You’re processing a resignation. The employee has been with you for nine years. Before you can close the Full & Final, you need to confirm one number — the gratuity amount. Do you use Basic alone? Basic + DA? Which divisor — 26 or 30? And what happens if they worked 8 years and 7 months — is that 8 years or 9?
If you’ve ever paused on any of those questions, you’re not alone. Gratuity is one of those calculations that looks simple on the surface but trips up HR managers regularly — especially in small and mid-sized companies where there’s no dedicated payroll team. This guide walks you through everything: the formula, eligibility rules, tax treatment, worked examples, and the mistakes you want to avoid before they become a legal headache.
- Gratuity kicks in after 5 continuous years of service with the same employer (or earlier in case of death/disablement).
- Formula for covered employers: (Basic + DA) × 15 ÷ 26 × Years of Service.
- Tax-free up to ₹20 lakh for private sector employees under Section 10(10) of the Income Tax Act.
- Employers must pay within 30 days of the date gratuity becomes payable — delay attracts interest.
What Is Gratuity? A Plain-Language Definition
Gratuity is a statutory retirement benefit paid by an employer to an employee in recognition of long service. Under the Payment of Gratuity Act 1972, any establishment with 10 or more employees is required to pay gratuity when an eligible employee leaves — whether through resignation, retirement, retrenchment, death, or disablement. It is a one-time lump sum, not a monthly payout.
Think of it as the company’s acknowledgment that this person gave you a significant chunk of their working life. The law ensures they leave with something tangible to show for it.
Who Is Eligible for Gratuity in India?
Eligibility for gratuity hinges on three conditions — all of which must be satisfied together.
1. Minimum 5 Years of Continuous Service
The employee must have worked continuously for at least five years with the same employer. The Supreme Court has clarified that “continuous service” includes authorised leave, temporary layoffs, and strikes — breaks in service due to the employer’s own actions do not disqualify an employee.
The five-year rule has one important exception: if the employee dies or suffers a permanent total disablement, gratuity is paid to the nominee or legal heir regardless of how many years of service the person had completed.
2. The Employer Must Be a Covered Establishment
The Payment of Gratuity Act applies to factories, mines, oilfields, plantations, ports, railways, shops, and other establishments that employ 10 or more people on any day during the preceding 12 months. Once covered, the Act continues to apply even if the headcount later drops below 10.
3. Termination Must Be Due to a Covered Reason
Gratuity is payable on resignation (after 5 years), retirement or superannuation, retrenchment, death, or permanent disablement. An employer can legally forfeit gratuity only if an employee is terminated for misconduct that caused damage to property — and even then, forfeiture is capped at the actual damage amount.
The Gratuity Formula — Which One Applies to Your Employee?
There are two versions of the gratuity formula. Which one you use depends on whether the organisation is “covered” under the Payment of Gratuity Act.
| Employer Type | Formula | Divisor Logic |
|---|---|---|
| Covered (10+ employees) | (Basic + DA) × 15 ÷ 26 × Years | 26 = average paid working days/month |
| Not Covered (<10 employees) | (Basic + DA) × 15 ÷ 30 × Years | 30 = calendar days/month |
The “15” in both formulas represents 15 days’ salary per year of service — roughly half a month’s pay for every year you worked.
The Rounding Rule for Months
This is the one that catches people out most often. If the employee’s service in the last incomplete year is 6 months or more, you round up to the next full year. If it’s 5 months or fewer, you stay at the completed years.
So 8 years 7 months = 9 years for gratuity purposes. 8 years 4 months = 8 years. Getting this wrong changes the payout amount and exposes you to a valid legal claim from the employee.
What Goes Into “Basic + DA”?
Only Basic Salary and Dearness Allowance are included in the gratuity base. HRA, conveyance allowance, special allowance, LTA, medical reimbursement, bonus, and all other CTC components are explicitly excluded. Most private sector companies pay zero DA, so the gratuity base is usually just the Basic figure from the last payslip.
Worked Examples: Gratuity Calculation Step by Step
Let’s run through three scenarios you’re likely to encounter. You can verify all of these — and calculate for your own employees — using the free gratuity calculator on EZHRM.
Example 1: Standard Private Sector Employee
Basic salary: ₹45,000/month | DA: ₹0 | Service: 7 years 3 months | Covered employer
Effective years = 7 (since 3 months < 6)
Gratuity = ₹45,000 × 15 ÷ 26 × 7 = ₹1,82,692
Tax: Fully exempt (well under ₹20 lakh).
Example 2: Rounding Up Effect
Basic salary: ₹60,000/month | DA: ₹0 | Service: 9 years 8 months | Covered employer
Effective years = 10 (8 months ≥ 6, so rounds up)
Gratuity = ₹60,000 × 15 ÷ 26 × 10 = ₹3,46,154
Compare with 9 years (not rounding): ₹3,11,538. The rounding difference is ₹34,616 — real money that an employee is legally entitled to.
Example 3: Senior Manager Approaching the ₹20 Lakh Cap
Basic salary: ₹1,80,000/month | DA: ₹0 | Service: 22 years | Covered employer
Gratuity = ₹1,80,000 × 15 ÷ 26 × 22 = ₹22,84,615
Tax: ₹20,00,000 is fully exempt; the remaining ₹2,84,615 is taxable as salary income in the year of receipt. HR needs to reflect this correctly in the Full & Final TDS calculation.
| Basic + DA | Service | Effective Yrs | Gratuity | Taxable Amount |
|---|---|---|---|---|
| ₹30,000 | 7 yrs | 7 | ₹1,21,154 | Nil |
| ₹50,000 | 10 yrs | 10 | ₹2,88,462 | Nil |
| ₹1,00,000 | 15 yrs | 15 | ₹8,65,385 | Nil |
| ₹1,80,000 | 22 yrs | 22 | ₹22,84,615 | ₹2,84,615 |
| ₹2,00,000 | 25 yrs | 25 | ₹28,84,615 | ₹8,84,615 |
Tax Treatment of Gratuity Under Section 10(10)
The tax rules around gratuity depend entirely on whether the employee is a government employee or a private sector employee.
Private Sector Employees
Gratuity received is exempt from income tax up to ₹20 lakh (enhanced from ₹10 lakh in 2019). This limit is per employer — so if an employee has received gratuity from previous employers in their career, the ₹20 lakh is a lifetime aggregate limit across all employers. The exemption is the least of: the actual gratuity received, ₹20 lakh, or the formula-calculated amount. Practically, if you’re paying exactly what the Act mandates, the full amount up to ₹20 lakh is exempt.
Government Employees
Central and state government employees and employees of local authorities receive a full exemption — no upper limit. The entire gratuity is tax-free regardless of the amount.
Gratuity Received on Death
When gratuity is paid to a nominee or legal heir after the death of an employee, it is fully exempt from income tax in the hands of the recipient — no ceiling applies.
For the detailed tax filing rules, refer to the Income Tax portal (incometax.gov.in) or your CA. And when processing the Full & Final, the Full & Final Settlement Calculator lets you combine gratuity with earned leave encashment and other dues — with TDS computed correctly.
Gratuity vs Leave Encashment: How They Interact in F&F
When an employee exits, you’re usually calculating gratuity and leave encashment at the same time. These are two separate statutory benefits with different rules — don’t mix up the formulas.
Key Differences
| Parameter | Gratuity | Leave Encashment |
|---|---|---|
| Act | Payment of Gratuity Act 1972 | State Shops & Establishments / Co. Policy |
| Eligibility | 5 years continuous service | Accumulated earned/privilege leaves |
| Base | Basic + DA only | Basic + DA (or Gross, per policy) |
| Formula | (Basic+DA) × 15/26 × Years | (Basic+DA) ÷ 26 × Leaves pending |
| Tax-free limit | ₹20 lakh (private sector) | ₹25 lakh (private sector, at retirement) |
Both are paid together at exit but calculated independently. Use the Leave Encashment Calculator to get that number right before combining it in the Final Settlement. You can also explore all our free HR calculators to cover every component of F&F without a spreadsheet.
What HR Managers Get Wrong About Gratuity
After working with hundreds of Indian SMEs, these are the most frequent gratuity mistakes we see:
- Using Gross Salary instead of Basic + DA. This is the single most common error. If an employee’s gross is ₹80,000 but their basic is ₹40,000, using gross inflates the gratuity by 2x. Always pull the basic from the payslip, not the offer letter CTC.
- Forgetting the rounding rule. As shown in Example 2 above, rounding down when you should round up can cost an employee tens of thousands of rupees — and creates legal exposure. When in doubt: if last-year months ≥ 6, round up.
- Using the wrong divisor. Small companies with fewer than 10 employees are “not covered” and should use 30 as the divisor, not 26. Many use 26 out of habit, which underpays the employee.
- Ignoring the 30-day payment deadline. Gratuity must be paid within 30 days of it becoming payable. Delay beyond that attracts simple interest — and repeated delays can trigger complaints to the Controlling Authority under the Act.
- Not provisioning gratuity monthly. Gratuity isn’t a surprise at exit — it accrues every month. HR teams that don’t provision monthly get caught off-guard when multiple long-service employees leave in the same quarter. A monthly provision of approximately 4.81% of Basic + DA is the standard approach.
How to Provision Gratuity Every Month
The formula to arrive at monthly gratuity provision is derived from the annual formula:
Annual gratuity accrual per employee = (Basic + DA) × 15 ÷ 26 = (Basic + DA) × 0.5769
Monthly provision = Annual accrual ÷ 12 = (Basic + DA) × 4.81%
So an employee with a Basic of ₹50,000 accrues ₹2,404 of gratuity liability for your company every month they work. Multiply this across your headcount and you’ll quickly see why gratuity provisioning is a material line item — one that needs to be tracked in your payroll system rather than remembered at year-end.
Many companies also opt for a Group Gratuity Scheme from an insurer (LIC, SBI Life, HDFC Life) where premiums fund future payouts — a smart move for companies with 25+ employees. For more on how payroll compliance fits into the bigger picture, the Statutory Compliance module in EZHRM handles gratuity provisioning alongside PF, ESI, and PT in one place.
FAQ: Gratuity Calculator India 2026
Can an employer pay more than the formula amount?
Yes, absolutely. The Payment of Gratuity Act sets the minimum payable. Many companies — especially in IT and financial services — pay ex-gratia gratuity above the statutory floor as a retention or goodwill gesture. The tax-exempt ceiling of ₹20 lakh still applies; any excess is taxable regardless of why it was paid.
Does gratuity apply to contract and fixed-term employees?
This is a grey area that has evolved through court judgments. If a fixed-term employee completes 5 years of service (renewals counted), they are eligible for gratuity. The 2018 amendment to the Code on Industrial Relations clarified that fixed-term workers should receive proportionate gratuity — though full implementation depends on state-level rules. Consult your labour lawyer for ongoing contract workers.
What if an employee resigns after exactly 4 years 10 months?
They are not eligible for statutory gratuity. You need 5 full years. 4 years 10 months does not meet the minimum threshold. (Note: the rounding rule only applies within each year once the 5-year threshold is crossed, not to the eligibility threshold itself.) The employer can choose to pay ex-gratia as a goodwill gesture, but is not legally required to.
Can an employee nominate someone to receive their gratuity?
Yes, and they should. The Act requires employees to file a nomination in Form F within 30 days of completing one year of service (or at the time of joining if they’re already over 18). If the employee dies without a valid nomination, gratuity is paid to the legal heirs — which can mean delays and paperwork. HR teams should remind employees to update nominations after marriage, divorce, or the birth of a child.
Is gratuity compulsory for startups and LLPs?
If your startup, LLP, or private limited company employs 10 or more people — even for a single day in the past year — you are covered by the Payment of Gratuity Act. The entity type (Pvt Ltd, LLP, OPC, etc.) doesn’t matter. Many first-time founders discover this liability only when an early employee resigns — by which point arrears may have accumulated for years.
Where can I verify the official Payment of Gratuity Act rules?
The full text of the Act and its amendments are available at the Ministry of Labour & Employment website (labour.gov.in). For FY 2026-27 TDS treatment on gratuity, refer to the Income Tax Department’s publications on Section 10(10).
Getting gratuity right is one of those things where a 10-minute check today saves an angry phone call — or worse, a complaint to the labour office — three months later. Use the EZHRM Gratuity Calculator to verify any calculation before it goes into the Full & Final statement. And if you’d like to see how EZHRM auto-calculates gratuity, leave encashment, and notice period recovery in one integrated F&F workflow — without a single spreadsheet — drop us a line and we’ll show you a quick demo. More HR guides like this are on the EZHRM blog.