Gratuity Eligibility, Calculation, and Payroll Considerations

Gratuity is one of the most sensitive and regulated components of employee separation payroll in India. Errors in eligibility determination or calculation can lead to compliance risks, employee disputes, and reputational issues. HR teams must understand gratuity not only as a statutory obligation but also as a critical part of exit payroll governance.

This article explains gratuity eligibility, calculation basics, and payroll handling from an HR perspective.

What Is Gratuity?

Gratuity is a statutory terminal benefit payable to eligible employees under the Payment of Gratuity Act, 1972. It is intended as a reward for long-term service and is payable upon separation due to:

• Resignation

• Retirement or superannuation

• Death or disablement

Who Is Eligible for Gratuity?

Standard Eligibility

An employee becomes eligible if they:

• Have completed at least 5 years of continuous service, and

• Are separated due to resignation, retirement, or termination

Exception

• In cases of death or permanent disablement, the 5-year condition does not apply.

Continuous service includes:

• Paid leave

• Weekly offs

• Layoffs

• Maternity leave (as applicable)

Gratuity Calculation Formula

For employees covered under the Gratuity Act:

Gratuity = (Last drawn Basic + DA) × 15 × Years of Service ÷ 26

Key points:

• A year exceeding 6 months is rounded up to the next year

• Only Basic and DA are considered

• Maximum payable amount is subject to statutory limits

Payroll Treatment of Gratuity

Gratuity is:

• Not part of regular monthly payroll

• Paid as a one-time terminal benefit

• Processed during Full & Final settlement

Payroll must ensure:

• Separate computation from salary

• Proper classification in settlement statements

• Accurate accounting entries

Tax Treatment of Gratuity

Tax exemption depends on:

• Whether the employee is covered under the Gratuity Act

• Amount received

• Government-notified exemption limits

For most non-government employees:

• Gratuity is partially exempt up to the statutory ceiling

• Excess amount is taxable

TDS applicability should be verified at the time of payout.

Gratuity Checklist for HR

Eligibility & Policy

• ☐ Confirm applicability of Gratuity Act

• ☐ Validate continuous service duration

• ☐ Check rounding rules for service years

Calculation & Payroll

• ☐ Use correct Basic + DA values

• ☐ Apply statutory limits accurately

• ☐ Separate gratuity from salary components

Documentation & Compliance

• ☐ Maintain gratuity calculation sheets

• ☐ Issue settlement statements clearly

• ☐ Record employee acknowledgement

Common HR Errors to Avoid

• Incorrect service period rounding

• Including allowances in calculation

• Delayed gratuity payments

• Misapplication of tax exemptions

Conclusion

Gratuity is a legally protected employee right and a high-risk payroll component if mishandled. Clear eligibility checks, accurate calculation, and timely payment help HR maintain compliance and employee trust during exits.

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