Payment of Gratuity Act Calculation

Gratuity is the lump-sum terminal benefit an employer pays an employee for long service. It is not discretionary, not a bonus, and not something an employer can convert into “ex gratia” goodwill. Where the statutory conditions are met, it is a debt.

The calculation is where almost all the difficulty sits – and, oddly, not because the arithmetic is hard. The arithmetic is one line. Every material error is an input error. Feed the formula the wrong wage figure, the wrong year count, or apply it to someone who was never eligible, and you produce a confident, precisely-wrong number. Under-pay and you are exposed to a statutory claim with interest. Over-pay and you have created an unrecoverable provision across your whole workforce.

This entry therefore takes the formula apart rather than restating it. One caveat first: the legal foundation moved. The Payment of Gratuity Act, 1972 was repealed when the Code on Social Security, 2020 came into force on 21 November 2025, and gratuity now sits in Chapter V of the Code, Sections 53 to 58. The architecture survived almost intact – which is why the 1972 Act is still the reference point in most published guidance – but the section numbers, and one crucial input, have changed. More on that at the end.

The formula – and where the 26 actually comes from

The number everyone quotes:

Gratuity = (Last drawn wages × 15 × Completed years of service) ÷ 26

Worth knowing: the statute does not contain a “26.” Section 53(2) says gratuity is payable “at the rate of fifteen days’ wages, or such number of days as may be notified by the Central Government, based on the rate of wages last drawn.”

Fifteen days’ wages. For a monthly-rated employee, you therefore need a daily wage, and the convention – carried across from the 1972 Act – is to divide monthly wages by 26, treating a month as 26 working days rather than 30 calendar days. The 26 is a derived step, not a statutory constant. That matters for two reasons: the “15 days” figure is expressly variable by notification, and for employees who are not monthly-rated the divisor is not 26 at all (see Input 4).

You may also encounter a 15/30 formula attributed to “establishments not covered by the Act.” Treat this with care. That calculation – half a month’s average salary over the last ten months, per completed year – is the basis for income-tax exemption for employees not covered by the gratuity statute. It is not an alternative statutory payment formula. Conflating a tax-computation rule with a payment obligation is a common and expensive error.

Input 1 – Is the employee eligible at all?

Run this gate before touching the formula. The default is five years of continuous service, and gratuity becomes payable on superannuation, retirement or resignation, death or disablement due to accident or disease, expiry of fixed-term employment, or any event notified by the Central Government.

The five-year gate has real exceptions, and they are where liability is most often missed:

• Death or disablement – the five-year requirement does not apply at all. Payment goes to the nominee or legal heirs.
• Fixed-term employees – eligible on a pro-rata basis after one year of continuous service. This closes the back-to-back-11-month-contract workaround, and it is the single biggest coverage change under the Code.
• Working journalists – as defined under the Working Journalists Act, 1955, “five years” reads as three years.
• The four-years-and-240-days question – a line of authority treats 240 days of service in the fifth year as satisfying continuous service for the five-year threshold (190 days for underground mine workers). It is widely applied and judicially supported, but not uniformly settled. Take a documented position rather than letting the payroll system decide silently.

Continuous service is read generously. Section 54 treats service as continuous despite interruption for sickness, accident, leave, absence without leave, lay-off, strike, lock-out, or cessation of work not attributable to the employee.

Note also that once an establishment crosses the 10-employee threshold, coverage does not lapse if headcount later falls below it.

Input 2 – What counts as “wages”

This is the input that changed, and the one that will move your numbers most.

Under the 1972 Act, the base was essentially basic pay plus dearness allowance. Under the Code, gratuity is computed on “wages” as defined in Section 2(88) – a single definition applied across the labour codes, carrying a 50% test: where excluded allowances such as house rent allowance, conveyance and overtime together exceed 50% of total remuneration, the excess is deemed to be wages.

The consequence is direct. Salary structures that deliberately kept basic pay at 30–35% of CTC in order to suppress provident fund and gratuity exposure no longer achieve that outcome. Gratuity provisioning rises even though the formula, the multiplier and the divisor are all unchanged.

Worked illustration. An employee on ₹1,00,000 per month, structured as ₹30,000 basic and ₹70,000 allowances, with 10 completed years:

• On the old basis – wages ₹30,000. Gratuity = (30,000 × 15 × 10) ÷ 26 = ₹1,73,077
• Applying the 50% test – excluded allowances of ₹70,000 exceed half of ₹1,00,000, so ₹20,000 is deemed wages, giving a base of ₹50,000. Gratuity = (50,000 × 15 × 10) ÷ 26 = ₹2,88,462

Same tenure, same formula, roughly 67% more liability. Multiply across a long-tenure population and the balance-sheet effect is significant. What it is not is a reason to include HRA and allowances wholesale in the base – the 50% test adds only the excess, not the whole allowance block.

Input 3 – How many years count

Section 53(2) pays for every completed year of service, or part thereof in excess of six months. So the year count rounds up when the trailing fraction exceeds six months, and is discarded when it does not.

• 10 years 7 months → 11 years
• 10 years 5 months → 10 years

Two cautions. First, the rounding rule is a computation rule and is entirely separate from the five-year eligibility gate in Input 1 – an employee with 4 years 7 months does not reach five years by rounding. Second, “part thereof in excess of six months” means strictly more than six months; exactly six months does not round up.

Input 4 – Which daily-wage basis applies

For monthly-rated employees, monthly wages ÷ 26. Section 53(2) then sets out three departures:

• Piece-rated employees – daily wages are the average of total wages over the three months immediately preceding termination, excluding any overtime.
• Seasonal establishments, where the employee is not employed throughout the year – seven days’ wages for each season, not fifteen.
• Fixed-term employees and deceased employees – gratuity on a pro-rata basis.

There is also a specific rule for employees on reduced wages following disablement: wages before disablement are taken for the pre-disablement period, and the reduced wages for the period after.

Input 5 – The ceiling, and the three numbers people confuse

Section 53(3) caps gratuity at an amount notified by the Central Government. The operative figure carried forward is ₹20 lakh, raised from ₹10 lakh in March 2018.

Three distinct things get run together here, and separating them resolves most disputes:

• The statutory maximum – the most the employer is obliged to pay under the Code.
• What the employer may actually pay – nothing prevents paying more than the ceiling, contractually or voluntarily. The cap limits the obligation, not the payment.
• The tax-exempt ceiling – a lifetime aggregate across all employers, not per employment. An employee who used ₹8 lakh of exemption at a previous employer has ₹12 lakh of headroom left, whatever the new employer pays.

On tax specifically: the exemption sat at Section 10(10) of the Income Tax Act, 1961, and since the Income Tax Act, 2025 has replaced the 1961 Act, employers should confirm the corresponding provision and current ceiling before relying on the old section reference in employee communications.

Three worked calculations

A standard resignation. Wages ₹50,000, service 10 years 7 months → 11 years. (50,000 × 15 × 11) ÷ 26 = ₹3,17,308.

A fixed-term contract ending at two years. Wages ₹40,000, no five-year gate. (40,000 × 15 × 2) ÷ 26 = ₹46,154, payable pro rata on expiry of the term.

Death in service at three years. Wages ₹45,000. The five-year requirement does not apply and payment is pro rata: (45,000 × 15 × 3) ÷ 26 = ₹77,885, payable to the nominee, or to legal heirs where no valid nomination subsists.

Where the standard formula does not apply

Six situations in which the one-line calculation is the wrong starting point:

• Forfeiture for damage or loss. Under Section 53(6), where services are terminated for a wilful act, omission or negligence causing damage, loss or destruction of the employer’s property, gratuity is forfeited to the extent of that loss – a proportionality limit, not a licence to withhold the whole amount.
• Forfeiture for conduct. Gratuity may be wholly or partially forfeited where termination is for riotous or disorderly conduct or another act of violence, or for an offence involving moral turpitude committed in the course of employment.
• Forfeiture is narrow, and courts police it. In Jaswant Singh Gill v. Bharat Coking Coal, the Supreme Court held that gratuity is a statutory right that cannot be withheld unless the statutory forfeiture conditions are actually satisfied – internal company rules do not override the statute. Forfeiture requires the specific ground, not merely a contested exit.
• Better terms elsewhere. Where a contract, award or settlement gives more favourable gratuity terms, those prevail. The statute sets a floor.
• Government employees holding posts governed by other gratuity rules are outside Chapter V.
• Seasonal and piece-rated employees, per Input 4.

Payment mechanics

• Nomination is provided for under Section 55 and should be collected at onboarding, not at exit. Its absence is what turns a death claim into a legal-heirs exercise.
• Notice of determination – under Section 56(2), the employer must issue notice of the amount within 30 days of gratuity becoming payable.
• Payment – under Section 56(3), within 30 days of the date it becomes payable. Delay attracts simple interest at a rate notified by the Central Government, unless the delay is attributable to the employee. Under the 1972 Act this rate was 10%; confirm the notified rate under the Code rather than assuming continuity.
• Compulsory insurance – Section 57 requires non-government employers to obtain insurance for their gratuity liability, from a date to be notified by the appropriate Government, with exemption available where an approved gratuity trust already exists. For employers operating in more than one State the appropriate Government is the Centre. This is a funding obligation, not merely a provisioning one, and it is worth confirming the notified commencement position for your States.
• Competent authority – Section 58 provides the determination and recovery machinery.

What actually changed in November 2025

For anyone reconciling this entry against older guidance:

• The Payment of Gratuity Act, 1972 is repealed; gratuity is in Chapter V, Sections 53–58 of the Code on Social Security, 2020, in force from 21 November 2025. Section 4 of the old Act maps broadly to Section 53.
• Preserved: the five-year threshold, the 15 days’ wages rate, the six-month rounding rule, the death and disablement waiver, the forfeiture grounds, the 10-employee coverage threshold, the ₹20 lakh ceiling figure.
• New or changed: the uniform wage definition with the 50% test, pro-rata gratuity for fixed-term employees after one year, an express compulsory insurance requirement, and a ceiling and delay-interest rate that are now set by notification rather than written into the statute.
• The Central Social Security Rules were notified on 8 May 2026, and rules and notifications under the Code continue to be issued in phases – including at State level, where positions vary.

How Mercans supports gratuity compliance in India

Mercans is a global leader in payroll technology and Employer of Record services, operating across 160 countries through proprietary SaaS platforms and in-country delivery teams, with its own legal entity in India.

On gratuity, Mercans tests eligibility against the correct threshold for each employee category, applies the Code’s wage definition and the 50% test to the calculation base, handles the rounding, pro-rata and seasonal variants, maintains nominations, tracks the 30-day notice and payment windows, and reflects gratuity liability alongside EPF, ESI, TDS and Professional Tax obligations. Because the labour-code transition is still in progress, ongoing changes are tracked in the Mercans statutory alerts library.

See also Mercans’ India payroll and EOR capabilities, global payroll outsourcing, local statutory compliance services and the HR Blizz platform.

Frequently Asked Questions (FAQs)

1. What is the gratuity calculation formula, and what does the 26 represent?

(Last drawn wages × 15 × completed years of service) ÷ 26. The statute provides for 15 days’ wages per completed year, based on wages last drawn; the 26 is the conventional step for converting monthly wages into a daily rate, treating a month as 26 working days. It is not a statutory constant, and it does not apply to piece-rated or seasonal employees, who have their own bases. The “15/30” formula sometimes cited applies to income-tax exemption for employees outside the statute, not to the payment obligation.

2. Has gratuity calculation changed under the labour codes?

The formula has not; the wage base has. The Payment of Gratuity Act, 1972 was repealed on 21 November 2025 and gratuity now sits in Chapter V of the Code on Social Security, 2020. Gratuity is computed on “wages” as defined by the Code, which applies a 50% test – where excluded allowances exceed half of total remuneration, the excess is deemed to be wages. Employers whose structures kept basic pay low to suppress gratuity exposure will see materially higher liability. Fixed-term employees also now qualify pro rata after one year.

3. Can an employee claim gratuity with less than five years of service?

Yes, in defined cases. The five-year requirement does not apply on death or disablement due to accident or disease. Fixed-term employees qualify on a pro-rata basis after one year. Working journalists have a three-year threshold. There is also a line of authority treating 4 years plus 240 days in the fifth year as meeting the requirement, though this is not uniformly settled and warrants a documented position. Outside these routes, a resignation before five years does not attract statutory gratuity.

4. When must gratuity be paid, and what happens if it is late?

The employer must issue notice of the determined amount within 30 days of gratuity becoming payable, and make payment within 30 days of that date. Late payment attracts simple interest at the rate notified by the Central Government, unless the delay is attributable to the employee – under the 1972 Act this was 10%, and the notified rate under the Code should be confirmed rather than assumed. Employers cannot withhold gratuity as leverage in a disputed exit: forfeiture is available only on the narrow statutory grounds, and courts have consistently held that internal rules do not displace the statutory entitlement.