Gratuity is the retirement benefit employers forget until the resignation letter arrives with a calculation attached: 15 days' wages for every year of service, crystallising after five years, payable within 30 days — whether or not you ever provisioned for it. For a 10-person business, that's a quiet liability growing every month. Here are the rules, the math, the exceptions everyone argues about, and how prudent employers fund it.
Coverage and the five-year rule
- The Payment of Gratuity Act covers establishments with 10+ employees (and once covered, always covered even if headcount falls)
- Eligibility: 5 years of continuous service — with the critical exceptions: the 5-year bar does NOT apply on death or disablement (payable regardless of tenure, to nominees/heirs)
- The 4-years-240-days question: judicial rulings have treated 4 years + 240 days in the fifth year as qualifying service — contested terrain, but employers should know exits in that window carry claim risk
- Continuous service counts authorized leave, maternity leave (up to 26 weeks), and interruptions not amounting to break — termination-and-rehire games to reset clocks don't survive scrutiny
The calculation
The formula: (Last drawn wages × 15 ÷ 26) × completed years of service — where wages means Basic + DA (not full CTC), 26 represents working days in a month, and service beyond 6 months in the final year rounds up to a full year. Example: ₹26,000 Basic+DA, 7 years 8 months service → 26,000 × 15/26 × 8 = ₹1,20,000. The statutory cap: ₹20 lakh (tax-exempt to that limit for covered employees). Seasonal establishments compute at 7 days per season. Two employer notes: artificially suppressing Basic to shrink gratuity collides with the labour codes' 50% wage-definition direction; and better-than-Act schemes (some employers pay on gross) bind once promised.
Pay-as-you-go (fund exits from cash) works until three seniors resign the same quarter. The prudent structures: a gratuity provision in books (accrue ~4.8% of Basic+DA monthly — auditors of companies will force actuarial provisioning anyway as you grow), or a funded group gratuity plan with an insurer (LIC and private group-gratuity schemes): contributions are deductible when paid (Section 36(1)(v) with an approved trust), the corpus earns, and payouts stop shocking your cash flow. From ~20 employees, funded schemes are simply better engineering.
Compliance duties employers skip
- Nomination: collect Form F from every employee at joining (family nominations — the document that prevents succession disputes at the worst moment)
- Display/notice obligations and establishment details to the controlling authority where applicable
- Payment discipline: gratuity is due within 30 days of it becoming payable — delay attracts interest, and the controlling authority (labour department) hears claims summarily
- Forfeiture: only for termination for riotous conduct/moral turpitude offences (full) or damage-caused (to that extent) — with due process; casual forfeiture loses at the authority every time
- Fixed-term employees: gratuity on pro-rata basis even below five years under the fixed-term framework — factor into project staffing costs
Gratuity in the business lifecycle
The liability follows the establishment: in business transfers, accrued gratuity typically travels with continuity of service (price it into acquisition negotiations — diligence teams schedule it); in closures, gratuity ranks with workers' dues (priority claims); in CTC design, showing employer gratuity accrual as a CTC line is lawful and common — but the obligation is statutory regardless of what CTC sheets say. And the audit reality: as companies formalise (funding, audits, ESOP-hungry hires), unprovisioned gratuity surfaces as the adjustment that embarrasses founders — a monthly provision entry started today is the cheap version of that conversation.
How Aidwish helps
Aidwish sets up gratuity compliance — applicability assessment, provisioning/funded-scheme structuring with insurers, nomination and records systems, and exit-calculation support — so the statutory promise is funded before it is invoked.