Payment of Gratuity Act (India)
India's central legislation enacted in 1972 that requires employers to pay a lump-sum gratuity amount to employees who have completed 5 or more years of continuous service, upon resignation, retirement, death, or disablement.
- What Is the Payment of Gratuity Act (India)?
- Applicability and Coverage
- How to Calculate Gratuity
- Events That Trigger Gratuity Payment
- Tax Treatment of Gratuity
- Gratuity Payment Process and Timelines
- Penalties for Non-Payment or Delayed Payment
- Gratuity Compliance Checklist for HR Teams
- Gratuity Payment Data in India
- Frequently Asked Questions About the Payment of Gratuity Act
What Is the Payment of Gratuity Act (India)?
Key Takeaways
- ✓The Payment of Gratuity Act, 1972, mandates that employers pay a retirement benefit (gratuity) to employees who have completed 5 years of continuous service in an establishment with 10 or more employees.
- ✓Gratuity is calculated as 15 days' wages for every completed year of service (or part thereof exceeding 6 months), using the formula: (Last drawn salary x 15 x years of service) / 26.
- ✓The maximum gratuity amount payable is Rs 25 lakh (raised from Rs 20 lakh by the 2024 notification). Employers can pay more than the statutory maximum voluntarily.
- ✓Gratuity is payable upon superannuation, resignation, death, or disablement. In case of death, the amount is paid to the nominee or legal heir, and the 5-year qualifying period is waived.
- ✓Once an establishment employs 10 or more persons and becomes covered, the Act continues to apply even if the headcount later drops below 10.
Gratuity is a reward for long and meritorious service. Unlike PF (where both employer and employee contribute monthly), gratuity is entirely employer-funded and paid as a lump sum at the time of separation. The Payment of Gratuity Act made this benefit a legal right for employees across all sectors. Before the Act, only government servants and employees of large corporations received gratuity as a matter of policy. The Act extends this benefit to every employee in a covered establishment who completes 5 years of service. The 5-year requirement has an important nuance: courts have interpreted "continuous service" to include periods where the employee was absent due to sickness, accident, authorized leave, or lockout, provided the total service (counting 240 days of actual work in a year as a full year) meets the threshold. Gratuity is distinct from pension and provident fund. PF is a monthly savings scheme. Pension provides recurring post-retirement income. Gratuity is a one-time lump sum. All three can coexist for the same employee, and employers can't offset one against another.
Applicability and Coverage
The Act covers a wide range of establishments, and once covered, an establishment can't escape the obligation.
Covered establishments
The Act applies to every factory, mine, oilfield, plantation, port, railway company, shop, or other establishment employing 10 or more persons on any day in the preceding 12 months. "Other establishment" is broadly interpreted and includes IT companies, BPOs, consulting firms, hospitals, educational institutions, and NGOs. The 2009 Amendment extended coverage to all establishments where 10 or more persons are employed, removing earlier limitations on specific industry types. Once an establishment is covered, it remains covered permanently (Section 1(3)), even if headcount drops below 10 later.
Eligible employees
Every employee who has completed 5 years of continuous service is eligible, regardless of designation, salary level, or employment type. Unlike the Payment of Bonus Act (which has a salary ceiling), the Gratuity Act has no salary cap for eligibility. A CEO earning Rs 50 lakh per month is as entitled to gratuity as a clerk earning Rs 15,000. The only differences are in the calculation formula and the Rs 25 lakh ceiling on the amount. "Employee" covers anyone employed for wages, whether on a regular, temporary, or contractual basis.
The 5-year continuous service requirement
"Continuous service" under the Act means uninterrupted service, including periods of sickness, accident, maternity leave, authorized leave, strike that isn't illegal, and lockout. An employee is deemed to have been in continuous service for a year if they've worked for 240 days in that year (190 days for employees working in mines or seasonal establishments). So in practice, 4 years and 240 days of service qualifies as 5 years. Courts have also held that if an employee is retrenched and rehired, the previous service counts toward the 5-year threshold. The 5-year requirement is waived only in case of death or disablement.
How to Calculate Gratuity
The calculation formula differs slightly for employees covered under the Act and those employed in seasonal establishments.
Standard formula
For employees covered under the Act: Gratuity = (Last drawn salary x 15 x completed years of service) / 26. Here, "last drawn salary" means the basic salary plus dearness allowance drawn at the time of cessation. Years of service exceeding 6 months in the final year are rounded up to the next full year. Division by 26 represents the number of working days in a month (excluding 4 Sundays). Example: An employee with a last drawn salary (basic + DA) of Rs 40,000 and 12 years of service gets: (40,000 x 15 x 12) / 26 = Rs 2,76,923.
Piece-rated employees
For piece-rated employees, the daily wage is calculated as the average of their total wages for the last 3 months preceding their cessation, divided by the number of days actually worked. The gratuity is then 15 days' wages multiplied by years of service. This ensures piece-rated workers aren't disadvantaged during slow periods.
Maximum gratuity limit
The statutory maximum is Rs 25 lakh (increased from Rs 20 lakh by government notification in 2024, and from Rs 10 lakh by the 2018 Amendment). If the formula yields an amount exceeding Rs 25 lakh, the employer is legally required to pay only Rs 25 lakh. However, employers can voluntarily pay more than the statutory maximum. Many large companies, particularly in IT and financial services, pay gratuity beyond the ceiling as part of their total compensation strategy. Amounts above the statutory ceiling don't enjoy tax exemption benefits under Section 10(10) of the Income Tax Act.
Events That Trigger Gratuity Payment
Gratuity becomes payable upon specific events, each with its own rules.
Resignation
An employee who resigns after completing 5 years of continuous service is entitled to full gratuity. The employer can't withhold gratuity because the employee resigned without serving full notice, or because the employer doesn't agree with the resignation. The only exception: if the employee is terminated for fraud, riotous/violent behavior, or moral turpitude that led to their departure being classified as misconduct-based termination rather than resignation.
Superannuation and retirement
Gratuity is payable upon reaching the retirement age specified in the employment contract or company policy. For most private sector employees, this is 58 or 60. Voluntary retirement under a VRS scheme also triggers gratuity payment, and the VRS compensation is separate from and in addition to gratuity.
Death or disablement
If an employee dies or becomes totally or partially disabled due to disease or accident, gratuity is payable regardless of how many years they've served. The 5-year requirement is waived. In case of death, gratuity is paid to the nominee. If no nominee is designated, it goes to the legal heir. The full formula applies, and the amount can't exceed Rs 25 lakh. Many employers carry group gratuity insurance to fund this contingency.
Forfeiture grounds
Section 4(6) allows forfeiture of gratuity (wholly or partially) if the employee's services are terminated for: riotous or disorderly conduct, violence against another person on the establishment's premises, or any act constituting a criminal offense involving moral turpitude committed during employment. Forfeiture for the specific act must be the cause of termination, not a post-hoc justification. If the employee is terminated for poor performance and also had a minor misconduct incident, the employer can't retroactively use the misconduct to forfeit gratuity.
Tax Treatment of Gratuity
Gratuity enjoys partial tax exemption under the Income Tax Act, but the rules differ by employee category.
| Category | Tax Exemption | Limit |
|---|---|---|
| Government employees | Fully exempt under Section 10(10)(i) | No limit |
| Employees covered under Gratuity Act | Exempt up to statutory ceiling | Rs 25 lakh |
| Employees not covered under Gratuity Act | Exempt to the lower of: half month's salary per year, Rs 25 lakh, or actual gratuity | Rs 25 lakh |
| Gratuity above exemption limit | Taxable as salary income | Subject to applicable slab rates |
Gratuity Payment Process and Timelines
The Act prescribes a formal process for claiming and paying gratuity.
Employee's application
The employee (or their nominee/legal heir in case of death) must apply for gratuity in Form I within 30 days of the date gratuity becomes payable. However, the Act states that gratuity is payable whether or not the employee applies. The application is a procedural step, not a precondition. Late applications aren't rejected if the employer was aware of the triggering event. In practice, HR teams should process gratuity proactively as part of the full and final settlement without waiting for a formal application.
Employer's obligation and timeline
The employer must determine the amount of gratuity and pay it within 30 days of the date it becomes due. If the employer disputes the claim, they must notify the employee in Form L within 15 days, specifying the reasons. If payment is delayed beyond 30 days, the employer must pay simple interest at the rate notified by the government (currently 10% per annum) from the date gratuity became due to the date of actual payment. This interest provision is a strong incentive for timely payment.
Penalties for Non-Payment or Delayed Payment
The Act takes non-payment seriously, with penalties including imprisonment.
| Violation | Penalty | Section |
|---|---|---|
| Non-payment of gratuity after it becomes payable | Imprisonment of 6 months to 2 years (unless there are sufficient reasons for non-payment) | Section 9 |
| Employer disputes the claim without valid grounds | Court can order payment with interest and costs | Section 7(7) |
| Failure to comply with the Controlling Authority's order | Imprisonment up to 1 year, fine, or both | Section 9 |
| Reduction of wages to avoid gratuity liability | Such reduction is void and unenforceable | Section 14 |
| Delayed payment (beyond 30 days) | Simple interest at 10% per annum on the delayed amount | Section 7(3-A) |
Gratuity Compliance Checklist for HR Teams
Essential steps for maintaining compliant gratuity practices.
- Maintain a gratuity register showing each employee's joining date, last drawn salary (basic + DA), completed years of service, and calculated gratuity amount.
- Collect nominee details from every employee at the time of joining (Form F). Update nominees when employees report changes due to marriage, birth, or other events.
- Accrue gratuity liability in the company's financial statements using an actuarial valuation, as required by Indian Accounting Standard (Ind AS) 19.
- Consider purchasing a group gratuity insurance policy from LIC or a private insurer to fund the liability. This protects the company from large lump-sum payouts when multiple senior employees exit simultaneously.
- Process gratuity as part of the full and final settlement within 30 days of the employee's last working day. Don't wait for a formal Form I application.
- Include a gratuity estimate in every senior employee's total compensation statement to improve retention through visibility of accrued benefits.
- Track the 5-year milestone for each employee and flag accounts where employees are approaching eligibility, so there are no surprises during exit processing.
Gratuity Payment Data in India
Numbers reflecting gratuity's role in employee compensation across India.
Frequently Asked Questions
Is gratuity payable to contract workers?
What if an employee works 4 years and 11 months and resigns?
Can gratuity be denied for poor performance?
Is gratuity payable in addition to severance or VRS compensation?
Does gratuity apply to probationary employees?
Written by Adithyan RK