Gratuity is a statutory monetary benefit payable by an employer to an employee upon termination of employment after completion of five years of continuous service, calculated at the rate of fifteen days' wages for every completed year of service. Under Indian law, gratuity is governed by the Payment of Gratuity Act, 1972, with the entitlement, calculation formula, and maximum limit prescribed under Section 4.
Legal definition
The Payment of Gratuity Act, 1972 establishes the entitlement:
Section 4(1): Gratuity shall be payable to an employee on the termination of his employment after he has rendered continuous service for not less than five years, — (a) on his superannuation, or (b) on his retirement or resignation, or (c) on his death or disablement due to accident or disease.
Section 4(2): For every completed year of service or part thereof in excess of six months, the employer shall pay gratuity to an employee at the rate of fifteen days' wages based on the rate of wages last drawn by the employee concerned.
The formula for calculation is:
Gratuity = Last drawn wages x 15/26 x Number of completed years of service
"Wages" for this purpose includes basic wages and dearness allowance but excludes bonus, overtime, house rent allowance, and other allowances. For piece-rated employees, the calculation is based on average daily wages over the last three months preceding termination.
Maximum limit: The statutory ceiling on gratuity was raised to Rs 25 lakh with effect from 29 March 2024 (previously Rs 20 lakh from 29 March 2018). Any gratuity payable under the Act cannot exceed this ceiling.
Exception to five-year requirement: Section 4(1) provides that the condition of five years' continuous service is not necessary where the termination of employment is due to death or disablement.
New law equivalent: The Social Security Code, 2020 retains the gratuity provisions under Section 53 with similar structure and proposes to extend coverage to fixed-term employees without the five-year minimum service requirement.
How courts have interpreted this term
Surendra Kumar Verma v. Central Government Industrial Tribunal [(1980) 4 SCC 443]
The Supreme Court established the principle that the Payment of Gratuity Act is a beneficial legislation and must be interpreted liberally in favour of the employee. The Court held that the term "continuous service" under Section 2A should be given a wide interpretation and that interruptions in service caused by the employer (such as unauthorized lay-off or illegal termination followed by reinstatement) should not break the continuity of service for computing gratuity.
Lalappa Lingappa v. Laxmi Vishnu Textile Mills [(1981) 2 SCC 238]
The Court held that the Payment of Gratuity Act is a self-contained code for the determination and recovery of gratuity. An employee need not file a civil suit; the statutory machinery under Section 7 (Controlling Authority) and Section 7A (appellate authority) provides the exclusive remedy. This ruling streamlined the enforcement mechanism for gratuity claims.
Metroark Ltd. v. Commissioner of Central Excise [Though the primary gratuity jurisprudence is supplemented by] D.S. Nakara v. Union of India [(1983) 1 SCC 305]
While D.S. Nakara dealt principally with pension, the Supreme Court's reasoning — that retirement benefits are deferred wages and constitute a fundamental right to livelihood under Article 21 — has been applied to gratuity claims. Courts have relied on this principle to hold that gratuity, once accrued, is a vested right that cannot be arbitrarily denied.
Why this matters
Gratuity functions as a form of deferred compensation — a reward for long and meritorious service that provides a financial cushion upon separation from employment. It is one of the three pillars of statutory retirement benefits in India, alongside the Employees' Provident Fund and the Employees' Pension Scheme.
For employers, the gratuity obligation is universal across all establishments employing 10 or more persons. Unlike the EPF (which requires monthly contributions), gratuity is a terminal benefit — the full amount becomes payable only upon the employee's exit. Prudent employers maintain a gratuity fund (either through the Life Insurance Corporation's Group Gratuity Scheme or an approved gratuity trust) to avoid a large lump-sum liability. Section 7(3A) mandates payment within 30 days of it becoming payable; failure to pay attracts simple interest at the rate notified by the government.
For employees, the five-year threshold is the most critical practical issue. An employee who is terminated or resigns after four years and eleven months is not entitled to gratuity (unless the exit is due to death or disablement). This has led to allegations of employers engineering terminations just before the five-year mark, which courts have treated as an unfair labour practice in appropriate cases.
A common misunderstanding is that gratuity is discretionary or that it can be forfeited at the employer's will. Under Section 4(6), an employer may forfeit gratuity only in two situations: (a) where the employee's services are terminated for riotous or disorderly conduct or any act of violence, or (b) where the services are terminated for any act constituting an offence involving moral turpitude, provided such offence is committed in the course of employment and the employee is convicted for it. Partial forfeiture is permitted to the extent of damage caused to the employer's property.
Related terms
Related statutory benefits:
Related concepts:
Frequently asked questions
How is gratuity calculated in India?
The formula is: Last drawn wages x 15/26 x Number of completed years of service. "Last drawn wages" means basic pay plus dearness allowance. The division by 26 (not 30) accounts for working days in a month. For example, an employee with 20 years of service and last drawn wages of Rs 50,000 per month is entitled to Rs 50,000 x 15/26 x 20 = Rs 5,76,923. The maximum payable is Rs 25 lakh.
Is gratuity taxable in India?
For government employees (central, state, local authority, defence), gratuity received is fully exempt from income tax. For employees covered under the Payment of Gratuity Act, the exemption is limited to the least of: (a) Rs 25 lakh, (b) 15 days' wages for each completed year of service, or (c) the actual gratuity received. For employees not covered under the Act, a separate calculation applies under Section 10(10) of the Income Tax Act.
Can an employer deny gratuity to an employee who is terminated?
An employer cannot deny gratuity merely because the employee was terminated (as opposed to resigning or retiring). Gratuity is payable on any termination of employment after five years of continuous service. The only grounds for forfeiture are: (a) termination for riotous or violent conduct, or (b) termination for an act involving moral turpitude committed during employment, for which the employee has been convicted. Even in these cases, forfeiture must be to the extent specified in Section 4(6).
Does gratuity apply to contract workers and fixed-term employees?
The Payment of Gratuity Act applies to all employees in establishments with 10 or more persons, regardless of the nature of employment. Contract workers who have completed five years of continuous service are entitled to gratuity. For fixed-term employees, the Social Security Code, 2020 proposes to make gratuity payable on a pro-rata basis even if the contract period is less than five years, though this provision awaits notification.
This entry is part of the Veritect Indian Legal Glossary, a comprehensive reference of Indian legal terminology grounded in statutory text and judicial interpretation.
Last updated: 2026-03-27. Veritect provides this content for informational purposes and does not constitute legal advice.