"You need 5 full years for gratuity": What the law actually says

Ask ten salaried people in India when gratuity becomes payable and nine will say "after five years." Ask them what happens if they leave at four years and eight months and they will say they get nothing. Both statements are wrong in ways that cost real money — and the second one is wrong in a way that has been settled by courts for over a decade.

The five-year rule exists. It just does not say what people think it says. And the tax treatment of gratuity — the part that decides how much of it you actually keep — runs on an entirely separate set of rules under Section 10(10) of the Income-tax Act, 1961 (Section 11 read with Schedule II of the Income Tax Act, 2025), which most employees never read.

What the law actually says

The eligibility rule. Section 4(1) of the Payment of Gratuity Act, 1972 says gratuity is payable to an employee "on the termination of his employment after he has rendered continuous service for not less than five years." That is the source of the folklore. But Section 4(1) has a proviso most people never reach: the five-year condition does not apply where termination is due to death or disablement. In those cases gratuity is payable regardless of tenure — one year, three years, whatever has been served.

What "continuous service" actually means. This is where the four-years-eight-months case lives. Section 2A of the Act defines continuous service and says that for an employee working in an establishment that operates for six days a week, a year is treated as completed if he has worked for 240 days in that year. The Madras High Court in Mettur Beardsell Ltd. v. Regional Labour Commissioner held that an employee who completes 240 days in the fifth year has completed "continuous service" for that year and is entitled to gratuity. In practical terms: 4 years and 240 days, not 5 calendar years. For establishments working five days a week, the threshold is 190 days.

Employers routinely deny gratuity at 4 years 8 months. They are usually wrong, and a Controlling Authority application under Section 7 will usually say so.

The computation formula. Section 4(2) prescribes:

Gratuity = Last drawn wages × 15 ÷ 26 × Completed years of service

"Wages" under Section 2(s) means basic salary plus dearness allowance — not gross salary, not CTC, and not basic plus HRA plus allowances. Employers who compute on gross are overpaying; employees who expect gross-based numbers are disappointed.

The 26 is the deemed number of working days in a month. The 15 is fifteen days' wages for every completed year. Under Section 4(2)'s explanation, service of more than six months in the final part-year is rounded up to a full year; six months or less is dropped.

For employees not covered by the Act (establishments with fewer than 10 employees), the divisor changes: the calculation runs on half a month's average salary of the last 10 months × completed years, with no rounding up of part-years.

The statutory ceiling. Section 4(3) caps gratuity payable under the Act at ₹20,00,000, raised from ₹10 lakh by the Payment of Gratuity (Amendment) Act, 2018. An employer can contractually pay more; the Act simply does not compel it.

The tax exemption. Section 10(10)(ii) of the Income-tax Act, 1961 — carried forward into the Income Tax Act, 2025 under Section 11 read with Schedule II — exempts gratuity received by an employee covered by the Payment of Gratuity Act to the least of:

• Actual gratuity received
• ₹20,00,000
• Last drawn wages × 15 ÷ 26 × completed years

Government employees fall under Section 10(10)(i) and receive full exemption with no ceiling. Employees not covered by the Act fall under Section 10(10)(iii), where the exemption is the least of actual received, ₹20 lakh, or half a month's average salary of the last 10 months × completed years.

The ₹20 lakh is a lifetime aggregate, not per-employer. If you claimed ₹12 lakh of exemption at one employer, only ₹8 lakh of headroom survives for every gratuity you ever receive again.

Practical implications

Scenario 1 — the 4 years 8 months exit. Ravi resigns after 4 years, 9 months at a six-day-week manufacturing company. Basic + DA at exit: ₹60,000/month. His employer says "sorry, five-year rule." Ravi has completed 240 days in his fifth year, so under Section 2A he has five years of continuous service. Entitlement: ₹60,000 × 15 ÷ 26 × 5 = ₹1,73,077. Fully exempt — it is below both ₹20 lakh and the formula amount.

Scenario 2 — the gross-salary misunderstanding. Priya's CTC is ₹24 lakh. Basic + DA is ₹8 lakh a year, i.e. ₹66,667/month. After 12 years she expects gratuity computed on ₹2,00,000/month gross and is quoted ₹4,61,538 instead (₹66,667 × 15 ÷ 26 × 12). Nothing is wrong. Section 2(s) does not include HRA, special allowance, or variable pay in "wages."

Scenario 3 — crossing ₹20 lakh. Anand has 28 years of service with basic + DA of ₹1,60,000/month. Formula: ₹1,60,000 × 15 ÷ 26 × 28 = ₹25,84,615. His employer pays the full amount contractually. Exemption is capped at ₹20 lakh, so ₹5,84,615 is taxable as salary income in Tax Year 2026-27, taxed at his slab rate. The employer must deduct TDS on that excess under Section 192.

Scenario 4 — the second gratuity. Meera received ₹9 lakh gratuity in 2021 and claimed the full exemption. She now receives ₹16 lakh from her next employer. Only ₹11 lakh of the lifetime ceiling remains, so ₹5 lakh is taxable even though this gratuity on its own is under ₹20 lakh. The ceiling aggregates across employers, and the current employer will not know your history unless you disclose it in Form 12B.

Scenario 5 — death in service. An employee with 2 years and 4 months of service dies. Under the proviso to Section 4(1), the five-year requirement is waived entirely and gratuity is payable to the nominee. Gratuity received by legal heirs on the employee's death is exempt in the heirs' hands.

Step-by-step: what to do

• Pull your last payslip and isolate basic + DA. That number, not gross and not CTC, is the input to every calculation below.
• Count your service in days, not years. Get your date of joining and date of relieving. If you fall between 4 years and 5 years, count working days in the fifth year against the 240-day threshold (or 190 if your establishment works a five-day week). Attendance records and payslips are your evidence.
• Compute the entitlement yourself. Basic + DA × 15 ÷ 26 × completed years, rounding the final part-year up if it exceeds six months.
• Apply for gratuity in Form I within 30 days of it becoming payable, addressed to your employer. Note that under Section 7(2) the employer must determine and pay gratuity within 30 days of it becoming payable, whether or not you apply. Delay beyond 30 days attracts simple interest under Section 7(3A) at the rate notified by the Central Government.
• If the employer refuses or underpays, file Form N with the Controlling Authority under Section 7(4) — this is the Assistant Labour Commissioner for your area. The limitation is 90 days from the date the dispute arises, extendable for sufficient cause. This is an administrative proceeding, not a civil suit; you do not need to file in court.
• Declare prior gratuity to your new employer in Form 12B at the time of joining, so TDS is computed against the correct residual exemption ceiling rather than a fresh ₹20 lakh.
• Reconcile against Form 26AS (now Form 168 under ITA 2025) at year end. If your employer deducted TDS on the taxable excess, it should appear there. If gratuity was fully exempt, it should appear in your Form 16 Part B as an exempt allowance under Section 10(10), not in taxable salary.
• Report correctly in your return. Exempt gratuity goes in the "Exempt Income" schedule of ITR-1 or ITR-2. Taxable excess goes into salary income. Reporting the whole amount as exempt when part of it exceeds the ceiling is a common trigger for a Section 143(1) adjustment.

FAQ

Q: I have 4 years and 7 months. Do I get gratuity?
No. The 240-day test applies to the fifth year, and 4 years 7 months does not reach it in most six-day-week establishments. You need 4 years plus 240 days of actual work in the fifth year — roughly 4 years and 8 months of continuous employment allowing for weekly offs and leave. If you are close, count actual working days rather than calendar months before conceding.

Q: Is gratuity taxable if I am an NRI working abroad for an Indian employer?
Gratuity is taxed based on where the service was rendered, not where you live. Gratuity attributable to service rendered in India is Indian-source income under Section 9(1)(ii) and taxable in India regardless of your residential status, subject to the same Section 10(10) exemption. Gratuity for service rendered wholly outside India by a non-resident is not taxable in India. Where both apply, apportion by service period and check the relevant DTAA article on dependent personal services.

Q: My employer says gratuity is not payable because I resigned rather than being terminated.
Section 4(1) covers termination "on his superannuation, on his retirement or resignation, or on his death or disablement." Resignation is explicitly covered. Gratuity is not a discretionary retention bonus and cannot be forfeited for resigning. Forfeiture is permitted only under Section 4(6), and only for damage caused by the employee's wilful act, or for termination on grounds of riotous conduct or an offence involving moral turpitude committed during employment.

Q: Does the ₹20 lakh exemption apply per employer or across my career?
Across your career. It is an aggregate lifetime ceiling. The Act's ₹20 lakh cap under Section 4(3) governs what an employer must pay; the Section 10(10) ceiling governs what you may exempt across all gratuity ever received. A person who receives gratuity from three employers over a career has one shared ₹20 lakh of exemption between them, not three.

Getting this right

The two expensive errors here are symmetrical: employees walking away from money they are legally owed at 4 years and 8 months, and employees assuming a fresh ₹20 lakh exemption on their second gratuity and under-declaring income. Both are avoidable with a payslip, a calendar, and the correct section.

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