Gratuity in India: rules, formula, and payout under the Payment of Gratuity Act, 1972

What is gratuity?

Gratuity is a one-time lump-sum payment made by an employer to an employee as a token of gratitude for their continuous service. In India, it is governed by the Payment of Gratuity Act, 1972, applicable to every establishment employing 10 or more persons on any day in the preceding 12 months.

Who is eligible?

An employee becomes eligible for gratuity on termination of employment after rendering continuous service of five years or more. The five-year requirement is waived in case of death or disablement of the employee. Termination includes resignation, retirement, superannuation, or any other form of separation other than dismissal for proven misconduct that caused loss to the employer (which can be a ground for partial forfeiture).

• Applicable establishments: factories, mines, oilfields, plantations, ports, railways, shops or establishments with 10+ employees.
• Continuous service: 240 days in a year for non-mining establishments; 190 days for mining.
• Forfeiture: permitted only where the employee's services were terminated for proven moral turpitude or wilful damage.

Gratuity calculation formula

For employees covered by the Act:

Gratuity = (Last drawn basic + DA) × 15 × Number of completed years of service ÷ 26

The number 26 represents the working days in a month. Any service of six months or more in the final year counts as a completed year (round up). For example, a salary of ₹50,000 (basic + DA) with 12 years 7 months of service yields a gratuity of ₹50,000 × 15 × 13 ÷ 26 = ₹3,75,000.

For employees not covered by the Act (rarely the case post amendments), the formula uses 30 days instead of 26 and excludes the rounding rule.

Gratuity ceiling and tax exemption

• The maximum gratuity payable under the Act is currently ₹20 lakh (raised from ₹10 lakh via the 2018 amendment).
• Tax exemption: Section 10(10) of the Income Tax Act exempts the least of: actual gratuity received, ₹20 lakh, or the formula-computed amount.
• For government employees, the full amount is exempt.

Payment timelines and interest

Gratuity must be paid within 30 days from the date it becomes payable (typically the date of termination). Delay attracts simple interest at the rate notified by the Central Government (currently 10% per annum) unless the delay is due to fault of the employee.

Gratuity nomination (Form F)

Every eligible employee must file Form F nominating one or more family members within 30 days of completing one year of service. The nomination can be modified anytime via Form H. On the employee's death, gratuity is payable to the nominee(s) regardless of length of service.

Penalties for non-compliance

• Non-payment after 30 days attracts simple interest.
• Failure to pay gratuity is punishable with imprisonment up to two years or fine up to ₹20,000 (Section 9).
• The Controlling Authority (typically Assistant Labour Commissioner) can adjudicate disputes and order recovery as land revenue arrears.

How Texlaculture automates gratuity

• Monthly accrual: Provisions gratuity each pay cycle based on current basic + DA.
• Eligibility tracking: Flags employees crossing 5 years; surfaces nomination gaps via Form F reminders.
• Exit computation: On separation, computes gratuity per the Act, applies ₹20 lakh ceiling and Section 10(10) exemption, and routes the F&F.
• Audit trail: Year-end actuarial inputs for IndAS 19 / AS 15 reporting.

Common employer mistakes

1. Computing gratuity on basic only when DA is part of the structure.
2. Missing the 30-day payout deadline post-separation.
3. Not collecting Form F nominations during onboarding.
4. Not provisioning gratuity in the books — leading to large hits when employees exit at scale.
5. Treating contractual or fixed-term staff as ineligible when 5+ years of continuous service has been rendered.