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Gratuity is a statutory lump-sum payment made by an employer to an employee as a recognition of long service. It is governed by the Payment of Gratuity Act, 1972 and is one of the most significant employee retirement benefits in India alongside Provident Fund and ESI.
The Act applies to every factory, mine, oil-field, plantation, port, and railway, and to every shop or establishment that employs 10 or more persons. Once a company comes under the Act, it remains covered even if its headcount later falls below 10.
Rounding rule: If an employee has served for 6 months or more in the last year, it is rounded up to a full year. For example, 7 years and 8 months is treated as 8 qualifying years.
Maximum gratuity payable: There is no statutory upper limit on the gratuity amount, but the tax-free ceiling is ₹20 lakhs for private-sector employees. Any amount beyond that is taxable as salary income.
For seasonal establishments: A reduced formula applies — 7 days' wages per season of employment (instead of 15), using the same divisor of 26.
Gratuity received by central and state government employees is fully exempt from income tax under Section 10(10)(i) of the Income Tax Act — with no upper ceiling.
For employees covered under the Payment of Gratuity Act, gratuity is exempt up to ₹20 lakhs. Amount beyond ₹20 lakhs is added to income and taxed at the applicable slab rate.
A different formula applies: ½ × average salary of last 10 months × completed years of service, subject to a maximum of ₹20 lakhs.
Gratuity paid to a nominee or legal heir due to an employee's death or permanent disablement is fully tax-exempt, regardless of the amount.
The Code on Social Security, 2020 — one of four consolidated Labour Codes — introduces significant changes to gratuity eligibility, the wage base, and coverage of new worker categories.
The Labour Codes redefine "wages" to include all remuneration except a specified list of exclusions (HRA, conveyance allowance, overtime, statutory bonuses above a threshold, etc.). Crucially, the new law mandates that this redefined wage component must constitute at least 50% of total CTC.
Since gratuity is calculated on Basic + DA — which together form the bulk of "wages" — the 50% floor effectively prevents employers from structurally reducing their gratuity liability by inflating allowances. In practice, this means businesses that currently pay low Basic / high allowances will see a significant increase in their gratuity provisioning requirements.
Under the existing Payment of Gratuity Act, an employee must complete 5 continuous years of service to be eligible. The Code on Social Security, 2020 proposes that employees on fixed-term employment contracts become eligible for proportionate gratuity after completing just 1 year of service.
This will significantly impact sectors that rely on fixed-term contracts — manufacturing, construction, IT project staffing, and professional services. Employers will need to budget for gratuity provisioning from year one of every fixed-term engagement.
For the first time in Indian labour history, gig workers (delivery executives, ride-share drivers, freelance platform workers) are proposed to receive a form of social security benefit. The exact gratuity structure for this category is being defined in the rules, but the intent is clear: bringing the unorganised and platform economy workforce under a formal social security framework.
The Code on Social Security, 2020 — along with the three other Labour Codes — is applicable from 21 November 2025. All gratuity-related matters, including eligibility thresholds, wage base computation, fixed-term employee rights, and death/disability provisions, are now governed by the Social Security Code 2020. Additionally, as established by various High Court and Supreme Court verdicts, an employee who has completed 4 years and 240 days of continuous service is entitled to gratuity, treated as equivalent to 5 qualifying years.
Even before the new codes take effect, forward-thinking businesses should audit their current salary structures — particularly Basic and DA components — to understand the financial impact on gratuity provisioning when the codes are notified. GREAT LEAP can model the cost impact, redesign your salary structure, and ensure you're compliant well before the deadline.