What is Gratuity: How It Works, Eligibility and Calculation

What is Gratuity?If you have been working for a company for a few years, you’ve probably heard people talking about gratuity,  sometimes with excitement, sometimes with confusion. 

Many employees know they will receive some amount when they leave a job, but they don’t fully understand what it is, how it is calculated, or who exactly is eligible for it. So here we will cover all about Gratuity.

What is Gratuity?

Gratuity is a lump-sum amount your employer gives you as a “thank you” for the service you have provided to the company over the years. It is not part of your monthly salary. Instead, it is a one-time payment you receive when you:

• Leave the job, or

• Retire, or

• Are unable to continue working due to sickness or disability, or

• In unfortunate situations, your family receives it if something happens to you.

Think of gratuity as your company’s way of appreciating your loyalty and long-term commitment.

It is governed by the Payment of Gratuity Act, 1972 in India, which ensures that employees receive fair and consistent benefits.

Why Do Companies Pay Gratuity?

Companies pay gratuity because:

• It encourages long-term retention.

• It builds trust between the employee and employer.

• It is a part of social security benefits, helping employees after years of service.

• The law makes it mandatory for companies with 10 or more employees.

So, even though it feels like a bonus or reward, gratuity is actually your legal right, not a favour.

Eligibility for Gratuity: Who Can Get It?

This is one of the most common questions employees have. Here is the eligibility in the simplest terms:

You must complete at least 5 years of continuous service

This is the basic requirement. Continuous service means you have worked without major breaks.

But do you know something important?

4 years + 240 days also counts as 5 years in many cases.

This is because of certain court rulings. So if you have completed 4 years and at least 240 working days in the 5th year, you may still qualify.

Exceptions (You can receive gratuity even before 5 years)

Gratuity is paid even if you have not completed 5 years when:

• The employee passes away

• The employee suffers from permanent disability

In such cases, the full gratuity is paid immediately to the employee or family.

How Is Gratuity Calculated?

This is the secondary keyword many people search for because the formula can look confusing. So let’s simplify it.

If your company comes under the Gratuity Act:

Gratuity Formula

Gratuity = (Last drawn salary × 15 × Number of years of service) ÷ 26

Where:

• Last drawn salary = Basic salary + Dearness Allowance

• 15 = 15 days of salary per year

• 26 = Number of working days in a month (as per the Act)

Example

Let’s say:

• Basic + DA = ₹30,000

• You worked for 7 years

Then:

Gratuity = (30,000 × 15 × 7) ÷ 26
= (30,000 × 105) ÷ 26
= 31,50,000 ÷ 26
≈ ₹1,21,154

So you will receive ₹1.21 lakh as gratuity.

Why 15 days salary?

Because the law considers 15 working days of pay as the standard reward for a full year of service.

Maximum Limit of Gratuity

As per the latest rules, the maximum tax-free gratuity amount is ₹20 lakh.

When Is Gratuity Paid?

Gratuity is generally paid within 30 days from the date of leaving the company.

You do not have to “apply” for it in a complicated way. Most HR departments automatically process it. But if there is a delay beyond 30 days, the employer may have to pay interest on the pending amount.

Is Gratuity Taxable?

Yes, but only partially. Here’s the simple breakdown:

Up to ₹20 lakh is tax-free

Any amount above ₹20 lakh is taxable under income tax laws.

Who gets the tax benefit?

• Private sector employees - Limit ₹20 lakh tax-free

• Government employees - Entire gratuity is tax-free

Types of Employees Covered

You are legally entitled to gratuity if you work in:

• Private companies

• Public sector units

• Schools and colleges

• Shops and commercial establishments

• Mines and factories

• Railways

• Port and shipping companies

Basically, any organisation with 10 or more employees must follow the gratuity law.

Why Gratuity Matters for You

Gratuity plays an important role in your financial planning. Here’s why:

• It gives you financial support when you leave a job

• It acts as a mini retirement bonus.

• It rewards your long-term loyalty.

• You can use it for emergencies, savings, investment, or starting something of your own.

Over a 15-20 year career, gratuity can add up to a big amount.

What Happens to Gratuity During Mergers and Acquisitions (M&A)?

This is another important point employees often worry about. During M&A (Mergers and Acquisitions), many companies undergo structural changes. Employees get new IDs, new reporting managers, new HR rules, and sometimes even new roles.

But what about gratuity?

Here’s the good news:

Your gratuity is protected even if your company is taken over by another company.

During M&A:

• Your years of service continue (they don’t reset).

• The new employer becomes responsible for gratuity.

• You will receive gratuity based on total service, not just service after the takeover.

So, if you worked 6 years in Company A and it gets acquired by Company B, your total service will still be counted as 6 years.

This is a legal requirement and companies cannot take away your gratuity rights during mergers or acquisitions.

Can an Employer Refuse to Pay Gratuity?

Generally, no. But in some rare situations, gratuity can be withheld. These include:

• Misconduct involving violence

• Theft or fraud

• Damage to company property was caused intentionally

Note - Even in such cases, the employer must prove the misconduct legally. They cannot randomly deny your gratuity.

Does Changing Jobs Affect Gratuity?

Yes, but not in a negative way. Whenever you change companies, your gratuity does not carry forward.

Instead, the amount you earned is:

• Paid to you when you leave (if you completed 5 years), or

• Saved until you complete 5 years

Then, when you join a new company, a new gratuity cycle begins.

Gratuity in Case of Death or Disability

This is one of the most important parts of gratuity law.

If the employee passes away:

The family receives the gratuity amount.

If the employee becomes permanently disabled:

They still receive full gratuity—even if they have not completed 5 years of service.

The law is very employee-friendly in such situations.