Last reviewed: 24 October 2026. Gratuity was a simple line in most payroll sheets: last basic, years of service, multiply by 15/26. Since the four labour codes came into force on 21 November 2025, the wage base, the position of fixed-term staff and the way employers should provide for the liability have all moved. This note sets out what has changed, what has not, and how to compute it, with the tax position of the employee alongside.
What has actually changed
The Code on Social Security, 2020 replaces the Payment of Gratuity Act, 1972. The formula is familiar, but three things matter for payroll. First, "wages" is now defined in the Code itself, with a 50% test that pulls part of the allowances back into the base. Second, fixed-term employees are given a gratuity entitlement of their own. Third, the Ministry has said that existing rules continue until new rules under the Code are finally notified, so your compliance procedure runs on the Code for the substance and on the old rules for the mechanics, for now. Our employer guide to the new labour codes covers the wider payroll changes.
| Point | Position now | Action for the employer |
|---|---|---|
| Permanent employee | Five years of continuous service; waived on death or disablement | No change to the vesting date; recompute the wage base |
| Fixed-term employee | Pro-rata gratuity on contract completion; one-year qualifying period described in government communications | Add gratuity to the contract exit checklist and provision for it |
| Wage definition | Allowances above 50% of total remuneration are added back to wages | Re-run salary structures; correct the base in the gratuity sheet |
| Formula | 15/26 × last drawn wages × years of service | Keep the formula; change the wage input |
| Ceiling | ₹20 lakh, as notified by the Central Government | Cap the computation; watch for a revised notification |
| Payment | Within 30 days of becoming payable, with interest for delay | Build a 30-day clock into the exit process |
The 50% wages rule, with a worked example
Under the Ministry's FAQ, if allowances and benefits (leaving out gratuity and retrenchment compensation) together exceed 50% of total remuneration, the excess is added back to wages. Many CTC structures keep basic pay and dearness allowance at 30% to 40% of the package, so this is where the change bites.
Example 1 (permanent employee). Total monthly remuneration ₹1,00,000. Basic plus DA ₹30,000; allowances ₹70,000. The 50% limit on allowances is ₹50,000, so ₹20,000 is added back. Wages for gratuity become ₹50,000. With 10 completed years of service:
| Basis | Wage base | Gratuity = 15/26 × wages × 10 |
|---|---|---|
| Earlier practice (basic plus DA) | ₹30,000 | ₹1,73,077 |
| With the 50% add-back | ₹50,000 | ₹2,88,462 |
| Increase in liability | ₹20,000 | ₹1,15,385 |
The increase is not a one-time cost. Every employee on a similar structure carries a higher liability, which feeds the actuarial valuation and the provision in your accounts. The FAQ confirms that establishments may make provision as per accounting norms, which helps companies whose books close on a date other than the effective date.
Fixed-term employees
The Code gives fixed-term employees gratuity on a pro-rata basis, and the five-year condition does not apply when the fixed term expires. Government communications describe a one-year qualifying period for these employees. The FAQ itself confirms the waiver and the pro-rata payment, so read the Code's own text for the qualifying period before you finalise a policy.
Example 2 (fixed-term). Contract of two years, wages (after the 50% test) ₹30,000. Gratuity = 15/26 × 30,000 × 2 = ₹34,615. This is an extra cost that was often missing from fixed-term budgets; if you hire for projects or seasons, add it to the cost-to-company sheet at the time of offer.
Tax position of the employee
The wage definition under the labour code and the "salary" used for the income-tax exemption are different things, and payroll teams should not mix them. For tax, the exemption on gratuity received on retirement, resignation or death is the least of three amounts, and the substance carries into the Income-tax Act, 2025 from 1 April 2026 (confirm the clause reference in the schedule of exempt income when you cite it):
- The formula amount, using the salary as the exemption provision defines it (broadly basic pay and dearness allowance that counts for retirement benefits);
- ₹20 lakh; and
- The gratuity actually received.
Government employees are fully exempt. Any excess is taxed as salary, and the employer deducts tax on it under the salary TDS provisions; see our guide to TDS on salary under Section 392.
Example 3 (tax). A private-sector employee retires after 20 completed years. Salary for the tax formula ₹60,000. Formula amount = 15/26 × 60,000 × 20 = ₹6,92,308. The employer pays ₹7,50,000 under a more generous policy. Exempt = least of ₹6,92,308, ₹20,00,000 and ₹7,50,000 = ₹6,92,308. Taxable = ₹57,692, added to salary income. Earlier gratuity received from other employers is counted towards the ₹20 lakh limit.
Employer action plan
- Map the wage base. Run every active salary structure through the 50% test and record the revised gratuity wage per employee.
- Re-do the actuarial estimate. Share the revised wage data with your actuary and book the provision per accounting norms.
- Fix the funding route. Confirm whether your establishment must insure the liability or set up an approved trust, and check the tax deduction basis for contributions.
- Update contracts. Amend fixed-term contracts and exit letters to reflect pro-rata gratuity.
- Collect nominations. Obtain a nomination from each employee at joining and refresh old files.
- Set the 30-day clock. Tie gratuity payment to the full-and-final settlement checklist; add it to your month-end close as a payroll-dues line.
Common mistakes
- Treating the labour-code wage and the income-tax salary as the same number.
- Continuing to compute on basic pay alone after the 50% test has changed the base.
- Leaving fixed-term employees out of the gratuity provision.
- Booking a provision and assuming the tax deduction follows, when deduction is generally linked to funding an approved fund.
- Missing the 30-day payment window and the interest that follows.
Frequently asked questions
Has the five-year condition for gratuity gone?
Not for permanent employees. Five years of continuous service is still the general rule, with an exception for death or disablement. The change is for fixed-term employees, who become entitled to gratuity pro-rata on completing their contract, and government communications describe a one-year qualifying period for them. Confirm the exact wording in the Code before you apply it.
From when do the new gratuity provisions apply?
The Ministry of Labour and Employment FAQ states that gratuity is applicable from 21 November 2025, the date the Code came into force. The same FAQ says the old rules continue until new rules under the Code are finally notified.
Does the 50% rule always increase gratuity?
No. It increases gratuity only where allowances and other benefits exceed 50% of total remuneration, because the excess is added back to wages. If basic pay and dearness allowance already form 50% or more of remuneration, the wage base does not change.
Is gratuity taxable in India?
Gratuity on retirement, resignation or death is exempt up to the statutory limits. Government employees are fully exempt, and for private-sector employees covered by the gratuity law the exemption is the least of the formula amount, ₹20 lakh and the amount actually received. Any excess is taxed as salary.
What is the deadline to pay gratuity once it becomes payable?
The employer should pay within 30 days of the gratuity becoming payable. Delay attracts simple interest at a rate notified by the Central Government, unless the delay is caused by the employee.
Can an employer just make a provision in the books and not fund gratuity?
The FAQ says establishments may make provision as per accounting norms, which settles the books. Funding is a separate question: confirm whether your establishment must insure the liability or set up an approved trust, and note that a tax deduction is generally linked to contributions to an approved fund rather than a book provision alone.
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This note is for general information on the position as understood on 24 October 2026 and is not legal or tax advice. The Code's rules are still to be finally notified, and section references, the qualifying period for fixed-term employees and the income-tax clause reference should be checked against the current statutory text before you rely on them. Illustrations use round numbers.