How Gratuity Is Calculated in India

Summary

Gratuity is a lump-sum benefit paid to employees who have completed 5 or more years of continuous service (1 year for fixed-term contracts under the new labour codes). It is calculated using the formula: (15/26) x Last drawn salary x Years of service. The maximum tax-exempt gratuity is Rs 20 lakh.

How it works

The formula

Gratuity = (15/26) x Last drawn salary x Completed years of service

Where:

• 15 represents 15 days’ wages for each year of service
• 26 is the number of working days in a month (excluding 4 Sundays)
• Last drawn salary = Basic pay + Dearness Allowance (DA)
• Years of service rounded up if the fraction exceeds 6 months

Eligibility

Under the Payment of Gratuity Act 1972:

• Employee must complete 5 years of continuous service (relaxed to 1 year for fixed-term employees under new labour codes from November 2025)
• Applies to establishments with 10 or more employees
• Applies on resignation, retirement, death, or disablement

Tax treatment

Worked example

Basic + DA: Rs 80,000/month, Service: 12 years 8 months

1. Years of service: 13 (8 months > 6, rounds up)
2. Gratuity = (15/26) x Rs 80,000 x 13
3. = 0.5769 x Rs 80,000 x 13
4. = Rs 6,00,000

This is below the Rs 20 lakh limit, so the entire amount is tax-exempt.

High salary example: Basic + DA Rs 2,00,000/month, Service: 20 years

1. Formula gratuity = (15/26) x Rs 2,00,000 x 20 = Rs 23,07,692
2. Capped at Rs 20,00,000 (tax-exempt limit)
3. Excess Rs 3,07,692 is taxable as income

Inputs explained

• Last drawn basic salary + DA — the salary at the time of leaving
• Years of service — total years with the employer
• Employee type — government or private sector

Outputs explained

• Gratuity amount — calculated using the 15/26 formula
• Tax-exempt portion — amount within the Rs 20 lakh limit
• Taxable portion — any amount exceeding the exemption

Assumptions & limitations

• The 15/26 formula applies to employees covered under the Act. Non-covered employees (establishments with fewer than 10 workers) use a half-month salary formula.
• New labour codes (effective November 2025) redefine wages — basic component must be at least 50% of CTC, which may increase gratuity amounts.
• Gratuity is forfeited if an employee is terminated for misconduct causing damage to employer property.
• The Rs 20 lakh cap has remained unchanged since 2019 and may be revised.