Gratuity explained: who gets it, the formula, and the tax

Gratuity is a lump sum your employer pays you when your job ends after enough years of service. You don’t contribute anything. It’s a thank-you for staying, worked out from your last salary and the years you served. It’s separate from your EPF, which you and your employer both pay into every month and which the EPFO runs. Your employer pays gratuity directly.

Which law applies

Gratuity now falls under the Code on Social Security, 2020. All four Labour Codes took effect on 21 November 2025, per the government, and the Code replaced the Payment of Gratuity Act, 1972. The Labour Ministry says gratuity under the Code applies from that date onward, not backdated.

It covers factories, mines, oilfields, plantations, ports and railway companies, plus any shop or establishment with 10 or more employees. Government employees whose gratuity comes under their own service rules sit outside it.

Who qualifies, and when

You get gratuity when your job ends after at least 5 years of continuous service: on retirement, resignation, death, or disablement from an accident or illness. On death or disablement, the 5 years aren’t needed, and the money goes to your nominee.

Fixed-term employees get a better deal now. The Labour Ministry says they qualify after one year of continuous service, paid in proportion to the time served, when the contract ends.

The formula

For each completed year, you get 15 days’ wages. For a monthly salary, the law spells it out: divide your last monthly wage by 26, then multiply by 15. Any part year over six months counts as a full year.

An illustration. Say your last wage was 50,000 rupees a month and you served 10 years and 7 months. The 7 months round up, so that’s 11 years. 50,000 divided by 26, times 15, times 11, comes to about 3.17 lakh rupees. Try your own numbers in the gratuity calculator.

What counts as your wage

“Wages” means basic pay, dearness allowance and any retaining allowance. Items like house rent allowance, conveyance, bonus and overtime are left out, but only up to half of your total pay. If they add up to more than half, the extra is added back to your wages. So a CTC built mostly from allowances can’t shrink your gratuity much below half your pay.

The cap and the tax

The law lets the government cap the payout. The Labour Ministry’s FAQ puts it at 20 lakh rupees, though your employer can agree to pay more.

Tax is a separate rule. Retirement gratuity for government employees is fully tax-free. For most private-sector staff, the Income-tax Act, 2025 makes gratuity tax-free up to the lowest of three amounts: what you actually received, half a month’s average salary for each completed year, and a limit the government notifies. That limit is 20 lakh rupees over your whole working life. It was notified in 2019 under the old law, and section 536 of the new Act keeps such notifications in force. The tax formula still uses its own salary definition, which can differ from the labour law’s wage rule, so the tax-free part can be lower than the gratuity you’re paid.

More to read: PF withdrawal rules, how your Employees’ Pension Scheme works alongside it, your first salary slip, and the lessons on how salary is taxed and retirement planning.