Gratuity Calculation Formula: Eligibility, Examples and Tax Under the New Labour Codes

Quick answer: gratuity = last drawn basic pay plus DA × 15 × years of service ÷ 26. An employee with ₹50,000 basic and 7 years' service gets ₹2,01,923. Permanent employees need 5 years of continuous service; fixed-term employees qualify after 1 year under the Code on Social Security. Private-sector employees can receive up to ₹20 lakh tax-free.

Check your own figure with the gratuity calculator. This guide explains the formula, the eligibility rules after the labour codes, and the details that cause disputes at full and final settlement.

What gratuity is

Gratuity is a lump sum an employer pays to thank an employee for long service. For decades it was governed by the Payment of Gratuity Act, 1972. From 21 November 2025 it sits within the Code on Social Security, 2020, which kept the core formula but widened eligibility and changed how wages are defined.

It applies to establishments with 10 or more employees. Once an establishment is covered, it stays covered even if headcount later falls.

The formula, explained

For each completed year of service, the employee earns 15 days of wages. Because a month is treated as 26 working days (excluding four Sundays), the daily wage is monthly wages ÷ 26.

Gratuity = monthly wages × 15 ÷ 26 × years of service

Monthly wages means the last drawn basic pay plus dearness allowance. For piece-rated workers, it is the average of the last three months.

Examples

A quick way to remember it: each year of service is worth a little over half a month's basic pay (15 ÷ 26 = 0.577).

How service is counted

• Part years: in the final year, a period of more than six months counts as a full year. 5 years 7 months becomes 6 years; 5 years 6 months stays at 5.
• Continuous service: includes periods of sickness, accident, authorised leave, lay-off, strikes that are not illegal and interruptions not caused by the employee.
• Just short of five years: several High Courts have held that an employee who worked 240 days in the fifth year has completed five years of continuous service. Employers should check the position that applies to them rather than rejecting such claims automatically.

Eligibility after the labour codes

The one-year rule for fixed-term employees is the biggest change for employers who use contract hiring. A person on a 14-month fixed-term contract now receives gratuity when it ends.

The 50% wage rule

The labour codes use a single definition of wages. Basic pay, DA and retaining allowance are wages. HRA, conveyance, overtime, bonus, commission and employer PF contributions are excluded, but if these exclusions add up to more than 50% of total remuneration, the excess is treated as wages.

Example: total monthly pay is ₹1,00,000, of which basic is ₹35,000 and allowances ₹65,000. Allowances exceed half of total pay by ₹15,000, so wages for gratuity become ₹50,000. After 8 years, gratuity rises from ₹1,61,538 to ₹2,30,769.

This is why many companies restructured salaries so basic is at least half of CTC. The in-hand salary calculator shows the effect on monthly take-home.

Employers not covered by the law

Smaller establishments that are not covered may still pay gratuity under their own policy or employment contract. The customary formula uses a 30-day month and counts only completed years: wages × 15 × completed years ÷ 30. The tax exemption for this category is capped at half a month's average salary (of the last 10 months) for each completed year, subject to the same ₹20 lakh limit.

Tax on gratuity

The ₹20 lakh limit is for your whole career. If you claimed an exemption with an earlier employer, only the balance is available now. The taxable part is added to salary income in the year you receive it. Gratuity received by a nominee after an employee's death is not taxed as salary.

Payment timelines and interest

Gratuity becomes payable when employment ends. The employee (or nominee) applies, usually within 30 days, although late applications cannot be rejected for delay alone. The employer must pay within 30 days of it becoming payable. If it pays late, simple interest is due from the date it became payable. Disputes go to the controlling authority under the law.

Nomination

Employees should file a nomination soon after completing a year of service. If the employee has a family, the nomination must be in favour of one or more family members. Keeping nominations current avoids long delays for families at an already difficult time.

Funding gratuity as an employer

Gratuity is a long-term liability that grows with every salary increase. Most companies either:

1. Provide for it in the books using an actuarial valuation each year, or
2. Fund it through a group gratuity scheme with an insurer, which also offers a tax deduction for contributions to an approved fund.

Either way, the numbers depend on accurate service dates and salary history.

Full and final settlement checklist

When an employee leaves, gratuity is only one line. A complete settlement usually includes:

• Salary for days worked in the final month
• Leave encashment for unused earned leave
• Gratuity, if eligible
• Bonus or incentives due
• Recovery of notice pay shortfall, advances or assets
• Experience letter and relieving letter

MizUp BMS stores joining dates, salary structures and leave balances in one place, so HR can calculate settlements quickly and explain every figure to the employee.

Frequently asked questions