Gratuity in India after the 2025 labour codes: 5-year vs 1-year eligibility, the 15/26 formula, the 50% wage rule and Rs 20 lakh tax cap.
The rules, formula, tax limit and employer cost at a glance.
Employer takeaway: gratuity may look like an exit-stage cost, but it needs to be built into workforce budgeting from the start.
Gratuity is a lump sum an employer in India must pay an employee when they leave, calculated as 15 days of wages for every completed year of service. It applies to every establishment with 10 or more employees. Permanent staff qualify after five years of continuous service. Fixed-term employees qualify after one year, on a pro-rata basis, following the four labour codes coming into force on 21 November 2025. The formula is last drawn wages multiplied by 15, divided by 26, multiplied by completed years. Wages means basic pay plus dearness allowance plus retaining allowance.
The statutory ceiling is Rs 20 lakh. For a foreign company hiring in India, gratuity is a real accruing liability from an employee’s first day, not a discretionary bonus, and it belongs in your fully loaded employee cost model at roughly 4.81% of annual basic pay.
What changed in 2026 is not the formula. It is the wage base the formula runs on, the eligibility floor for contract staff, and the statute the tax exemption now sits in. Most guidance still online was written against the 1972 Act and the Income-tax Act, 1961. Both have been superseded. This guide covers the current position for employers, plus the two disputes that generate the most litigation and the most confused payroll queries in India
Gratuity is a statutory terminal benefit owed by any establishment that employed 10 or more people on any day in the preceding 12 months. Once the threshold is crossed, the obligation is permanent: it does not lapse if headcount later drops below 10. It is payable on superannuation, retirement, resignation, death, or disablement due to accident or disease, and on completion of a fixed-term contract.
The Code on Social Security, 2020 absorbed the Payment of Gratuity Act, 1972 largely intact, so the core mechanics carry over. What is new is the extension of coverage to fixed-term employees, a broader statutory definition of wages, and a compulsory gratuity insurance requirement for private employers that takes effect from a date the government has yet to notify. Andhra Pradesh and Karnataka already had insurance rules in place and remain bound by them. If you are mapping the wider framework, our guide to India’s labour laws sets out how gratuity sits alongside EPF and ESIC employer contributions.
Both, depending on contract type. Permanent employees still need five years of continuous service. Fixed-term employees are entitled to gratuity on a pro-rata basis after one year of continuous service, payable when the contract term ends. The five-year threshold is waived entirely where employment ends through death or disablement.
No, and this is the single most widely repeated error in circulation. Headlines announcing “gratuity after 1 year in India” describe a change scoped to fixed-term employees, gig workers, and contract staff. A permanent employee who resigns at three years is entitled to nothing. Expect this question from every Indian hire who has read a news summary, and answer it in the offer letter rather than at exit.
This is genuinely unsettled, and employers should treat it as a risk item rather than a rule. The definition of continuous service treats 240 working days in a year as a full year for establishments working six days a week, and 190 days for five-day weeks. On that reading, an employee who completes four years plus 240 days in the fifth year has met the threshold. The Delhi, Madras, Kerala, and Punjab and Haryana High Courts have upheld that position. The Karnataka High Court, in a 2022 ruling, went the other way and required a full five years.
The formula is: Gratuity = Last drawn wages x 15 / 26 x completed years of service. The 26 represents working days in a month, the 15 represents half a month of pay for each year served. Service beyond six months in the final year rounds up to a full year, so 6 years and 7 months counts as 7. Seasonal establishments pay 7 days of wages per season, and piece-rated workers are paid on average wages across the three months before termination.
Wages means basic pay plus dearness allowance plus retaining allowance. It excludes HRA, conveyance, bonus, overtime, and commission. The change that matters is the 50% rule: excluded allowances cannot exceed 50% of total remuneration, and any excess is pulled back into wages for statutory calculation. Employers who historically set basic at 30% to 40% of CTC to suppress contributions no longer can.
Between 25% and 50%, depending on how low your basic was previously set. An employer moving basic from 40% to 50% of CTC sees a 25% rise. One moving from 33% sees a 50% rise. The worked example below uses an employee on Rs 12,00,000 CTC with six completed years of service, with basic moving from 40% to 50%.
| Component | Old structure (basic at 40%) |
New structure (basic at 50%) |
|---|---|---|
| Monthly basic + DA | Rs 40,000 | Rs 50,000 |
| Gratuity at 6 years | Rs 1,38,462 | Rs 1,73,077 |
| Annual accrual at 4.81% | Rs 23,088 | Rs 28,860 |
| Increase in exit liability | Baseline | +25% (Rs 34,615) |
No. Many employers assumed service would be split, with old wages applied up to 20 November 2025 and new wages after. The Ministry of Labour and Employment addressed this directly in its Additional FAQs of 16 March 2026 and confirmed that gratuity is paid on the rate of wages last drawn at the time of termination. The revised wage definition therefore applies across the full tenure at the point of exit, not just the post-code portion. If you carry a provision built on the old assumption, it is understated. Rework it against your employer cost model for India before your next audit.
The 4.81% figure is an accounting provision, not a deduction. It comes from dividing the annual gratuity accrual by 12: 15 divided by 26 divided by 12 equals 0.0481. Employers include it in CTC so the offer reflects the true cost of the hire, but nothing is withheld from the employee’s monthly pay and nothing is credited to a personal account.
If an employee leaves before vesting, the provision simply stays with the employer or the gratuity trust. Nothing is owed and nothing is refunded. This is a frequent source of friction with Indian candidates who read CTC as take-home entitlement, and it is worth pre-empting during offer negotiation. Our employee cost calculator for India separates provisioned costs from cash compensation so both sides see the same numbers, and the cost of hiring employees in India guide walks through the full stack.
The exemption now sits in Schedule II of the Income-tax Act, 2025, which came into force on 1 April 2026 and replaced Section 10(10) of the 1961 Act. The substance is unchanged, but any policy document or payroll note still citing Section 10(10) is referencing repealed law and should be updated.
| Employee category | Exempt amount | Practical effect |
|---|---|---|
| Central, state, local authority and defence employees | Fully exempt, no monetary cap | No tax regardless of quantum |
| Private sector, covered by the Act | Least of: actual gratuity, Rs 20 lakh, or 15/26 formula amount | Tax-free for almost all exits |
| Private sector, not covered | Least of: actual gratuity, Rs 20 lakh, or half-month average salary of the last 10 months × years served | Lower effective ceiling |
Three points employers get wrong. First, the Rs 20 lakh ceiling is a lifetime cumulative limit across every employer in a career, not a fresh allowance per job. An employee who has already claimed Rs 14 lakh exempt elsewhere has Rs 6 lakh of headroom left with you, and you have no visibility into that unless you ask. Second, gratuity paid during service rather than on exit is fully taxable. Third, anything above the ceiling is taxed as salary income in the year of receipt, so a senior exit can create a withholding obligation you need to plan for. The income tax threshold limits published by the department are the authoritative reference.
Payment is due within 30 days of gratuity becoming payable. That clock starts at the exit date, not at the point the employee submits a claim form, and simple interest accrues on delayed payment. The obligation is triggered automatically, so an employer who waits to be asked is already exposed.
For the wider statutory picture, the Ministry of Labour and Employment publishes a compliance handbook for employers under the four labour codes, and Cyril Amarchand Mangaldas has a detailed guide to the labour codes covering the insurance and ceiling provisions.
The Employer of Record is the legal employer on record, so it carries the gratuity obligation and pays the employee at exit. What varies, and what you should confirm in writing before signing, is how that liability is funded and who absorbs the shortfall.
Three funding models are common. Some providers accrue monthly and hold the funds, which is cleanest. Some invoice the full amount at exit, which creates an unbudgeted charge years after the hire. Some quote a headline PEPM that silently excludes gratuity, which surfaces as a dispute the first time someone crosses five years. Ask which model applies, whether accruals are refundable if the employee leaves before vesting, and which position the provider takes on 4 years and 240 days. Our EOR vetting checklist includes these as scored questions, and the guide to EOR payroll explains how accruals appear on a monthly invoice.
If you are still choosing a structure, what an Employer of Record actually does and EOR versus PEO in India cover the trade-offs, and our comparison of the best EOR providers in India benchmarks how each handles statutory benefits. Note that misclassifying a worker as a contractor to avoid gratuity is a well-litigated risk in India, covered in employee versus contractor.
Peorient is an independent EOR and PEO advisory. We compare providers based on statutory benefit handling, including how each one accrues gratuity, rather than headline PEPM alone.
Yes. Any establishment with 10 or more employees must pay gratuity to eligible employees. It is a statutory obligation, not a discretionary benefit, and it cannot be contracted out of.
A permanent employee cannot. A fixed-term employee can, on a pro-rata basis, because the one-year eligibility threshold applies to fixed-term contracts. Gratuity is also payable regardless of tenure in cases of death or disablement.
On wages, which means basic pay plus dearness allowance plus retaining allowance. HRA, conveyance, bonus, overtime and commission are excluded, though the 50% rule pulls excess allowances back into the wage base.
Yes, if the employee serves it. A served notice period is part of continuous service and counts towards the tenure calculation. Pay in lieu of notice generally does not.
Rs 20 lakh under the statutory ceiling, until the central government notifies a higher figure. An employer may pay more voluntarily, but the excess is taxable in the employee’s hands.
Apply to the controlling authority under the labour department in the relevant state. The authority can order payment with interest, and the burden of justifying non-payment sits with the employer.
Written by
Senior US Employment and HR Tech Analyst · 12+ years experience
Sarah leads US employment and HR technology coverage for Peorient. Former in-house HR Director at a 400-person fintech across 22 states and senior HR-tech analyst at G2 Crowd, where she built the review methodology for the payroll and HRIS categories. SHRM-SCP, SPHR, CPP. MILR, Cornell ILR.
Gratuity in India 2026: Rules, Formula & Tax Treatment
Gratuity in India after the 2025 labour codes: 5-year vs 1-year eligibility, the 15/26 formula, the 50% wage rule and Rs 20 lakh tax cap
