Gratuity is a statutory benefit every eligible employee in India is entitled to receive, yet many employees underestimate the amount or have no way to verify what their employer 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.
Run 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 isn't 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're 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 doesn't 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 falls under the Act, all subsequent employees, including those who join after the headcount drops below 10, stay 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 the Payment of Gratuity Act 1972 prescribes. Some employers voluntarily use a more generous version, say 30 instead of 26, but the statutory minimum stays at 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 doesn't matter here; pay ₹4,15,384.
- If the formula produces, say, ₹24,00,000, the employer pays ₹20,00,000 instead of 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 gets assessed for rounding. The rule is simple:
- 6 months or more beyond a completed year rounds up to the next whole year
- Less than 6 months counts 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 |
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. Escalate to the Controlling Authority if your employer disputes this.
Step 6: Understand Taxation
Tax treatment depends on who your employer is:
Government employees (central, state, defence): Gratuity is fully exempt from income tax, with no upper limit.
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
Anything above this exempt amount gets 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, and check your Form 16, since your employer should reflect the exempt and taxable portions correctly.
Gratuity for Non-Act Companies
Companies with fewer than 10 employees aren't legally bound by the Payment of Gratuity Act 1972. Many still pay gratuity voluntarily, usually following the same 15/26 formula as a convention. If your employer isn't covered under the Act, your gratuity rights rest on your employment contract or company policy rather than statute, so review those documents carefully.
The income tax exemption on gratuity still applies even for non-Act companies. The ₹20 lakh ceiling and the three-way minimum test remain in force for 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 can't 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 don't count as 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