Gratuity Calculation in India: Employer and Employee Guide
Gratuity is a statutory benefit under the Payment of Gratuity Act, 1972, payable to employees who have completed 5 years of continuous service. It is essentially a retirement benefit funded entirely by the employer. The Act applies to factories, mines, oilfields, plantations, ports, railways, and all establishments with 10 or more employees.
For Indian businesses, gratuity represents a significant financial liability. A company with 100 employees averaging ₹40,000 basic salary and 10 years of service faces a gratuity liability of approximately ₹2.3 crores. Actuarial valuation of gratuity liability is mandatory under Ind AS 19.
Gratuity Calculation Formula
Gratuity = (Last Drawn Salary × 15 / 26) × Years of Service
- • Last Drawn Salary = Basic Salary + Dearness Allowance (only these two components)
- • 15/26 = 15 days wages calculated on 26 working days per month
- • Years of Service = Completed years only; fraction above 6 months rounded up
- • Maximum limit = ₹20 lakhs (tax-exempt ceiling for government employees; no payment cap for private sector)
Example Calculation
Employee: Basic + DA = ₹50,000/month, Service = 20 years 7 months (rounded to 21 years)
Gratuity = (₹50,000 × 15/26) × 21 = ₹28,846 × 21 = ₹6,05,769
Tax Treatment of Gratuity
Government Employees
Entire gratuity amount is tax-exempt under Section 10(10)(i). No upper limit on exemption.
Private Sector (Covered by Act)
Exempt up to least of: (a) Actual gratuity received, (b) ₹20 lakhs, or (c) 15/26 × last drawn salary × years of service. Excess is taxable.
Key Takeaways
- ✓ Gratuity is payable after 5 years of continuous service (4 years 240 days in some cases)
- ✓ Employer must pay within 30 days of it becoming due—interest payable on delay
- ✓ Tax-exempt up to ₹20 lakhs (lifetime limit across all employers)
- ✓ Actuarial valuation mandatory under Ind AS 19—engage an actuary for accurate provisioning
- ✓ Consider gratuity insurance (LIC, ICICI Prudential) to fund the liability
Frequently Asked Questions
Is gratuity payable if an employee is terminated?
Yes, gratuity is payable on termination (including retrenchment) if the employee has completed 5 years. It can be forfeited only for moral turpitude or riotous/violent behaviour causing damage to employer property.
What if the employer does not pay gratuity?
File Form I with the Controlling Authority (usually Labour Commissioner). Penalty for non-payment: imprisonment up to 2 years and/or fine up to ₹20,000. Interest accrues at 10% p.a. on delayed payments.