Gratuity Calculation under Payment of Gratuity Act: Formula, Tax Exemptions & Rules (2026)

Gratuity is a statutory monetary benefit paid by an employer to an employee as a token of appreciation for rendering long-term continuous service.

In India, gratuity payments are governed by the Payment of Gratuity Act, 1972. For HR managers and payroll administrators, calculating gratuity correctly, managing employer accrual reserves, and understanding tax exemptions under Section 10(10) of the Income Tax Act is a core compliance duty.

In this comprehensive 10-minute guide, we cover gratuity eligibility rules, the 15/26 statutory calculation formula, tax exemption limits, forfeiture conditions, and worked payroll calculations.

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1. Who is Eligible for Gratuity in India?

Under the Payment of Gratuity Act, 1972:

Primary Eligibility Criteria:

1. Applicable Establishments: Mandatory for factories, mines, oilfields, plantations, ports, railway companies, shops, and commercial establishments employing 10 or more employees on any day of the preceding 12 months.
2. 5-Year Continuous Service Rule: An employee is eligible for gratuity upon resignation, retirement, or termination only after completing at least 5 years of continuous service with the same employer.

💡 Exceptions to 5-Year Rule: The 5-year continuous service requirement is waived if the employee’s service is terminated due to death or permanent disablements caused by accident or disease!

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2. The Statutory Gratuity Calculation Formula

The gratuity calculation formula differs depending on whether the employer is covered under the Payment of Gratuity Act:

  Covered under Gratuity Act                     Not Covered under Gratuity Act
  ┌──────────────────────────────┐                ┌──────────────────────────────────┐
  │ Gratuity = (15 / 26)         │                │ Gratuity = (15 / 30)             │
  │ × Last Drawn Salary          │ ─────────────► │ × Last Drawn 10-Month Avg Salary │
  │ × Tenure in Completed Years  │                │ × Tenure in Completed Years      │
  └──────────────────────────────┘                └──────────────────────────────────┘

1. For Covered Establishments (Formula):

📐 Gratuity Formula: Gratuity Payable = ( 15 / 26 ) × Last Drawn Salary × Tenure in Years

• Last Drawn Salary = Basic Pay + Dearness Allowance (DA) + Commission (if part of net turnover).
• 26 Factor: Represents 26 working days in a calendar month (excluding 4 Sundays).
• Rounding Tenure Rule: Any service period of 6 months or more is rounded UP to a full year (e.g., 7 years and 7 months is counted as 8 years).

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3. Worked Numerical Example

Let us calculate gratuity for Ramesh Sharma:

• Basic Salary + DA at Retirement: ₹52,000 per month
• Total Tenure: 14 years and 8 months (Rounded up to 15 Years)

Calculation Step-by-Step:

📐 Gratuity = (15 / 26) × ₹52,000 × 15
Gratuity = 0.576923 × ₹52,000 × 15 = ₹4,50,000

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4. Income Tax Exemption Limits under Section 10(10)

Gratuity received by employees enjoys tax exemption under Section 10(10) of the Income Tax Act:

Employee Category	Maximum Statutory Tax Exemption Limit
Government Employees (Central/State/Local Body)	100% Fully Exempt (No upper monetary cap)
Non-Government Employees (Covered under Gratuity Act)	Least of: 1. Actual Gratuity Received 2. Statutory Cap of ₹20,000,000 (₹20 Lakhs) 3. Formula Amount [(15/26) × Salary × Years]
Non-Government Employees (Not covered under Act)	Least of: 1. Actual Gratuity Received 2. Statutory Cap of ₹20,000,000 (₹20 Lakhs) 3. Formula Amount [(15/30) × 10-Month Avg Salary × Years]

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5. Forfeiture of Gratuity Rules

Under Section 4(6) of the Payment of Gratuity Act, an employer may forfeit or withhold an employee’s gratuity under specific conditions:

1. Property Damage: Gratuity can be forfeited to the extent of actual damage or loss caused by the employee’s willful omission or negligence.
2. Gross Misconduct: Gratuity can be fully or partially forfeited if employment is terminated for riotous behavior, violence, or moral turpitude committed during employment.

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6. Frequently Asked Questions (FAQ)

Q1: Is gratuity calculated on total CTC or Basic Salary?

Gratuity is calculated strictly on Basic Salary + Dearness Allowance (DA). Allowances like HRA, Special Allowance, Conveyance, and Bonus are excluded.

Q2: Is employer gratuity contribution deducted monthly from salary?

In CTC structuring, employers often show a 4.81% monthly gratuity provision (Basic Salary × 15/312). However, actual cash payout is made only when the employee leaves after completing 5 years.

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7. Conclusion

Automating gratuity provisions and terminal settlement calculations in your payroll ERP ensures compliance with the Payment of Gratuity Act while giving departing employees accurate, transparent settlement slips.

👉 Try ForkOST Automated Payroll & Gratuity Settlement ERP — 14-day free trial, automated 15/26 gratuity calculations, Section 10(10) tax exemptions, and F&F settlement slips.
👉 Watch Payroll Compliance Tutorials at ForkOST Academy — video guides and CTC structure templates.