Gratuity = 15 ÷ 26 × last drawn monthly wages (basic + DA) × years of service, where a part year of more than six months counts as a full year. It is payable after five years of continuous service, except on death or disablement (no minimum) and for fixed-term employees after one year. The ceiling is ₹20 lakh, which is also the lifetime tax-free limit for private-sector employees. On ₹50,000 wages and 7 years 7 months, gratuity is ₹2,30,769.
The rule after the Labour Codes
The Payment of Gratuity Act, 1972 has been absorbed into Chapter V of the Code on Social Security, 2020, in force from 21 November 2025. The formula did not change: section 53(2) gives 15 days' wages for every completed year of service or part thereof in excess of six months, and Explanation 3 says that for a monthly-rated employee 15 days' wages = monthly wages ÷ 26 × 15. The divisor is 26 because a month is treated as 26 working days.
Two things did change. First, wages now follow the Code definition: basic, DA and retaining allowance, with excluded allowances above 50% of total remuneration added back. The Labour Ministry's FAQs say this applies to gratuity from 21 November 2025, based on the wages last drawn at exit. Second, fixed-term employees are entitled to gratuity on a pro rata basis once they have served one year under the contract.
Worked example
Arjun leaves after 7 years and 7 months. His last drawn basic plus DA is ₹50,000 a month and he resigns.
- Eligibility: more than five years of continuous service, so gratuity is payable on resignation.
- Years counted: 7 years plus 7 months. The extra months exceed six, so the service counts as 8 years.
- Gratuity: 15 ÷ 26 × ₹50,000 × 8 = ₹2,30,769.
- Tax: the employer is covered by the law, so the exempt amount is the least of ₹2,30,769 (actual), ₹2,30,769 (formula) and ₹20,00,000. All of it is tax-free.
Had he left at 7 years and 5 months, only 7 years would count: 15 ÷ 26 × ₹50,000 × 7 = ₹2,01,923. Leaving one month later than six months into a year is worth a full year's gratuity, which is why exit dates are negotiated.
If Arjun's ₹50,000 basic were part of a ₹1,20,000 total monthly package, the 50% rule would lift his gratuity wages to ₹60,000 and his gratuity to ₹2,76,923 (15 ÷ 26 × ₹60,000 × 8).
Exceptions and edge cases
- Death or disablement: no minimum service. Gratuity is paid to the nominee or heirs, and the Code provides for pro rata payment for a deceased employee.
- Fixed-term contract: eligible after one year of service under the contract, pro rata for the actual service. An 11-month contract does not qualify.
- Working journalists: three years instead of five.
- Continuous service includes leave, sickness, lay-off and strikes not caused by the employee. Courts have treated 240 days worked in the fifth year as completing that year; practice varies, so take advice before refusing a claim on a four-years-and-ten-months exit.
- Forfeiture: only for termination for misconduct causing loss (to the extent of the loss), riotous or violent conduct, or an offence involving moral turpitude in the course of employment.
- Employer not covered (fewer than 10 employees): gratuity depends on the contract, and the tax exemption is 15/30 of the average salary of the last 10 months × completed years only, with no rounding up.
Provision for it every month
Many employers set aside 4.81% of basic (15/26 ÷ 12) each month so the liability is never a surprise. FundRaksha HR calculates PF, ESI and PT for every employee automatically on each payroll run, so the challans, ECR and payslips agree without a spreadsheet. It also tracks service dates and wages last drawn, so the gratuity figure on the full and final settlement is right first time. See also the relieving letter format.