Gratuity

Gratuity was one of the statutory employee benefits under Indian labour law, mandated by the Payment of Gratuity Act, 1972, for establishments employing ten or more workers. The benefit became payable when an employee completed a minimum of five years of continuous service with the same employer — a threshold that did not apply in the event of death or disablement, where gratuity was paid regardless of years served. The Act covered employees across factories, mines, oil fields, plantations, ports, railways, shops, and other establishments.

The calculation formula was straightforward: Gratuity = (Last Drawn Basic Salary + Dearness Allowance) × 15/26 × Number of Years of Service. The factor 15/26 arose from the assumption of 26 working days per month, with the employee entitled to 15 days' salary for each completed year. For organisations not covered under the Act (those with fewer than ten employees), a slightly different formula applied — using 30 days in the denominator rather than 26 — and the benefit was voluntary. Years of service were rounded to the nearest full year: six months or more rounded up, less than six months rounded down.

The tax treatment of gratuity was favourable for most employees. For government employees, the entire gratuity amount was exempt from tax. For private-sector employees covered by the Payment of Gratuity Act, the exemption was the least of: (a) actual gratuity received, (b) Rs 20 lakh (the limit enhanced by the government in 2019), or (c) the amount calculated using the statutory formula. This Rs 20 lakh ceiling applied as a lifetime limit across all employers, meaning serial job-changers accumulating gratuity multiple times consumed the exemption limit faster.

A common point of confusion was whether gratuity was part of Cost to Company (CTC) or an additional benefit. Most Indian employers included a gratuity provision in the CTC structure, effectively setting aside 4.81 percent of basic salary (approximately 15/26 of one month's basic per year) as an annual gratuity accrual. This meant take-home pay was indirectly reduced by the gratuity provision, though the employee only received the accumulated amount upon qualifying exit.

Employers had two methods to fund gratuity obligations: self-funded (maintaining a provision on the balance sheet) or through a Group Gratuity scheme administered by life insurance companies (primarily LIC, HDFC Life, SBI Life). Insurance-funded gratuity schemes allowed employers to claim tax deductions on contributions and protected employees' claims in the event of employer insolvency, a safeguard that self-funded provisions did not provide.