The Ultimate Guide to the Payment of Gratuity Act, 1972: Rules, Calculation, and 2025 Legal Updates

1. Introduction

The Payment of Gratuity Act, 1972 is one of India’s most significant social security legislations. Unlike a monthly salary that compensates for current work, gratuity is a “terminal benefit”—a lump sum payment made by an employer to an employee upon the termination of their service. It acts as a reward for long and meritorious service, providing a financial cushion for the employee in retirement or during a transition to a new job.

While the concept of gratuity started as a voluntary “gift” (gratuitous payment) from an employer, the 1972 Act transformed it into a statutory right. This guide covers every aspect of the Act, including the latest Supreme Court interpretations in 2025 that have shifted the landscape of gratuity forfeiture.

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2. Applicability: Who is Covered?

The Act applies to organized sectors and specific establishments. It is crucial to note that once the Act becomes applicable to an establishment, the law continues to apply even if the number of employees drops below the threshold later.

Establishments Covered

The Act applies to:

• Factories, Mines, Oilfields, Plantations, Ports, and Railway Companies: Irrespective of the number of employees.
• Shops and Establishments: Any shop or establishment (as defined by state laws) employing 10 or more persons on any day of the preceding 12 months.
• Notified Establishments: Any other class of establishments specified by the Central Government employing 10 or more persons.

Note: The Act overrides any conflicting provisions in other contracts. If an employee has a contract offering less gratuity than the Act, the Act prevails. However, if an employer offers better terms than the Act, the employee is entitled to those better terms.

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3. Eligibility Criteria

To be eligible for gratuity under Section 4(1), an employee must meet specific criteria regarding the termination of their employment.

The 5-Year Rule

Generally, an employee is entitled to gratuity only if they have rendered continuous service for not less than five years. The gratuity becomes payable on termination of employment due to:

1. Superannuation: Reaching the retirement age fixed in the contract.
2. Retirement or Resignation.
3. Death or Disablement: Due to accident or disease.

Exceptions to the 5-Year Rule

There is a vital exception to the five-year service requirement:

• Death or Disablement: If an employee dies or suffers disablement (incapacitation for the work they were doing), the condition of 5 years of continuous service is waived.
  • In case of death: Gratuity is paid to the nominee or legal heirs.
  • In case of disablement: Gratuity is paid to the employee.

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4. Understanding “Continuous Service”

“Continuous service” is a technical term defined under Section 2A. It means uninterrupted service, but it essentially allows for breaks due to sickness, accident, leave, layoff, strike, or lockout (provided the strike is not illegal/due to employee fault).

The 190/240 Days Formula

What happens if an employee was absent for valid reasons? They are “deemed” to be in continuous service if they have actually worked for a minimum number of days in the preceding 12 months:

Type of Establishment	Minimum Days Worked (Deemed Continuous Service)
Mines / Below Ground Work	190 Days in the preceding 12 months
Establishments working < 6 days/week	190 Days in the preceding 12 months
All Other Establishments (General)	240 Days in the preceding 12 months
Seasonal Establishments	75% of the days the establishment was operational

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5. Gratuity Calculation: Formulas and Examples

The calculation of gratuity depends on the category of the employee. The statutory limit (cap) on tax-free gratuity under the Act is currently ₹20 Lakhs (though government employees have seen limits raised to ₹25 Lakhs recently).

A. Monthly Rated Employees

The formula is based on 15 days of wages for every completed year of service.

$Gratuity = \frac{\text{Last Drawn Monthly Wage} \times 15}{26} \times \text{Completed Years of Service}$

• Last Drawn Wage: Basic Pay + Dearness Allowance (DA).
• 26: Represents the number of working days in a month (excluding Sundays).
• Rounding Years: A period exceeding 6 months is counted as a full year. (e.g., 7 years and 7 months = 8 years).

Example:

• Scenario: Mr. Arjun retires after 10 years and 8 months of service. His last drawn Basic + DA is ₹50,000.
• Service: Rounded to 11 years.
• Calculation: $(50,000 \times 15 / 26) \times 11$
• Result: ₹28,846 $\times$ 11 = ₹3,17,307

B. Piece-Rated Employees

For employees paid by the piece (not a fixed monthly salary):

• Wage Rate: Average of total wages received in the 3 months immediately preceding termination.
• Formula: 15 days’ wages for every completed year of service based on this daily average.
• Note: Overtime wages are excluded.

C. Seasonal Establishment Employees

For employees in industries like sugar factories that only operate seasonally:

• Rate: 7 days’ wages for each season.
• Formula: $7 \times \text{Last Drawn Daily Wage} \times \text{Number of Seasons Worked}$.

D. The Statutory Cap

Under Section 4(3), the maximum gratuity payable under the Act is capped at ₹20,00,000 (20 Lakhs).

• Note: Employers can voluntarily pay more than this limit (Ex-gratia), but the statutory obligation stops at 20 Lakhs.

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6. Taxation of Gratuity

The tax treatment of gratuity (under the Income Tax Act, 1961) depends on the type of employee:

1. Government Employees: Gratuity is fully exempt from tax u/s 10(10)(i).
2. Employees Covered by Gratuity Act: The least of the following is exempt u/s 10(10)(ii):
   • Actual gratuity received.
   • ₹20,00,000 (Statutory Limit).
   • Calculation: $(15/26) \times \text{Last Drawn Salary} \times \text{Completed Years}$.
3. Other Employees (Not Covered by Act): The least of the following is exempt:
   • Actual gratuity received.
   • ₹20,00,000.
   • Calculation: Half-month’s average salary of last 10 months $\times$ Completed Years.

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7. Forfeiture of Gratuity (Crucial Legal Update)

This is the most critical and litigated section of the Act (Section 4(6)). Employers can withhold gratuity under specific conditions involving employee misconduct.

A. Forfeiture for Damage/Loss (Section 4(6)(a))

If an employee is terminated for any act, willful omission, or negligence that causes damage, loss, or destruction to the employer’s property:

• Gratuity can be forfeited to the extent of the damage or loss.
• Requirement: The employer must quantify the loss in monetary terms and issue a notice. They cannot forfeit the whole amount arbitrarily if the loss is small.

B. Forfeiture for Moral Turpitude (Section 4(6)(b)) - 2025 UPDATE

Gratuity can be wholly or partially forfeited if the employee is terminated for:

1. Riotous/disorderly conduct or violence.
2. Any act constituting an offence involving moral turpitude committed in the course of employment.

The Major Shift (2025 Supreme Court Ruling): For years, based on the Union Bank of India v. C.G. Ajay Babu (2018) judgment, it was believed that an employer could only forfeit gratuity for “moral turpitude” if the employee was convicted by a Criminal Court.

However, in 2025, the Supreme Court (in Western Coal Fields Ltd. v. Manohar Govinda Fulzele) clarified and effectively overruled this strict requirement.

• Current Law: A criminal conviction is NOT mandatory for forfeiture of gratuity.
• Condition: If a departmental inquiry is conducted fairly (following principles of natural justice) and finds the employee guilty of misconduct involving moral turpitude (e.g., fraud, theft, sexual harassment), the employer can forfeit gratuity.
• Why: The Court reasoned that “moral turpitude” is a civil standard within employment law, and waiting for a criminal court (which takes decades) would defeat the purpose of discipline.

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8. Nomination Rules and “Family” Definition

To ensure the gratuity reaches the right hands in case of the employee’s death, Section 6 mandates a nomination.

Filing the Nomination (Form F)

• Every employee must submit a nomination in Form F after completing one year of service.
• The nomination must be made in favor of one or more members of the employee’s “family”.

Definition of “Family”

You cannot nominate just anyone (like a friend) if you have a family.

• Male Employee: Himself, his wife, children, dependent parents, and dependent parents of his wife/widow.
• Female Employee: Herself, her husband, children, dependent parents, and dependent parents of her husband.
• Rule: If an employee has a “family” as defined above, a nomination made in favor of an outsider is void.

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9. Step-by-Step Claim Process (Forms I, J, K)

The process is strictly governed by the Payment of Gratuity (Central) Rules, 1972.

Step 1: Application

• Employee (Form I): Must apply to the employer within 30 days of the gratuity becoming payable.
• Nominee (Form J): Applies within 30 days if the employee dies.
• Legal Heir (Form K): Applies within 1 year if there is no valid nomination.

Step 2: Employer’s Responsibility

• Once the application is received, the employer has 15 days to verify the claim.
• If Admissible: Issue Form L (Notice for Payment) specifying the amount and date of payment.
• If Rejected: Issue Form M specifying the reasons for rejection.

Step 3: Payment

• The employer must pay the gratuity within 30 days from the date it becomes payable.
• Interest: If the employer delays payment (and the delay is not the employee’s fault), they must pay simple interest (currently around 10%) for the delayed period (Section 7(3A)).

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10. Dispute Resolution and Penalties

Disputes (Section 7(4))

If there is a dispute regarding the amount of gratuity or admissibility of the claim, the employee can file an application (in Form N) to the Controlling Authority (usually the Assistant Labour Commissioner).

• The Authority acts like a civil court, takes evidence, and issues a direction.
• Appeals: Any party aggrieved by the order can appeal to the Appellate Authority within 60 days.

Penalties (Section 9)

Non-compliance is a serious offence:

• Non-payment of Gratuity: Imprisonment for 6 months to 2 years.
• False Statements: To avoid payment, imprisonment up to 6 months or fine up to ₹10,000.
• General Contravention: Imprisonment of 3 months to 1 year or fine.

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11. IRAC Analysis: Misconduct and Denial of Gratuity

Below is a legal analysis of a hypothetical scenario based on the current legal position (post-2025).

Scenario: Mr. Sharma worked for ABC Corp for 15 years. He was terminated after a departmental inquiry found him guilty of misappropriating company funds (financial misconduct). No criminal case was filed. ABC Corp forfeited his gratuity under Section 4(6)(b)(ii). Mr. Sharma claims this is illegal because he was not convicted by a court.

Issue

Can ABC Corp forfeit Mr. Sharma’s gratuity for “moral turpitude” based solely on a departmental inquiry finding, without a criminal court conviction?

Rule

Section 4(6)(b)(ii) of the Payment of Gratuity Act states gratuity may be forfeited if the employee’s services are terminated for an act constituting an offence involving moral turpitude committed in the course of employment.

• Old Precedent (2018): In Union Bank of India v. C.G. Ajay Babu, the SC held a criminal conviction was required.
• Current Precedent (2025): In Western Coal Fields Ltd. v. Manohar Govinda Fulzele, the Supreme Court clarified that a criminal conviction is not a prerequisite. A departmental inquiry finding, arrived at after following principles of natural justice, is sufficient to establish moral turpitude for the purpose of forfeiture.

Analysis

Mr. Sharma committed financial misappropriation, which falls under the definition of “moral turpitude” (acts involving depravity or wickedness). ABC Corp conducted a departmental inquiry which proved the guilt. Under the Western Coal Fields (2025) doctrine, the employer is not required to wait for a criminal conviction. The internal finding of guilt for an offence involving moral turpitude is sufficient authority to invoke Section 4(6)(b)(ii).

Conclusion

ABC Corp acts lawfully. Mr. Sharma’s claim is likely to fail. ABC Corp is entitled to forfeit the gratuity wholly or partially, provided the departmental inquiry was fair and the misconduct (misappropriation) was clearly established.

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12. Frequently Asked Questions (FAQ)

Q1: Can I get gratuity if I resign after 4.5 years?

No. The Act requires a minimum of 5 full years of continuous service. There is no pro-rata payment for resigning early. The only exception is if you leave due to death or disablement.

Q2: My employer is refusing to pay gratuity saying they are in loss. Is this valid?

No. Gratuity is a statutory liability. Financial difficulty or loss is not a valid ground to deny gratuity. You can file a complaint (Form N) with the Controlling Authority.

Q3: Is the 5-year rule applicable to contract employees?

Yes. If a contract employee completes 5 years of continuous service with the same employer (even if the contract was renewed annually), they are eligible for gratuity.

Q4: Does “5 years” mean exactly 5 years?

In the case of Madras High Court (Mettur Beardsell Ltd), it was held that if an employee completes 4 years and 240 days, it might be rounded off to 5 years in certain contexts, but the general strict rule remains 5 full years. It is safer to rely on completing the full 5-year anniversary.

Q5: How is gratuity calculated for a 6-day work week vs a 5-day work week?

The formula $\frac{15}{26}$ remains the standard for monthly rated employees regardless of whether the company works 5 or 6 days a week. The denominator ‘26’ is fixed by the statute to represent the average working days in a month generally.

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Conclusion

The Payment of Gratuity Act, 1972 is a robust shield for employees, ensuring that their years of loyalty are rewarded. However, it also imposes a code of conduct; the 2025 legal position on forfeiture serves as a stern warning that serious misconduct involving moral turpitude can cost an employee their entire terminal benefit, even without a criminal trial.