Gratuity Under New Labour Codes: Rules, Eligibility, And Impact Explained

Gratuity is a lump-sum payment stipulated in the labour laws, per which employers make a payment to employees for their long-term service, typically at retirement, resignation, or death. This is in addition to the provident fund, pension, or arrears. Until the implementation of the labour codes on November 21, 2025, the provisions were defined under the Payment of Gratuity Act, 1972. However, since the introduction of labour codes, which replaced 29 old labour laws with four new labour codes, gratuity will now fall under the Code on Social Security, 2020.

As gratuity is 100 per cent tax-exempt for government employees and up to Rs 20 lakh, subject to conditions for private sector employees, any change in its provision is a matter of wide discussion. Many even assess the changes to result in a reduced take-home salary. Whether this is true or not, here we explore.

What Has Changed In The Gratuity Rules Under Code On Social Security, 2020?

There are three gratuity-related provisions included in the labour codes:

• Per the new rules, fixed-term employees are now eligible for gratuity benefits just after completing one year of continuous service. Earlier, it was five years of continuous service.

• The rules are applicable prospectively from the date of labour code implementation on November 21, 2025.

• It is calculated based on the last drawn wages. Notably, the wage definition has changed in the new labour codes. Now, wages will include basic pay, dearness allowance, and retaining allowance, and cannot be less than 50 per cent of the total remuneration. Any allowance (except gratuity and retrenchment compensation) if exceeds 50 per cent of all remuneration, the excess amount will be added back to wages.

The question here is whether the new gratuity rules will apply only to the newly recruited fixed-term employee or to permanent employees as well.  

Mousami Nagarsenkar, Partner, Deloitte India, clarified, saying, “All fixed-term employees will be eligible for gratuity on a prorated basis upon rendering service for at least 1 year. Permanent employees will continue to be eligible for gratuity upon completion of 5 years of service (4 years 240 / 190 days).

How Is Gratuity Calculated, And Is It Part Of The CTC (Cost-To-Company)?

Gratuity is calculated based on the last drawn salary. The formula to calculate it is:

Gratuity = (Last wages × 15/26 × years served)

A period of more than six months will be considered as one year, and the maximum gratuity can be Rs 20 lakh.

Pratik Vaidya, Managing Director and Chief Vision Officer, Karma Management Global Consulting Solutions Pvt. Ltd, points out, “In practice, many companies do show an estimated gratuity cost inside CTC, but legally, that does not change its nature. It remains an employer liability payable on exit, not a monthly deduction from the employee’s salary.”  

Nagarsenkar highlights that “Employers can opt to pay higher gratuity. However, whether gratuity is a part of CTC is a decision internal to each employer.”

So, while gratuity is a mandatory statutory benefit to be offered by the employer, it remains optional for employers to include in an employee’s cost-to-company (CTC) or keep it separate for calculation purposes.

Notably, it is payable upon superannuation, resignation, termination, or expiration of a fixed-term employment contract. It is also payable in case of an employee’s death, disablement due to accident or disease, or for any other event notified by the Central Government.

Will The New Rules Burden The Employer? Can They Reduce Employees’ Take-Home Monthly Salary?

“Since Gratuity will be payable on at least 50 per cent of the total remuneration paid to an employee, in cases where the base for determining salary was lesser, say 40 per cent of CTC, employers will see an increase in the liability on account of gratuity payouts as well as the hit to P&L on account of gratuity provisions,” says Nagarsenkar.

Vaidya adds another point, saying, “This does increase the employer’s compliance cost, especially in salary structures that are heavy on allowances”; however, he adds that “Gratuity is still non-contributory, it cannot simply be deducted as a separate monthly recovery from the employee. At most, some employers may redesign salary structures prospectively to manage overall CTC, but that is a compensation design issue, not a lawful gratuity deduction from take-home pay.”

In short, after the implementation of the labour codes, employees may see a change in salary design, but that will be more of a salary structure issue than the gratuity law.