Gratuity

Gratuity is a statutory lump-sum benefit paid by an employer to an employee upon leaving the organization after completing at least five years of continuous service. Governed by the Payment of Gratuity Act, 1972, it applies to every establishment with 10 or more employees. The formula for calculating gratuity is straightforward: last drawn salary multiplied by 15, multiplied by years of service, divided by 26. Gratuity is both a legal obligation for employers and a significant component of an employee’s terminal benefits, often amounting to several months’ salary.

How Gratuity Works

The Payment of Gratuity Act covers all employees regardless of designation or salary level. However, the calculation and tax exemption rules differ based on whether the employee is covered under the Act.

Eligibility Conditions:

• Minimum 5 years of continuous service (4 years and 240 days is treated as 5 years)
• Exception: No minimum service required if termination is due to death or disablement
• Applies on resignation, retirement, superannuation, death, or disablement

“Last Drawn Salary” for Gratuity:

For employees covered under the Act, “last drawn salary” means basic salary plus dearness allowance (DA). It does not include HRA, bonuses, overtime, or other allowances. For employees not covered under the Act (establishments with fewer than 10 employees), the definition may include all components of salary as per the employment terms.

Service Rounding Rules:

• Service of 6 months or more above a completed year is rounded up to the next full year
• Service of less than 6 months above a completed year is ignored
• Example: 7 years and 8 months = 8 years for gratuity calculation
• Example: 7 years and 4 months = 7 years for gratuity calculation

Maximum Gratuity:

The current statutory ceiling on tax-exempt gratuity is ₹20,00,000 (₹20 lakhs). An employer can pay more than this amount, but the excess is taxable in the employee’s hands.

Gratuity Calculation Example

Formula: (Last Drawn Salary × 15 × Years of Service) / 26

The divisor of 26 represents the number of working days in a month (30 minus 4 Sundays). The multiplier of 15 represents 15 days’ wages for each completed year of service.

Example 1: An employee with 8 years of service and a last drawn salary (basic + DA) of ₹50,000/month:

Parameter	Value
Last Drawn Salary (Basic + DA)	₹50,000
Years of Service	8
Formula	(50,000 × 15 × 8) / 26
Gratuity Amount	₹2,30,769

Example 2: A senior employee with 15 years of service and a last drawn salary of ₹1,20,000/month:

Parameter	Value
Last Drawn Salary (Basic + DA)	₹1,20,000
Years of Service	15
Formula	(1,20,000 × 15 × 15) / 26
Gratuity Amount	₹10,38,462

Most Indian employers include a gratuity provision in the CTC at 4.81% of basic salary (derived from 15/26 x 1/12). This is set aside monthly even though it is paid only at exit after 5 years. The current tax-exempt ceiling is ₹20,00,000 — any amount above this is taxable.

Why Gratuity Matters for Foreign Companies

Gratuity is one of the most commonly misunderstood obligations for foreign employers in India. Key considerations:

• It is not optional. Any establishment with 10+ employees must pay gratuity. There is no way to contract out of this obligation.
• It is a future liability. Even though gratuity is paid only at exit, the liability accrues from day one. Companies must provision for it in their books.
• It compounds with tenure. Long-serving employees can accumulate substantial gratuity amounts. A 20-year employee with a ₹80,000 basic salary would receive ₹9,23,077 in gratuity.
• Forfeiture is limited. An employer can forfeit gratuity only if the employee was terminated for misconduct causing damage to company property, and even then, only to the extent of the damage. Gratuity cannot be withheld for poor performance or policy violations.

For foreign companies hiring through an EOR, gratuity is the EOR’s liability — but the cost is passed through as part of the CTC structure.

How Omnivoo Handles Gratuity

Omnivoo provisions gratuity monthly as part of payroll processing, tracking each employee’s accrued liability in real time. When an employee exits after 5+ years, Omnivoo calculates the exact gratuity amount based on their final salary and tenure, includes it in the full and final settlement, and ensures payment within the statutory 30-day deadline. The platform also handles the tax treatment — applying the ₹20 lakh exemption and reporting any taxable excess.