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Eligibility and the formula
Gratuity becomes payable to an employee who has completed five or more years of continuous service with the same employer, under the Payment of Gratuity Act 1972 (the five-year requirement is relaxed in cases of death or disablement). The standard formula for employees covered under the Act is: (Last drawn basic salary + dearness allowance) × 15/26 × number of years of service, with the 15/26 factor representing 15 days' wages for each completed year, calculated on a 26-day working month.
Tax treatment
For employees covered under the Payment of Gratuity Act, the tax-exempt limit is currently Rs 20 lakh (aggregated across employers over an employee's career, not per employer), with any amount above that taxable as income. Government employees receive full exemption regardless of amount. Employers should also note that gratuity is a statutory liability that needs proper accounting treatment — many companies underestimate this by treating it as a discretionary payment rather than the legal obligation it is, which becomes a real cash-flow issue when a large cohort crosses the five-year mark around the same time.
Frequently asked questions
Who is eligible for gratuity in India?
An employee is eligible for gratuity after completing five years of continuous service with an employer. Gratuity is payable on retirement, resignation, death, or disablement due to accident or disease. In case of death or disablement, the five-year service requirement is waived. Under the new Code on Social Security, fixed-term contract employees may be eligible for gratuity after one year of service.
How is gratuity calculated in India?
Gratuity is calculated as: Last drawn salary multiplied by 15 divided by 26 multiplied by number of years of service. Here, last drawn salary includes basic salary and dearness allowance. The 15/26 formula accounts for 15 days salary per year of service, with 26 being the number of working days in a month. For example, an employee with 10 years of service and last drawn basic of Rs 50,000 per month receives Rs 2,88,462 as gratuity.
What is the maximum gratuity payable?
The maximum gratuity payable under the Payment of Gratuity Act is Rs 20 lakhs. This limit was increased from Rs 10 lakhs in 2018. Employers can choose to pay more than the statutory maximum as an employment benefit. Government employees have different gratuity limits under their service rules.
Is gratuity taxable in India?
Gratuity received by government employees is fully tax exempt. For private sector employees, gratuity up to Rs 20 lakhs is tax exempt under Section 10(10) of the Income Tax Act. The tax-exempt limit was enhanced to align with the statutory maximum. Gratuity received beyond this limit is taxable as salary income.
Must employers maintain a gratuity fund?
Employers are not required to maintain a separate gratuity fund but many choose to by subscribing to a group gratuity scheme with an insurance company. This ensures funds are available when gratuity becomes payable. The Payment of Gratuity Act requires employers to pay gratuity within 30 days of it becoming due. Late payment attracts simple interest at the prescribed rate.
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