Gratuity is a defined benefit plan and is one of your retirement benefits offered by your employer. You can generally find Gratuity eligibility details in your CTC (Cost to Company) or Company’s offer letter.
The general meaning of Gratuity is – ‘a favor or gift, usually in the form of money, given in return for service.’ In employment terms, Gratuity Benefit amount is similar to a bonus, meaning that it is a portion of your salary provided to you, by your employer, for the services rendered on the company’s behalf. Gratuity is a reward for your long and meritorious service.
(Meaning of Defined Benefit Scheme is – A plan/scheme in which a certain amount or percentage of money is set aside each year by a company for the benefit of the employee. Gratuity is a defined benefit plan. )
Earlier, it was not compulsory for an employer to reward his employee at the time of his retirement or resignation. But in 1972 the Government passed the Payment of Gratuity Act and made it mandatory for all the employers with more than 10 employees to pay gratuity.
The new Labour Code effective from November 21, 2025, introduced some more significant changes to the gratuity provisions in India. The key update is that fixed-term employees are now eligible for gratuity after just one year of continuous service, compared to the earlier requirement of five years.
New Gratuity Rules 2025 Explained
What’s Changing Under the New Labour Codes?
Here are must-know highlights from the new labor code regarding gratuity benefit applicable to all the employees;
Eligibility Changes for Gratuity
Under the new Labour Code, fixed-term employees—those hired for a specific tenure or project—will qualify for gratuity after completing one year of continuous service with at least 240 days worked. This change aims to benefit contract and temporary workers by providing earlier access to long-term service benefits. Permanent employees will still need to complete five years before becoming eligible for gratuity. For partial years of service exceeding 6 months, the year is rounded up to the next full year for gratuity calculation.
Expanded Definition of Wages
The Code mandates that “wages” for gratuity calculation now include basic pay, dearness allowance, retaining allowance, and at least 50% of the total remuneration package. This broadening of wage components raises the gratuity calculation base, increasing the potential payout amount for many employees compared to the older definition which considered a narrower salary base.
Calculation and Payment Terms
- Earlier (before the new labour codes) the gratuity calculation did differ between:
- Employees covered under the Payment of Gratuity Act, 1972
- Employees NOT covered under the Act
- The formula is now uniform for all employees (covered vs non-covered difference is removed).
- Under the new labour code (effective November 21, 2025), the formula for calculating gratuity is broadly the same for “types” of employees — but what counts as “wages” (on which the gratuity is based) has been changed.
- Gratuity is calculated based on the last drawn wages, which now include basic pay, dearness allowance, and retaining allowance under the new wage definition.
- The last drawn wages, which now include basic pay, dearness allowance, and retaining allowance under the new wage definition.
- The formula for gratuity payment is:
| Category | Earlier Formula | Basis Days | Act Applicability |
|---|---|---|---|
| Covered under Gratuity Act | (Wages × 15 × Years) ÷ 26 | 26 | Yes |
| Not covered (Govt etc.) | (Wages × 15 × Years) ÷ 30 | 30 | No |
| Under new labour codes | Uniform formula | 26 | Applies to all |
- The maximum gratuity amount payable by an employer is ₹20 lakh. (For some central govt employees, the limit has been revised to Rs 25 lakhs w.e.f January 1, 2024.)
- Employers must release gratuity within 30 days post-termination, failing which they incur a 10% annual interest penalty.
Gratuity benefit & Tax Implications
Gratuity is considered as your retirement benefit and is tax exempted subject to certain conditions of Income Tax Act. For the intent of taxation on gratuity, employees are divided into two categories:
- Government Employees &
- Private Sector Employees
Any gratuity amount received by an employee (Govt or Private employee) during his service is taxable. But when gratuity is received by the employee at the time of his retirement, death or superannuation then tax exemption rules for government employees differs from private employees.
In case of Government Employees the entire gratuity amount that he/she receives on retirement or on death is exempted from paying any Income tax.
In case of private employees, any gratuity received is tax exempted to the extent of least of the following:
- Actual Gratuity received by you.
- Statutory limit of Rs 20 Lakh
- Last drawn wages * 15/26 * No. of completed years of service
Any gratuity amount above the exempted portion (or above ₹ 20 lakh) becomes taxable and must be included under “Income from Salaries.”
Gratuity Benefit | Old Vs New Rules
| Aspect | Old Labor Code | New Labor Code |
| Eligibility | Minimum 5 years of continuous service | Reduced to 1 year for fixed-term and contract workers; permanent employees still requires 5 years |
| Wage Definition | Based mainly on basic pay plus dearness allowance (DA) | Includes basic pay, DA, plus retaining allowance and other fixed components included under the new wage definition |
| Calculation Formula | (Last drawn basic + DA) × 15/26 × years of service | (Last drawn wages including allowances) × 15/26 × years of service |
| Maximum Gratuity Limit | ₹20 lakhs (latest cap before new code) | ₹20 lakhs (same cap, but potentially higher base due to wage definition) |
| Service Year Rounding | Completed years only; partial years not fully counted | Years of service rounded up if partial year exceeds 6 months |
| Payment Timeline | Usually 30 days after exit | Mandated within 30 days, with 10% annual interest on delay |
| Coverage | Mostly permanent employees | Expanded to contract, fixed-term, gig workers |
In summary, the new gratuity rules 2025 under the Labour Codes introduce clearer wage definitions, wider eligibility, and more consistent benefits for Indian employees. Whether you work in the private sector, public sector, or on a fixed-term contract, understanding these updated gratuity benefits is essential for accurate financial planning. As organisations transition to the new wage structures, employees should stay informed to make the most of the enhanced gratuity entitlement offered under the 2025 framework.
Related Article : Top 10 key Highlights of the New Labour Code every Employee should know!
(Post first published on : 01-Dec-2025)
