Code on Social Security, 2020
Gratuity is a statutory liability that accrues quietly on your books every year an employee stays. This works it out per employee under the 15/26 formula, subject to the twenty lakh statutory ceiling. Read the note on wages below before you rely on the figure: the Code on Social Security, 2020 changed what counts as wages.
Gratuity is fifteen days' wages for every completed year of service, worked out as 15/26 of monthly wages multiplied by years. Twenty-six is used because it treats a month as twenty-six working days, excluding weekly offs.
Wages here means basic plus dearness allowance. House rent allowance, conveyance, bonus, overtime and other allowances are excluded. A service period of more than six months in the final year rounds up to a full year; six months or less is dropped.
The ceiling is twenty lakh rupees per employee. Anything an employer chooses to pay above that is contractual rather than statutory, and is treated differently for tax.
The Act applies to every factory, mine, oilfield, plantation, port, railway company and shop or establishment with ten or more employees on any day in the preceding twelve months. Once it applies, it continues to apply even if headcount later falls below ten.
Gratuity is payable on resignation, retirement, superannuation, death or disablement. Five years of continuous service is the qualifying period, except on death or disablement, where it is payable regardless of how long the employee has been there.
It is not discretionary and it is not linked to profitability. A loss-making year does not suspend the obligation, and payment is due within thirty days of it becoming payable, with interest running after that.
Run this calculation for one long-serving employee and the number looks manageable. Run it across a workforce of two hundred and the accrued liability is often a figure the balance sheet has never carried explicitly.
It also grows in two directions at once. Every year of service adds to the multiplier, and every increment raises the wage the whole calculation is applied to. A ten per cent salary revision increases the accrued gratuity of every employee by ten per cent, retrospectively across all their past years, in one stroke.
The exposure clusters, too. Businesses with stable, long-serving workforces, which is most manufacturing in Rajasthan, face a bunching of retirements that can land several large payments in the same quarter.
A group gratuity scheme moves the liability off your cash flow. You contribute to a fund managed by a life insurer, the corpus earns a return, and payments are made from the fund as employees leave rather than from working capital in the month somebody retires.
Contributions to an approved gratuity fund are deductible under section 36(1)(v) of the Income Tax Act, subject to the conditions there, which an unfunded provision is not. The scheme also carries the death and disablement tail, where the full gratuity becomes payable immediately even for an employee with two years of service.
Actuarial valuation of the liability is required under AS 15 and Ind AS 19 for most employers regardless. Once the number is being computed anyway, the question of whether to fund it is worth answering deliberately.
Fifteen divided by twenty-six, multiplied by last drawn monthly wages, multiplied by completed years of service, capped at twenty lakh rupees. The formula survived the labour codes intact. The definition of wages did not, so read the next answer before you rely on a figure.
For a permanent employee resigning or retiring, five years of continuous service is still required. Two exceptions matter. It is payable from day one if the employee dies or becomes disabled, with no qualifying period at all. And under the Code on Social Security, 2020, a fixed-term employee earns gratuity pro rata after one year, which is new and catches employers who use fixed-term contracts at scale.
The Act applies to establishments with ten or more employees on any day in the preceding twelve months. Once it has applied, it continues to apply even if the headcount later falls below ten.
This changed on 21 November 2025 and it is the question worth getting right. The starting point is still basic plus dearness allowance, with house rent allowance, conveyance, overtime and bonus excluded. But the Code on Social Security, 2020 caps those exclusions: if they exceed half of total remuneration, the excess is added back into wages. Many Indian pay structures are allowance-heavy enough to be caught by that, which raises gratuity, and the calculator above will understate the liability if you enter only basic plus DA. Send us a sample salary structure and we will work out the correct wage base.
It converts an unpredictable cash outflow into a planned contribution, earns a return on the corpus, carries the immediate death and disablement liability, and contributions to an approved fund are deductible under section 36(1)(v), which a book provision is not.
Related: Group gratuity · Group term life · Workmen compensation calculator