Gratuity is a statutory benefit every eligible employee in India is entitled to receive — but many employees either underestimate the amount or do not know how to verify what their employer has calculated. This guide walks through the eligibility check, the formula, a worked example, the ceiling, taxation rules, and edge cases so you can arrive at the correct figure yourself.
Use the Gratuity Calculator alongside this guide to verify your numbers instantly.
What You Need Before You Start
You only need two numbers:
- Last drawn basic salary + dearness allowance (DA) in rupees per month
- Total years of continuous service (including any partial year to be assessed for rounding)
Gratuity is not calculated on gross salary, CTC, HRA, special allowances, or bonuses. Only basic salary and dearness allowance enter the formula.
Step 1: Check Your Eligibility
Under the Payment of Gratuity Act 1972, you are eligible for gratuity if:
- Your employer has 10 or more employees (on any day in the preceding 12 months), and
- You have completed at least 5 years of continuous service with that employer.
Exceptions where the 5-year rule does not apply:
| Situation | Gratuity payable? |
|---|---|
| Death of the employee | Yes — paid to nominee regardless of tenure |
| Permanent disablement due to accident or disease | Yes — paid to employee regardless of tenure |
| Seasonal establishment employees | 5 seasons of service counts as 5 years |
Once an establishment is covered under the Act, all subsequent employees — including those who join after the headcount drops below 10 — remain covered.
Step 2: Apply the Formula
Gratuity = (15 ÷ 26) × Last Basic Salary (+ DA) × Years of Service
- 15 = days of salary per year of service that the Act mandates
- 26 = the number of working days assumed in a month (total calendar days minus 4 Sundays)
This is the formula prescribed by the Payment of Gratuity Act 1972. Some employers voluntarily offer a more generous formula — for example, using 30 instead of 26 — but the statutory minimum is always 15/26.
Step 3: Work Through an Example
Scenario: An employee retires after 12 years of service. Last drawn basic salary + DA = ₹60,000 per month.
Gratuity = (15 ÷ 26) × 60,000 × 12
= 0.5769 × 60,000 × 12
= 0.5769 × 7,20,000
= ₹4,15,384 (rounded to nearest rupee)
Cross-check this instantly with the Gratuity Calculator by entering basic + DA and years of service.
Step 4: Apply the Ceiling
The Payment of Gratuity Act caps the maximum gratuity at ₹20 lakh (updated in 2018 from the earlier limit of ₹10 lakh).
- If the formula produces ₹4,15,384 as above, the ceiling is irrelevant — pay ₹4,15,384.
- If the formula produces, say, ₹24,00,000, the employer pays ₹20,00,000, not the higher amount.
The ceiling applies to private sector employees covered under the Act. Central government employees follow a separate set of rules under the Central Civil Services (Pension) Rules where no such ceiling exists.
Step 5: Handle Partial Years Correctly
Only the portion of service beyond the last completed year is assessed for rounding. The rule is simple:
- 6 months or more beyond a completed year → round up to the next whole year
- Less than 6 months → count only the completed years
| Actual service | Rounded years used in formula |
|---|---|
| 12 years 8 months | 13 years |
| 12 years 4 months | 12 years |
| 7 years 6 months | 8 years |
| 7 years 5 months | 7 years |
Note: The 4.5-year question (4 years 6 months) has been ruled eligible by several High Courts since 6 months triggers rounding up to 5 years. If your employer disputes this, escalate to the Controlling Authority.
Step 6: Understand Taxation
Tax treatment depends on who your employer is:
Government employees (central, state, defence): Gratuity is fully exempt from income tax. No upper limit applies.
Private sector employees covered under the Act: The exempt amount is the lowest of:
- ₹20 lakh
- Actual gratuity received
- (15/26) × last basic salary + DA × completed years of service
Any gratuity received above this exempt amount is added to your income for the financial year and taxed at your applicable slab rate. Report it under "Income from Salaries" when filing your ITR. Check your Form 16 — your employer should reflect the exempt and taxable portions correctly.
Gratuity for Non-Act Companies
Companies with fewer than 10 employees are not legally bound by the Payment of Gratuity Act 1972. However, they may voluntarily pay gratuity — and most do, using the same 15/26 formula as a convention. If your employer is not covered under the Act, your gratuity rights rest on your employment contract or company policy rather than statute, so review those documents carefully.
Even for non-Act companies, the income tax exemption on gratuity still applies — the ₹20 lakh ceiling and the three-way minimum test remain operative for the purpose of computing exemption under Section 10(10) of the Income Tax Act.
Forfeiture of Gratuity
An employer can forfeit gratuity in two narrow situations under Section 4(6) of the Act:
- Loss caused by wilful omission or negligence: Forfeiture is limited to the actual financial loss suffered by the employer — they cannot forfeit the entire gratuity for a partial loss.
- Termination for misconduct involving moral turpitude: This covers offences such as theft, violence on premises, sexual harassment, or arson — not poor performance or routine disciplinary matters.
Resignation, redundancy, or business closure are not grounds for forfeiture.
Key Terms
- Gratuity — a statutory lump-sum benefit paid by an employer to a long-serving employee on exit from service
- Basic Salary — the fixed component of salary before allowances; the base for gratuity and PF calculations
- Dearness Allowance — a cost-of-living supplement linked to the consumer price index; included in the gratuity formula alongside basic salary
- CTC — Cost to Company; the total annual cost of an employee including all components; gratuity is calculated on basic + DA, not CTC