Gratuity Obligations for Employers in India

Short answer: Under the Payment of Gratuity Act, 1972, employers with 10 or more employees must pay a one-time, lump-sum gratuity to employees who complete five years of continuous service. The payment is due upon resignation, retirement, death, or disablement. The amount is calculated based on a set formula using the employee's last drawn salary and tenure. Employers must pay this amount within 30 days of the employee's last working day.

Which employers must pay gratuity?

The Payment of Gratuity Act, 1972 applies to all factories, mines, oilfields, plantations, ports, and railway companies. It also applies to any shop or establishment, as defined under state law, that employs or has employed 10 or more people on any day in the preceding 12 months. Crucially, once the Act becomes applicable to an establishment, it continues to apply even if the number of employees later falls below 10. Startups and small businesses that cross this threshold must immediately plan for this liability.

When does an employee become eligible for gratuity?

An employee becomes eligible for gratuity after rendering 'continuous service' for at least five years. This is the general rule applicable on superannuation, retirement, or resignation. However, the five-year service requirement is waived if the employment is terminated due to the employee's death or disablement. In such tragic circumstances, the gratuity is payable to the nominee or legal heir, regardless of the service tenure.

How is gratuity calculated?

Gratuity is calculated using a specific statutory formula that employers must follow. The calculation differs slightly for employees covered by the Act versus those not covered (where an employer pays it voluntarily as a benefit).

For employees covered under the Act, the formula is:

Gratuity = (Last Drawn Salary × 15/26) × Number of Years of Service

• Last Drawn Salary: This includes only Basic Pay and Dearness Allowance (DA). It does not include House Rent Allowance (HRA), bonuses, commissions, or any other allowances.
• 15/26: This represents 15 days' salary for each year, based on a working month of 26 days.
• Number of Years of Service: Any period of service exceeding six months is rounded up to the next full year. For example, a tenure of 7 years and 7 months is counted as 8 years. A tenure of 7 years and 5 months is counted as 7 years.

What is considered 'continuous service'?

Continuous service is the cornerstone of gratuity eligibility. An employee is deemed to be in continuous service if they have worked without interruption. The Act provides a specific definition for what counts as a year of service, even if the employee wasn't present every single day.

An employee is considered to have completed one year of continuous service if they have worked for:

Establishment Type	Minimum Working Days in a Year	Notes
Standard Establishments	240 days	For establishments working 6 days a week.
Mines & Seasonal Establishments	190 days	For establishments working less than 6 days a week.

Days of absence due to sickness, accident, authorised leave, layoff, strike, or lockout (not due to employee fault) are included when calculating these working days.

What are the payment and funding obligations?

An employer's primary obligation is to pay the calculated gratuity amount within 30 days from the date it becomes payable. If the employer fails to pay within this period, they are liable to pay simple interest on the amount from the due date until the date of payment. The rate of interest is specified by the government from time to time.

Employers have two main options to manage this liability:

1. Pay from own funds: The employer can pay the gratuity amount from their business revenues when it becomes due. This can cause significant cash flow strain if multiple senior employees leave at once.
2. Obtain a group gratuity policy: The employer can take an insurance policy from Life Insurance Corporation (LIC) or another approved insurer. The employer pays annual contributions to the insurer, which then manages the fund and pays the gratuity claims. This is a prudent way to fund the liability systematically.

Can an employer forfeit an employee's gratuity?

Yes, but only in very limited and severe circumstances. Section 4(6) of the Act allows an employer to forfeit the gratuity, either wholly or partially, under specific conditions:

• Partial Forfeiture: If an employee's services are terminated for any act, willful omission, or negligence causing damage or loss to the employer's property, gratuity can be forfeited to the extent of the damage caused.
• Complete Forfeiture: Gratuity can be forfeited entirely if an employee's services are terminated for:
  • Riotous or disorderly conduct or any act of violence on their part.
  • An offence involving moral turpitude, provided the offence was committed in the course of their employment.

A proper domestic enquiry must be conducted and the misconduct must be proven before forfeiture can be invoked. This is not a decision to be taken lightly.

Worked example

Ms. Priya worked as an Operations Manager at a tech company in Bengaluru. Her employment details are as follows:

• Date of Joining: 15 February 2019
• Date of Resignation: 31 August 2026
• Last Drawn Salary: Basic Pay ₹80,000 + Dearness Allowance ₹10,000 = ₹90,000 per month.

Step 1: Calculate the period of service. Priya's total service is 7 years, 6 months, and 16 days.

Step 2: Round the years of service. Since the period of service over 7 years is more than 6 months, it is rounded up to the next full year. Therefore, the number of years for calculation is 8 years.

Step 3: Apply the gratuity formula. Gratuity = (Last Drawn Salary × 15/26) × Number of Years of Service Gratuity = (₹90,000 × 15/26) × 8 Gratuity = (₹51,923.07) × 8 Gratuity = ₹4,15,384.62

The company must pay Priya ₹4,15,384.62 within 30 days of her last working day.

Common mistakes

1. Incorrect Salary Calculation: Including HRA, special allowances, or performance bonuses in the 'last drawn salary' for the formula. The Act is clear that only Basic + DA must be used.
2. Believing the Act is Inapplicable: Assuming that once an organisation's employee count drops below 10, the Gratuity Act no longer applies. This is incorrect; once applicable, always applicable.
3. Delaying Payment: Failing to pay the gratuity within the 30-day statutory limit, which automatically triggers liability for interest.
4. Misunderstanding 'Continuous Service': Denying gratuity to an employee who worked for more than 5 years but had less than 365 days of attendance in some years. The 240-day rule is the correct measure.
5. Withholding Gratuity Improperly: Attempting to withhold gratuity for reasons like non-performance or general disputes, which is not permitted. Forfeiture is only allowed for specific, proven misconduct.

How SP & SC helps

Navigating labour law compliance is critical for business stability. At SP & SC, we provide comprehensive advice on all aspects of the Payment of Gratuity Act. We help businesses calculate actuarial gratuity liability for financial reporting (AS-15), structure and set up gratuity trusts, evaluate group insurance policies, and ensure correct and timely payment to exiting employees. Our end-to-end labour compliance services protect you from legal risks and financial penalties.

Frequently asked questions

H3: What is the maximum gratuity payable?

There is no legal limit on the amount of gratuity an employer can pay. However, under the Income-tax Act, the tax exemption for gratuity received by an employee is capped at ₹20 lakh. Any amount received over ₹20 lakh is taxable in the hands of the employee.

H3: Is gratuity taxable?

For government employees, gratuity is fully exempt from tax. For private-sector employees covered by the Payment of Gratuity Act, it is tax-exempt up to the least of the following: (i) 15 days' salary for each completed year of service, (ii) ₹20 lakh, or (iii) the actual gratuity received. You can find more details in our guide to gratuity calculation in India.

H3: Do contract employees get gratuity?

Yes, if they are considered employees under the Act. If a contract employee has worked for five continuous years and an employer-employee relationship is established (based on factors like supervision and control), they are entitled to gratuity just like permanent employees. The label 'contractor' does not automatically disqualify them.

H3: What happens if the employer doesn't pay gratuity?

An aggrieved employee can file a complaint with the Controlling Authority appointed under the Gratuity Act in their jurisdiction. The authority will investigate, and if the claim is valid, will order the employer to pay the due amount along with interest. Non-compliance can lead to penalties and even prosecution.

H3: Do the new labour codes change gratuity rules?

The Code on Social Security, 2020, which is yet to be fully implemented, will subsume the Payment of Gratuity Act, 1972. While it largely retains the core principles of the 1972 Act (like the 5-year eligibility and calculation formula), it expands the definition of 'employee' and may extend social security to gig and platform workers. Until the Code is fully enforced, the 1972 Act remains the governing law.

Get a fixed-fee quote

Ensuring compliance with labour laws is not optional. If you are unsure about your gratuity liability, funding methods, or have received a notice from the authorities, we can help. Contact SP & SC or WhatsApp us at +91 90356 74566 to share your documents. We provide a written fixed-fee quote after our initial review and handle your compliance requirements from start to finish.