the kind of dispute that ends up at a labour commissioner’s desk. Tightening this up is a lot easier when your leave management and payroll data live in one system instead of three spreadsheets.
New Wage Rules: Why Your Gratuity Base Might Have Just Gone Up
This is the part most payroll teams are still catching up on. The labour codes commenced on 21 November 2025, and the Ministry of Labour & Employment has confirmed that gratuity calculations follow the revised definition of “wages” from that date.
Under the new definition, wages are inclusive by default — everything you pay an employee counts as wages unless it falls under one of eleven specific exclusions (like PF employer contribution, bonus, or conveyance allowance beyond a limit). But here’s the catch that actually matters for gratuity: if the excluded components add up to more than 50% of an employee’s total remuneration, the excess gets added back to wages.
In plain terms: if you’ve been structuring CTC with a low basic (say 30%) and stuffing the rest into HRA, special allowance, and other heads to save on PF and gratuity contributions, that trick no longer fully works. The “notional wage” used for gratuity will now be higher than your basic + DA line on the payslip.
| Component | Old Practice (Pre-Nov 2025) | Under New Labour Codes |
|---|---|---|
| Basic + DA share of CTC | Often 30–35% | Must effectively be ≥50% for gratuity/PF base |
| Gratuity calculation base | Basic + DA only, as structured | Basic + DA, topped up if allowances exceeded 50% cap |
| Fixed-term employee eligibility | 5 years, same as permanent staff | Pro-rata gratuity after 1 year |
| Gratuity ceiling | ₹20 lakh (since 2018) | Unchanged at ₹20 lakh |
If you haven’t re-run your CTC structures against this rule, do it before your next round of full and final settlements — not after an employee’s lawyer does it for you. Our CTC salary calculator is a quick way to sanity-check whether your current basic-to-CTC ratio still holds up.
Nomination: Why Form F Matters More Than Your Onboarding Checklist
Every employee who has completed one year of service is required to file Form F — the gratuity nomination form — naming who should receive the gratuity amount in case of their death. Most SMEs skip this entirely, treating it as optional paperwork. It isn’t.
Without a valid Form F on record, a gratuity claim after an employee’s death can drag on for months while the employer figures out who the rightful nominee or legal heir is — sometimes involving succession certificates and family disputes that have nothing to do with HR but land on your desk anyway. Build Form F collection into your employee onboarding workflow at the one-year mark, not as an afterthought during an exit.
Forfeiture: When Can You Legally Withhold Gratuity?
HR managers sometimes assume gratuity can be withheld whenever an employee is terminated “for cause.” That’s not how Section 4(6) of the Act works. Gratuity can be wholly or partially forfeited only if:
- The employee’s services were terminated for riotous or disorderly conduct, or any act of violence, or
- The termination was for an offence involving moral turpitude, committed in the course of employment.
Even then, forfeiture isn’t automatic — the employer must issue a show-cause notice and give the employee a chance to respond before withholding any amount. Skipping this step is one of the fastest ways to lose a case at the labour court, gratuity dues plus interest, and your legal fees on top.
What HR Managers Get Wrong
- Using CTC instead of basic + DA in the formula — inflates or deflates the number and creates disputes at exit.
- Forgetting the 50% wage rule post-November 2025, understating the gratuity base for employees with heavily loaded allowances.
- Rounding service period incorrectly — anything over 6 months in the final year should round up to the next full year; many payroll sheets don’t do this consistently.
- Treating gratuity trusts as “set and forget” — if you fund gratuity through an LIC group scheme or private trust, the trust’s actuarial valuation needs to reflect the new wage base too.
- Withholding gratuity informally during a dispute without following the Section 4(6) show-cause process.
- Not filing Form F at the one-year mark, leaving nomination details missing when they’re needed most.
Frequently Asked Questions
Is gratuity taxable in India?
For private-sector employees covered under the Payment of Gratuity Act, gratuity is exempt under Section 10(10) of the Income Tax Act up to the least of: actual gratuity received, ₹20 lakh, or 15/26 × last drawn salary × years of service. Amounts above this are taxed as salary income.
Can an employee get gratuity before completing 5 years?
Only in cases of death or disablement, where the 5-year rule doesn’t apply, and for fixed-term employees, who now qualify for pro-rata gratuity after 1 year under the new labour codes.
Does gratuity apply to companies with fewer than 10 employees?
The Act applies to establishments with 10 or more employees on any day in the preceding 12 months. Once covered, the employer stays covered even if headcount later drops below 10.
What counts as “wages” for gratuity after the labour codes?
Basic pay and dearness allowance, plus any amount by which excluded allowances (HRA, conveyance, special allowance, etc.) exceed 50% of total remuneration — that excess is added back to the wage base used for gratuity.
Who receives gratuity if an employee dies without filing Form F?
It goes to the legal heirs as per succession law, which typically takes longer and may require legal documentation like a succession certificate — one more reason to collect Form F proactively.
Can gratuity be paid in instalments?
No. The Act requires gratuity to be paid within 30 days of it becoming payable, as a lump sum. Delayed payment attracts interest, payable by the employer.
Getting This Right, Every Time
Gratuity math looks simple until you factor in rounding rules, the new wage definition, nomination gaps, and forfeiture procedure — and then it’s exactly the kind of thing that turns into a legal notice if handled casually. Run your numbers through EZHRM’s free gratuity calculator before your next exit, and if you’d rather not track wage-rule changes manually every time the law shifts, that’s precisely what our compliance management module is built for. For more HR guides like this one, browse the EZHRM blog, or explore our full set of free HR calculators — including the Full & Final Settlement Calculator and Leave Encashment Calculator — for the rest of your exit-process math.
Sources: Ministry of Labour & Employment, Income Tax Department.