What is Gratuity – Meaning, Calculation and New Gratuity Rules

Gratuity is a statutory benefit that employers pay to employees as a gesture of appreciation for long and continuous service. From 21 November 2025, India’s updated gratuity rules recognise both permanent and fixed-term employees. 

Let us understand the gratuity meaning in salary and explore the latest gratuity rules!

Gratuity Meaning in Salary

Gratuity means a mandatory, one-time lump sum paid by an employer as appreciation for an employee’s long-term service. It is a statutory social security benefit meant to offer financial support when an employee leaves the organisation.

As of December 2025, India’s gratuity rules are now fully enforceable under the Social Security Code, 2020, which came into effect on November 21, 2025. These updates replace several provisions of the older Payment of Gratuity Act, 1972. The biggest changes relate to eligibility and how the base salary is calculated for gratuity.

Key Gratuity Rules in India (Updated for 2025)

1. Expanded Wage Definition for Gratuity Calculation (50 percent rule)

The Social Security Code has introduced a uniform definition of wages that affects how gratuity is calculated. 

Earlier, companies typically used basic pay plus dearness allowance to compute gratuity. Many employers kept basic pay low and provided higher allowances to reduce their gratuity and provident fund liability.

The new rule requires that wages must make up at least fifty percent of the total Cost to the Company. If the total allowances exceed fifty percent of the CTC, the excess amount will be added back to the wages for gratuity calculation.

This increases the gratuity base and results in higher payouts for many employees.

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

Gratuity eligibility in India now depends on the type of employment. 

1. For Permanent Employees

Permanent, full-time employees still need five years of continuous service to receive gratuity. This five-year rule remains unchanged for regular staff. The only exception continues to be cases of death or permanent disability, where the five-year condition is waived.

2. For Fixed Term and Contract Employees

Fixed-term employees become eligible for gratuity after one year of continuous service. This is the most important change introduced by the new rules. Employees hired on yearly contracts, project-based roles, and fixed-term letters now qualify without waiting for five years.

3. Other Eligibility Conditions

• Establishments must have at least ten employees to be covered under the gratuity law.
• Continuous service includes approved leave, absence due to sickness, accidents, or maternity.
• In the event of death or disablement, gratuity becomes payable even if the minimum service period is not completed.
  

3. Mandatory Timely Payment by Employers
Employers must pay the gratuity amount within thirty days of an employee’s exit. Delays attract a compulsory interest penalty of ten percent per year.

4. Maximum Tax-Exempt Limit
The tax-exempt limit for private sector employees remains ₹20 lakh.

5. Gratuity Formula Remains the Same
Only the wage definition has changed. 

6. Maximum Gratuity Limits in 2025

Under the new gratuity rules introduced through the Social Security Code, 2020 (effective November 21, 2025), the maximum tax-exempt gratuity limit for private sector employees remains ₹20 lakh. 

For Central Government employees, the limit was increased to ₹25 lakh from January 1, 2024, after the Dearness Allowance reached 50 percent.

How to Calculate Gratuity

The new labour codes have updated two important inputs: the definition of wages and eligibility for fixed-term employees. These changes may increase the final gratuity amount for many workers.

Gratuity Calculation Formula

The formula used depends on whether the employer is covered under the Payment of Gratuity Act, 1972.

1. Employers Covered by the Gratuity Act

This is the most common category.
Service is rounded up if the final year exceeds six months.

Formula:

 Gratuity = 15× Last Drawn Wage×Completed Years of Service/ 26

Last Drawn Wage: Basic + Dearness Allowance, adjusted to meet the fifty per cent CTC rule.
26: Assumed working days in a month.
15: Represents fifteen days of wages for every year of service.

2. Employers Not Covered by the Gratuity Act

Here, only fully completed years are counted.
For example, six years and ten months will be treated as six years.

Formula:

Gratuity= 15×Average Last 10 Months Wage×Completed Years of Service/ 30

Average Last 10 Months’ Wage: Basic, dearness allowance, and eligible commissions averaged over ten months.
30: Total days in a month.

Read-Income tax slabs in India

What is the Use of a Gratuity Calculator

You can use an online gratuity calculator to estimate the gratuity in your salary that you will receive. Gratuity calculators are online tools that estimate the gratuity amount based on inputs like the last drawn salary and years of service.

They are user-friendly and provide quick results.

Can an Employer Refuse to Pay Gratuity?

Certainly, an employer can refuse to pay gratuity under specific circumstances. For example, if an employee is terminated for misconduct, such as violent behaviour or illegal activities, the employer can withhold part or all of the gratuity based on the damage caused.

Is Gratuity Taxable?

The new gratuity rules, effective from November 21, 2025, focus mainly on eligibility and calculation changes. The taxation framework remains the same and continues to be governed by Section 10(10) of the Income Tax Act.

Read More About: New Income Tax Bill 2026

Gratuity Taxation Rules

Employee Type	Tax Status	Maximum Exemption Limit
Central Government	Fully exempt	₹25 lakh
Private sector (covered under Act)	Exempt up to the limit	₹20 lakh (lifetime)
Private sector (not covered)	Exempt up to the limit	₹20 lakh (lifetime)

New Gratuity Rules – FAQs

Source: https://timesofindia.indiatimes.com/

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