Gratuity Meaning: Rules, Process, Calculation and Employee Rights

We have all heard about gratuity, but how many of us truly understand our rights as employees in India or the gratuity meaning? It is a legal right that every eligible employee is entitled to receive after completing the required years of service with an organisation.

This detailed guide explains the gratuity meaning, the new gratuity eligibility rules, the revised wage definition for calculation, the new payment timelines, and the rights every employee must know.

What is gratuity?

The gratuity meaning is simple. It is a lump sum monetary payment given by an employer to an employee as a token of appreciation for long-term service, loyalty, and contribution to the organisation. This payment is a significant retirement benefit aimed at providing financial security to employees after their service ends.

How Gratuity Works in India?

Gratuity works by rewarding an employee for long and continuous service with a one-time lump sum when they leave the organisation. 

The amount is calculated using a fixed formula based on the employee’s last drawn salary and total years of service. It is paid entirely by the employer and becomes legally payable on resignation, retirement, death, or permanent disability.

The Government of India has taken an important step by bringing the four Labour Codes into effect from 21st November, 2025.

Gratuity Rules in India: Key Provisions under the Payment of Gratuity Act, 1972

Gratuity applies to every organisation in India that has ten or more employees, regardless of the industry. 

Major New Gratuity Rules in India 

India’s updated gratuity framework under the Social Security Code has introduced several important changes that affect both employees and employers. 

These updates focus on the New Gratuity Eligibility Rule, the wage definition for gratuity two thousand twenty five, and faster payment timelines.

Key Changes Under the New Gratuity Rules

1. Gratuity Eligibility Reduced to One Year for Fixed-Term Employees

One of the biggest changes is the introduction of gratuity eligibility for one year of service for fixed-term employees. Anyone working under a fixed-term contract can now receive gratuity on a pro rata basis after completing one continuous year. 

This is a major shift from the earlier five-year requirement and strengthens social security for short-term workers.

Gratuity for contract employees- Under India’s new labour codes, contract employees are now eligible for gratuity after just one year of continuous service, a significant change from the previous five-year requirement. 

2. New Wage Definition for Gratuity 2025 Calculation

The new Labour Codes introduce a revised definition of wages. This definition must be used for gratuity calculation.

Key points:

• Wages must form at least fifty per cent of total remuneration.
• If allowances exceed fifty per cent, the excess amount must be added back to wages.
• This prevents employers from reducing the gratuity base by increasing allowances.
• This creates a fairer and more accurate wage structure for statutory benefits.

This change directly affects the last drawn salary used in the gratuity formula.

3. Faster Gratuity Payouts

Under the new gratuity rules:

• Employers must pay gratuity within thirty days of the date it becomes payable.
• If the employer delays payment beyond thirty days, they must pay interest at ten per cent per year.
• The employer must initiate the payment. The employee does not need to make a demand first.

4. Possible Higher Tax Exemption Limit

Although the current limit remains twenty lakh rupees, ongoing discussions suggest the ceiling may increase to twenty-five lakh or even thirty lakh rupees. This is part of broader gratuity reforms taking shape.

Core Gratuity Rules Under the Payment of Gratuity Act

1. Gratuity Applicability and Coverage

The Payment of Gratuity Act applies to factories, mines, plantations, and all establishments with ten or more employees. Once applicable, it continues permanently, even if the employee count falls later.

2. Gratuity Eligibility in India

Gratuity becomes payable on superannuation, resignation, retirement, death, or permanent disability. Permanent employees need five years of service, while fixed-term employees qualify after one year.

3. Gratuity Taxation Rules

Government employees receive a full tax exemption on gratuity. Private sector employees get an exemption up to twenty lakh rupees, while those not covered by the Act receive a partial exemption based on a defined formula.

4. Gratuity Nomination

Employees must file a nomination after completing one year of service, usually in favour of a family member. Nominations can be updated anytime, and non-family nominations become invalid once the employee has a family.

5. Forfeiture of Gratuity

Gratuity may be forfeited fully or partly for misconduct, violence, willful damage, or acts involving moral turpitude during employment. Employers can forfeit the amount up to the extent of the loss caused.

Old Rules vs New Labour Codes: What Has Changed for Workers in India

Category	Before Labour Codes	After Labour Codes
Formal Employment	No mandatory appointment letters.	Appointment letters are mandatory for all workers, ensuring clarity and job security.
Social Security Coverage	Very limited coverage for workers.	All workers, including gig and platform workers, receive social security benefits such as provident fund, ESIC, insurance, and more.
Minimum Wages	Applied only to selected industries, leaving many workers uncovered.	All workers have a statutory right to minimum wages and timely wage payments.
Preventive Healthcare	No requirement for free annual health check-ups.	Employers must provide a free annual health check-up to workers above forty years of age.
Timely Wages	No strict rule for the timely payment of wages.	Employers must pay wages on time, supporting financial stability and reducing stress.
Women’s Workforce Participation	Women were restricted from night shifts and certain roles.	Women can work night shifts and in all types of roles with their consent and proper safety measures.
ESIC Coverage	Limited to notified areas and specific industries. Smaller establishments are usually excluded.	ESIC benefits are available across India. Voluntary for establishments with fewer than ten employees and mandatory for hazardous work with even one employee.
Compliance Burden	Multiple registrations, licences, and returns under different laws.	Single registration, single licence, and single return across India, reducing compliance burden.

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Gratuity Calculation Formula

As per the new gratuity rules for employees covered under the Gratuity Act, the basic formula remains the same.

Gratuity calculation new labour code = (Last drawn wages multiplied by fifteen multiplied by completed years of service) divided by twenty-six

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

• Qualifying Wages: This includes basic salary and dearness allowance (DA). The key new rule is that these components must collectively amount to at least 50% of the employee’s total monthly remuneration (CTC). 

If allowances exceed this 50% threshold, the excess amount is considered part of the “wages” for gratuity calculation purposes.

• 15 ÷ 26: This represents 15 days of wages for every completed year of service, based on a statutory 26-day working month (excluding weekly offs).
  
• Number of Years of Service: This is the total number of completed years of continuous service. If the final year of service is six months or more, it is rounded up to one full year (e.g., 7 years and 8 months counts as 8 years).

Example Calculation:

If the Qualifying Wage (after applying the 50% CTC rule) is ₹35,000 and the employee has completed nine years of service:

₹35,000×15×9÷26=₹1,81,731 (approx)

What is the Gratuity Form

The term “gratuity form” refers to statutory forms prescribed under the Payment of Gratuity (Central) Rules, 1972. Each form serves a specific purpose.

• Form F: Nomination form for employees
• Form I: Application for gratuity by an employee
• Form J: Application for gratuity by a nominee after the employee’s death
• Form K: Application for gratuity by a legal heir if the employee died without a valid nomination
• Form L: Notice issued by the employer detailing the gratuity calculation and the payable amount

Form M: Notice of rejection or refusal of gratuity payment, with reasons stated

Key Differences Between Gratuity and Pension

Gratuity and pension are both important post-employment benefits, but they serve very different purposes and operate under different rules. 

Feature	Gratuity	Pension
Type of Benefit	One-time lump sum payment	Regular monthly payment
Purpose	Immediate financial support after employment ends	Long-term income support during retirement
Paid By	Employer	Employer or pension fund, depending on the scheme
Eligibility	Gratuity eligibility 1 year	Depends on the pension scheme and the length of service requirements
Payment Timing	Paid once at the time of separation	Paid periodically, usually every month
Tax Treatment	Tax-free up to twenty lakh rupees	Partially taxable depending on the type of pension
Nomination	Filed through Form F under the Gratuity Act	Done as part of the pension scheme enrollment
Contribution	Entirely paid by the employer	May involve employer contribution, employee contribution or both, depending on the scheme

Conclusion

Gratuity is a long-term financial safeguard and a recognition of the time, effort and loyalty an employee has invested in an organisation. Knowing how gratuity works ensures that when the time comes to leave an organisation, you are prepared, protected and fully aware of what you are entitled to receive as part of your service journey.

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Gratuity Meaning- FAQs