An HR manager at a Gurugram auto-components plant called me last month with a spreadsheet that had stopped making sense. Her gratuity provision for FY 2026–27 had jumped by nearly a quarter and nobody in finance could explain it — salaries hadn’t moved, headcount hadn’t moved. What had moved was the definition of “wages.” If your gratuity numbers look odd this year, the new gratuity rules in India for 2026 are almost certainly why.
The four labour codes came into force on 21 November 2025, and gratuity is one of the areas they touched hardest. Three things changed: the wage base used in the formula, the eligibility clock for fixed-term staff, and who carries the liability for contract labour. The 15/26 arithmetic itself didn’t change at all — which is exactly why so many payroll teams missed the shift. Run your own numbers through EZHRM’s free Gratuity Calculator as you read, and you’ll see the gap immediately.
TL;DR
- Gratuity is now calculated on the revised definition of wages under Section 2(88) of the Code on Social Security, 2020 — effective 21 November 2025, confirmed by the Ministry of Labour & Employment.
- If your excluded allowances exceed 50% of total remuneration, the excess gets added back to the wage base. For most Indian SME salary structures, that pushes gratuity payouts up by 20–30%.
- Fixed-term employees now qualify for gratuity after one year of service under the contract — not five. This applies only to directly engaged FTEs, not contract labour through a contractor.
- The formula, the 5-year rule for permanent staff, and the ₹20 lakh tax exemption under Section 10(10) all stay exactly as they were.
What Actually Changed on 21 November 2025
The new gratuity rules in India for 2026 are not a rewrite of the Payment of Gratuity Act’s logic — they redefine the inputs that feed it. Gratuity is still 15 days’ wages per completed year, divided by 26. What changed is what “wages” means, who qualifies, and who pays.
The Ministry of Labour & Employment has been unusually direct here. In its Additional FAQs on the Labour Codes dated 16 March 2026, it confirmed that gratuity on the revised wage definition applies from 21 November 2025, and that the change is prospective — it does not reopen settlements completed before that date.
Here is the part that catches finance teams off guard: an employee exiting on or after that date is paid on wages last drawn at exit, as per the Code. There is no split calculation valuing pre-code service at the old base and post-code service at the new one. Your entire liability for every serving employee now sits on the wider base.
Change 1: The Wage Base Got Wider — and Gratuity Got Costlier
Under the Code on Wages, 2019, “wages” means basic pay, dearness allowance and retaining allowance, excluding HRA, conveyance and most special allowances. The catch is the proviso: if those excluded components exceed 50% of total remuneration, the excess is added back to wages.
The 50% rule in plain terms
Most Indian SMEs have kept basic at 30–40% of gross to hold down PF and gratuity costs. That structure now fails the test, and the shortfall is pulled back into the wage base automatically. A worked example on monthly remuneration of ₹50,400:
| Component | Monthly amount | Counts as “wages”? |
|---|---|---|
| Basic pay | ₹20,000 | Yes |
| Dearness allowance | ₹0 | Yes |
| House rent allowance | ₹10,000 | Excluded |
| Conveyance allowance | ₹2,000 | Excluded |
| Special allowance | ₹16,000 | Excluded |
| Employer PF contribution | ₹2,400 | Excluded, but counts in total remuneration |
| Total remuneration | ₹50,400 | — |
Wages under the included heads come to ₹20,000, or 39.7% of remuneration. The 50% floor is ₹25,200, so ₹5,200 is added back. Revised wages for gratuity: ₹25,200.
For an employee with 10 completed years, the difference is stark:
- Old basis: ₹20,000 × 15 × 10 ÷ 26 = ₹1,15,385
- New basis: ₹25,200 × 15 × 10 ÷ 26 = ₹1,45,385
- Increase: ₹30,000 per employee — roughly 26%
Across a 200-person workforce with average tenure of six or seven years, that is a provisioning gap in the tens of lakhs. Re-run your long-tenure employees through the Gratuity Calculator on the revised base before the next actuarial valuation, not during it.
What counts, and what the Ministry says doesn’t
The March 2026 FAQs settled several arguments running since November. For the 50% threshold, employer PF and pension contributions and statutory bonus are included in total remuneration; gratuity, ESI and other retirement benefits are not. Overtime allowance is counted. Annual performance incentives are not wages. Remuneration in kind — food coupons, ration items, even mobile recharge given under the terms of employment — does count.
One limit worth knowing: any payment not listed in Section 2(88) of the Code on Social Security cannot be pulled into the gratuity calculation at all. The wage base is wider, not unlimited.
Change 2: Fixed-Term Employees Qualify After One Year
This one has the biggest operational bite for manufacturing, retail and logistics employers. Under Section 53 of the Code on Social Security, 2020, a fixed-term employee becomes eligible for gratuity on completing one year of service under the contract, measured from the contract start date.
The Ministry has confirmed two boundaries. An FTE engaged for 11 months and exiting at contract expiry does not qualify — the one-year mark has to be crossed. And fixed-term employment covers only employees directly engaged by the employer; workers supplied through a contractor are not FTEs.
If you run rolling 11-month contracts, be clear-eyed about it: you are managing a statutory boundary, and labour authorities know that pattern well. Renewing the same person on successive 11-month contracts invites scrutiny over whether the engagement was ever genuinely fixed-term. Price the gratuity in, or stop using FTEs for roles that are functionally permanent.
Change 3: Contract Labour Gratuity Sits With the Contractor
Section 53 places the gratuity obligation for contract labour on the contractor as employer, not the principal employer — at the standard five years of continuous service and 15 days’ wages per completed year, on last drawn wages.
That reads like relief if you are the principal employer. In practice it’s a due-diligence job. If your contractor is undercapitalised and defaults, you are the party your workers — and the Controlling Authority — will look at first. Build gratuity into contractor rate cards, ask for proof of provisioning at renewal, and keep engagement records for contract workers as carefully as your own.
What Didn’t Change
- The formula. Last drawn wages × 15 × completed years ÷ 26. Untouched.
- Five years for permanent employees. The one-year rule is specific to fixed-term staff.
- The ₹20 lakh tax exemption. Section 10(10) of the Income-tax Act still caps lifetime tax-free gratuity at ₹20 lakh across all employers — see the Income Tax Department.
- The 30-day payment window and 10% simple interest on delay.
- Death and disablement. The five-year condition still doesn’t apply in those cases.
What HR Managers Are Getting Wrong
Assuming the change is retrospective — or that it splits. It is prospective from 21 November 2025, but for anyone exiting after that date the whole tenure is valued on the new base. Both errors produce wrong numbers, in opposite directions.
Testing the 50% rule on gross salary alone. Employer PF and statutory bonus belong in total remuneration. Leave them out and you’ll under-add and underpay.
Treating CTC provisioning as compliance. The 4.81% gratuity line in a salary breakup is a costing convention. Section 4A insurance or an approved fund is the actual legal requirement.
Restructuring salary to dodge the rule. Raising the basic ratio is legitimate planning. Renaming allowances to escape the add-back is not — the Ministry’s clarification on remuneration in kind shows how little room there is for cleverness.
Recalculating gratuity but not PF or bonus. The same wage definition drives all three. If gratuity moved, check the others with the PF & ESI Calculator.
Your Six-Step Action Checklist
- Test every salary structure: do excluded allowances exceed 50% of total remuneration?
- Recompute gratuity liability on the revised wage base for everyone with a completed year.
- Flag fixed-term employees nearing 12 months and confirm the contract is genuinely fixed-term.
- Ask contractors in writing how they are funding gratuity for workers deployed at your site.
- Share the revised provisioning number with finance ahead of the next actuarial valuation.
- Verify your Section 4A gratuity insurance or approved fund is live and adequately funded for the higher liability.
FAQs
When did the new gratuity rules take effect in India?
The labour codes came into force on 21 November 2025, and the revised wage definition applies to gratuity from that date. The Ministry of Labour & Employment confirmed in its March 2026 FAQs that the change is prospective and does not reopen settlements completed before 21 November 2025.
Does the new wage definition make gratuity more expensive for employers?
Usually, yes. Where excluded allowances such as HRA and special allowance exceed 50% of total remuneration, the excess is added back to the wage base. For typical Indian SME salary structures with basic at 30–40% of gross, gratuity payouts rise by roughly 20–30%.
Do fixed-term employees really get gratuity after one year?
Yes. Under Section 53 of the Code on Social Security, 2020, a fixed-term employee who renders one year of service under the contract is eligible for gratuity. An FTE on an 11-month contract who exits at expiry does not qualify. The rule covers only directly engaged employees.
Who pays gratuity for contract labour — the contractor or the principal employer?
The contractor, as the employer, is liable under Section 53 — at five years of continuous service and 15 days’ wages per completed year. Principal employers should still verify that contractors are provisioning for it, since practical exposure tends to travel upward when a contractor defaults.
Has the ₹20 lakh gratuity tax exemption changed under the labour codes?
No. Section 10(10) of the Income-tax Act continues to exempt gratuity up to ₹20 lakh, and the ceiling applies cumulatively across an employee’s career. Anything above that is added to taxable salary in the year of receipt.
Is the gratuity formula itself different now?
No. It remains last drawn wages × 15 × completed years of service ÷ 26. Only the value plugged in for “wages” has changed, which is precisely why the shift is easy to miss on a payroll run.
If you haven’t re-run your gratuity provisioning since November, this week is a good time. Start with EZHRM’s free Gratuity Calculator, then check the knock-on effects with the Full & Final Settlement Calculator, the Leave Encashment Calculator and the CTC Salary Calculator, or browse the complete set of free HR calculators. EZHRM’s compliance management module applies the revised wage definition across gratuity, PF and bonus automatically, so your provisioning stays current without a quarterly spreadsheet rescue. For more HR guides, visit the EZHRM blog.