Gratuity Law in India: Payment of Gratuity Act 1972 Explained

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Introduction

Gratuity is one of the most important statutory benefits available to employees in India. It represents a lump-sum monetary reward paid by an employer to an employee in recognition of their long and meritorious service. The underlying principle is that an employee who has devoted a significant portion of their working life to an employer deserves a financial cushion upon leaving service, whether through retirement, resignation, or otherwise.

The legal framework governing gratuity in India is primarily contained in the **Payment of Gratuity Act, 1972** (hereinafter "the Act"), which applies to a wide range of establishments across the country. The Act was enacted with the express purpose of providing a uniform scheme for the payment of gratuity and ensuring that employees receive this benefit as a matter of right, not as a matter of employer discretion.

This article provides a comprehensive educational overview of gratuity law in India, covering the applicability of the Act, eligibility criteria, the formula for calculation, forfeiture provisions, tax implications, the nomination process, the dispute resolution mechanism, and key judicial pronouncements.

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Applicability of the Payment of Gratuity Act, 1972

Establishments Covered

Under **Section 1(3)** of the Act, the Payment of Gratuity Act applies to:

**(a)** Every factory, mine, oilfield, plantation, port, and railway company.

**(b)** Every shop or establishment within the meaning of any law in force in a State in which **ten or more employees** are employed, or were employed, on any day of the preceding twelve months.

Once the Act becomes applicable to an establishment (by employing ten or more persons), it continues to apply even if the number of employees falls below ten at a later date. This principle was affirmed in **Jivanbhai Lalbhai Patel v. State of Gujarat (2004)**, where the court held that the Act's applicability, once triggered, is not extinguished by a subsequent reduction in workforce.

Employees Covered

The Act applies to every employee (as defined under **Section 2(e)**) who is employed for wages in any establishment to which the Act applies. The definition of "employee" is broad and includes:

- Persons employed on wages in any capacity, whether skilled, semi-skilled, or unskilled

- Manual, supervisory, technical, or clerical workers

- Employees irrespective of whether their terms of employment are express or implied

However, the Act does **not** apply to apprentices engaged under the **Apprentices Act, 1961**.

Central and State Government Employees

Central and state government employees are generally covered by the **Central Civil Services (Pension) Rules** or equivalent state rules, which contain separate gratuity provisions (Death-cum-Retirement Gratuity). The Payment of Gratuity Act primarily benefits employees in the private sector and public sector undertakings not covered by pension rules.

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Eligibility for Gratuity

The Five-Year Rule

Under **Section 4(1)** of the Act, gratuity is payable to an employee on the **termination of employment** after the employee has rendered **continuous service for not less than five years**:

- On superannuation (retirement)

- On retirement or resignation

- On death or disablement due to accident or disease

Exception: Death and Disablement

The requirement of five years of continuous service is **relaxed** in cases of **death or disablement**. If an employee dies or becomes disabled due to accident or disease, gratuity is payable even if the employee has not completed five years of service. This is a humanitarian provision that recognises the employee's family should not be deprived of this benefit in tragic circumstances.

Meaning of Continuous Service

**Section 2A** of the Act defines "continuous service." An employee is deemed to be in continuous service for a period if they have been in uninterrupted service during that period, including periods of:

- Sickness

- Accident

- Leave (authorised absence)

- Lock-out

- Strike that is not illegal

- Cessation of work not due to the employee's fault

For the purpose of computing continuous service:

- An employee who has actually worked for **not less than 190 days** in a period of twelve months (for establishments working below ground in mines) or **not less than 240 days** in a period of twelve months (for other establishments) is deemed to have been in continuous service for that year.

The Supreme Court in **Surendra Kumar Verma v. Central Government Industrial Tribunal-cum-Labour Court (1980) 4 SCC 443** interpreted the concept of continuous service liberally, holding that temporary breaks in service (such as brief periods of absence) do not necessarily break the continuity of service.

The 4 Years and 240 Days Question

A significant legal question has been whether an employee who has completed four years and 240 days of service (but not five full years) is eligible for gratuity. The Supreme Court in **Metroland Plastics Ltd. v. P.P. Sharma and Others (1995)** and subsequently in several High Court decisions held that an employee who has completed 240 days of service in the fifth year (even if the fifth year is not complete) is deemed to have been in continuous service for five years and is therefore eligible for gratuity.

This interpretation has been applied in **Surya Enterprises v. State of Maharashtra (2009)** by the Bombay High Court, where it was held that the employee who worked for four years and 240 days had completed five years of continuous service for the purpose of gratuity.

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Calculation of Gratuity

Formula for Employees Covered Under the Act

The gratuity payable under **Section 4(2)** is calculated using the following formula:

**Gratuity = Last Drawn Salary x 15/26 x Number of Years of Service**

Where:

- **Last Drawn Salary** = Basic salary + dearness allowance (DA) as last drawn

- **15/26** = 15 days' wages for every completed year of service (26 working days in a month)

- **Number of Years of Service** = Completed years (any period exceeding six months is rounded up to the next full year)

Illustration

If an employee's last drawn salary (basic + DA) is Rs. 50,000 per month and they have completed 20 years of service:

Gratuity = 50,000 x 15/26 x 20 = Rs. 5,76,923 (approximately)

For Piece-Rated Employees

For employees paid on a piece-rate basis, the daily wages are computed on the average of the total wages received by them for a period of three months immediately preceding the termination, divided by the number of days actually worked.

For Seasonal Establishments

In seasonal establishments, the employer pays gratuity at the rate of **seven days' wages** for each season.

Maximum Limit

The Act prescribes a **maximum limit** on the amount of gratuity payable. This limit has been revised periodically. As amended by the **Payment of Gratuity (Amendment) Act, 2018**, the maximum gratuity payable is **Rs. 20,00,000 (Twenty Lakh Rupees)**. The Central Government has the power to notify a higher ceiling by executive order.

Any amount of gratuity payable that exceeds this ceiling is capped at the maximum, unless the employer voluntarily agrees to pay a higher amount.

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Forfeiture of Gratuity

Section 4(6): Grounds for Forfeiture

Under **Section 4(6)** of the Act, gratuity can be **forfeited** (wholly or partially) if the services of the employee have been terminated for any of the following reasons:

**(a)** The employee's services are terminated for any act constituting an offence involving **moral turpitude**, provided that the employee has been convicted of such offence by a court of law.

**(b)** The employee's services are terminated for **riotous or disorderly conduct** or any other act of **violence** on the part of the employee.

**(c)** The employee's services are terminated for any act that constitutes an offence involving **moral turpitude**, provided that the employee has been convicted for such offence.

Interpretation by Courts

The Supreme Court in **Union Bank of India v. C.G. Ajay Babu (2018) 8 SCC 110** held that the employer's right to forfeit gratuity under Section 4(6) is not absolute. The forfeiture must be for acts constituting moral turpitude, and the employer must establish that the employee was convicted by a court for such an offence. Merely being dismissed for misconduct is not sufficient for forfeiture unless the specific grounds under Section 4(6) are satisfied.

In **Jaswant Singh Gill v. Bharat Coking Coal Ltd. (2007) 1 SCC 663**, the Supreme Court held that forfeiture of gratuity can only be to the extent of the damage or loss caused to the employer due to the employee's conduct. The entire gratuity cannot be forfeited unless the damage equals or exceeds the gratuity amount.

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Nomination Under the Payment of Gratuity Act

Section 6: Nomination

Under **Section 6**, every employee who has completed one year of service is required to make a **nomination** for the purposes of receiving gratuity in the event of the employee's death. The key provisions are:

- If the employee has a family at the time of making the nomination, the nomination must be made **in favour of one or more members of the family** and no other person.

- If the employee has no family at the time of making the nomination, the nomination may be made in favour of any person. However, if the employee subsequently acquires a family, the earlier nomination becomes void and the employee must make a fresh nomination in favour of family members.

- A nomination can be **modified** by the employee at any time after giving notice to the employer.

Distribution of Gratuity on Death

If an employee dies, the gratuity payable to the employee is paid to the nominee. If no valid nomination exists, the gratuity is distributed among the heirs of the deceased employee.

In **Kedar Nath Sinha v. State of Bihar (2001)**, the court held that where there is a valid nomination, the nominee's right to receive gratuity prevails, and the employer is discharged of liability upon payment to the nominee.

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Tax Treatment of Gratuity

For Government Employees

Gratuity received by government employees (Central, State, or local authority) is **fully exempt** from income tax under **Section 10(10)(i)** of the Income Tax Act, 1961.

For Non-Government Employees Covered Under the Act

For employees covered under the Payment of Gratuity Act, the exemption under **Section 10(10)(ii)** is available to the **least** of the following:

1. Actual gratuity received

2. Rs. 20,00,000 (the current ceiling)

3. 15 days' salary (based on last drawn salary) for each completed year of service or part thereof exceeding six months

For Non-Government Employees Not Covered Under the Act

For employees not covered by the Payment of Gratuity Act, the exemption under **Section 10(10)(iii)** is available to the **least** of the following:

1. Actual gratuity received

2. Rs. 20,00,000

3. Half month's salary for each completed year of service (based on average salary of the last ten months)

Any amount exceeding the exempt portion is taxable as "Income from Salary."

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Employer's Obligations

Payment Within 30 Days

Under **Section 7(3)** of the Act, the employer is required to determine the amount of gratuity and pay it to the person entitled within **thirty days** from the date it becomes payable. If the gratuity is not paid within this period, the employer is liable to pay **simple interest** on the amount from the date on which it becomes payable to the date on which it is paid, at such rate not exceeding the rate notified by the Central Government.

No Condition or Deduction

The employer cannot impose any condition for the payment of gratuity that is not authorised by the Act. The employer cannot deduct any amount from the gratuity payable, except to the extent of the damage or loss caused by the employee as provided under the forfeiture provisions.

Compulsory Insurance or Fund

Under **Section 4A**, every employer is required to obtain an **insurance** for their liability towards gratuity from the Life Insurance Corporation (LIC) or any other approved insurer, **or** establish an approved **gratuity fund** for the payment of gratuity. This provision is intended to ensure that the employer's obligation to pay gratuity is secured and that employees are not left without recourse due to the employer's financial difficulties.

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Dispute Resolution Under the Act

Controlling Authority

Under **Section 7** of the Act, if there is any dispute regarding the payment of gratuity (whether as to the amount, eligibility, or entitlement), the employee (or the person entitled) may make an **application** to the **Controlling Authority** (appointed under Section 3 of the Act, typically the Assistant Labour Commissioner or Deputy Labour Commissioner).

The Controlling Authority conducts an inquiry, hears both parties, and determines the amount of gratuity payable. The Controlling Authority has the power to direct the employer to pay the gratuity as determined.

Appellate Authority

Any person aggrieved by the order of the Controlling Authority may file an **appeal** before the **Appellate Authority** (under Section 7(7)) within **sixty days** of the order. The Appellate Authority is typically a higher-ranking labour officer or a judicial officer designated by the appropriate government.

Recovery as Land Revenue

Under **Section 8**, if the amount of gratuity payable is not paid by the employer within the prescribed period, the Controlling Authority may issue a **certificate** to the Collector, who shall recover the amount along with compound interest as **arrears of land revenue** and pay the same to the person entitled. This is a powerful recovery mechanism that ensures enforcement.

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Key Judicial Pronouncements

Jivanbhai Lalbhai Patel v. State of Gujarat (2004)

The court held that once the Payment of Gratuity Act becomes applicable to an establishment, its applicability continues even if the number of employees subsequently falls below ten.

Surendra Kumar Verma v. Central Government Industrial Tribunal (1980) 4 SCC 443

The Supreme Court interpreted the concept of continuous service liberally, holding that temporary breaks in service do not necessarily disrupt the continuity for purposes of gratuity eligibility.

Union Bank of India v. C.G. Ajay Babu (2018) 8 SCC 110

The Supreme Court clarified that forfeiture of gratuity under Section 4(6) requires conviction by a court for an offence involving moral turpitude; mere dismissal for misconduct is not sufficient.

Birla Corporation Ltd. v. Adventz Investments and Holdings Ltd. (2019) 16 SCC 610

The Supreme Court examined the interplay between the Payment of Gratuity Act and other labour legislations, holding that the Act's provisions are in addition to and not in derogation of any other rights available to employees.

Kerala Hume Pipe Factory Ltd. v. The Controlling Authority (2014)

The Kerala High Court held that delay in payment of gratuity beyond 30 days attracts mandatory payment of interest, and the employer cannot escape this liability even if there was a bona fide dispute regarding the amount.

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The Code on Wages, 2019 and Its Impact

The **Code on Wages, 2019** (one of the four labour codes enacted to consolidate India's labour laws) redefines "wages" and may impact the calculation of gratuity. Under the Code, "wages" is defined to include basic pay, dearness allowance, and retaining allowance, but excludes certain allowances and benefits. Importantly, the Code provides that the excluded components (such as house rent allowance, overtime, etc.) **cannot exceed 50%** of the total remuneration. If they do, the excess is deemed to be part of wages.

This redefinition may increase the base salary figure used for gratuity calculation for some employees, potentially increasing the gratuity amount.

**Note:** The Code on Wages has been enacted but its enforcement depends on the notification of rules by the Central and State Governments. Until notified, the existing provisions of the Payment of Gratuity Act continue to apply.

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Gratuity Under the Industrial Relations Code, 2020

The **Industrial Relations Code, 2020** introduced a significant change for **fixed-term employees**. Under **Section 2(o)** of the IR Code, a fixed-term employee is entitled to gratuity on a **pro-rata basis** even if the period of employment is less than five years. This is a departure from the five-year requirement under the Payment of Gratuity Act and is intended to ensure that fixed-term employees are not disadvantaged merely because of the nature of their engagement.

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Frequently Asked Questions

Is gratuity payable if an employee resigns before completing five years?

No. Under the Payment of Gratuity Act, gratuity is payable only after an employee has completed **five years of continuous service**. If an employee resigns before completing five years, they are not entitled to gratuity under the Act. The only exception is death or disablement, where the five-year requirement is waived. However, some employers may voluntarily pay gratuity for service less than five years under their internal policies.

Can an employer refuse to pay gratuity?

An employer cannot refuse to pay gratuity to an eligible employee. The Payment of Gratuity Act makes it a **statutory obligation**. Under **Section 9**, any employer who contravenes the provisions of the Act or fails to pay gratuity is punishable with imprisonment up to **two years** (with a minimum of six months, unless the court reduces it for adequate reasons) and/or a fine up to **Rs. 20,000**.

Is gratuity applicable to contract workers?

Contract workers employed through a contractor may be eligible for gratuity from the contractor (as their employer) if they have completed five years of continuous service and the contractor's establishment is covered under the Act. However, the determination of who is the "employer" (the contractor or the principal employer) can be a contentious issue and depends on the facts of each case.

How is gratuity calculated if there is a change in salary during service?

Gratuity is calculated based on the **last drawn salary** (basic + DA) at the time of termination, not the average salary over the entire service period. Any change in salary during service is irrelevant; only the final salary matters.

Can gratuity be forfeited if an employee is terminated for misconduct?

Gratuity can be forfeited only under the specific grounds listed in **Section 4(6)** of the Act -- namely, if the employee is terminated for an act involving moral turpitude (with a court conviction), riotous or disorderly conduct, or violence. Mere termination for misconduct not falling within these categories does not entitle the employer to forfeit gratuity.

Is gratuity payable on death of the employee?

Yes. If an employee dies during service, gratuity is payable to the **nominee** or, in the absence of a nomination, to the **legal heirs** of the deceased. The five-year continuous service requirement is waived in cases of death.

What if the employer becomes insolvent -- can gratuity still be recovered?

Gratuity is a statutory liability and takes priority over other debts in certain circumstances. Under **Section 4A**, employers are required to insure their gratuity liability with LIC or maintain an approved gratuity fund, which provides a measure of security for employees even if the employer becomes insolvent. In practice, the Controlling Authority can issue a recovery certificate to the Collector for recovery as arrears of land revenue.

Does gratuity apply to employees of NGOs and trusts?

Yes, if the NGO, trust, or other establishment employs ten or more persons and falls within the definition of a "shop or establishment" under the applicable State Shops and Establishments Act, the Payment of Gratuity Act applies, and employees are entitled to gratuity upon completing five years of service.

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**Disclaimer:** This article is published for educational and informational purposes only. It does not constitute legal advice, a solicitation, or an advertisement. The information provided is based on Indian laws and judicial pronouncements as of the date of publication and may be subject to change. The Payment of Gratuity Act is a central legislation, but certain aspects of its implementation may vary by state. No reader should act or refrain from acting based on this article without seeking professional legal advice tailored to their specific facts and circumstances. For personalised guidance, please consult a qualified advocate.