From 21 November 2025, India ushered in a major overhaul of labour laws by implementing four new Labour Codes, replacing 29 legacy statutes with a streamlined framework covering wages, social security, industrial relations, and occupational safety. Among the most impactful changes — especially for employers and workers — are the revised gratuity rules.
What Is Gratuity?
Gratuity is a statutory lump-sum payment made by an employer to an employee as a mark of appreciation for long-term service when the employee leaves the job due to resignation, retirement, death, or disability. Traditionally, gratuity entitlement under the old Payment of Gratuity Act, 1972 required a minimum of 5 years of continuous service.
Key Changes in the New Labour Codes
1. Gratuity Eligibility Reduced to 1 Year for Fixed-Term Employees
One of the most significant changes is that fixed-term employees (FTEs) now qualify for gratuity after just 1 year of continuous service — instead of waiting for five years. This shift is intended to make gratuity more accessible for workers in contractual or project-based roles, which have historically lacked robust benefits.
Important Clarification:
- The one-year eligibility applies only to fixed-term employees (workers hired on specific contracts with a defined end date).
- For permanent employees, the traditional 5-year qualifying rule remains unchanged.
2. Expanded Definition of “Wages” for Gratuity Calculation
Under the new codes, the definition of “wages” used to calculate gratuity has been broadened:
- The wage base now includes basic salary + dearness allowance + retaining allowance, and other components may be added back if excluded allowances exceed 50% of total remuneration.
What this means: Even if an employee’s basic pay is a smaller part of their package, gratuity payouts may increase significantly because more components of the salary are factored into the calculation.
3. Timely Payment and Penalty
Employers must pay gratuity within 30 days of an employee’s exit. If they fail to do so on time, a 10% annual interest penalty applies on the unpaid amount.
4. Retained Tax-Free Ceiling
The tax-free gratuity limit remains at ₹20 lakh, meaning any gratuity received up to this amount is not taxed in the employee’s hands.
Impact on Employers
Increased Gratuity Liabilities
The expanded wage definition and broader eligibilities mean that companies — especially those with large contract workforces — may see higher gratuity liabilities. This has already translated into significant one-time charges for some major firms as they adjust to the new rules.
Accounting Implications
Professional bodies like the Institute of Chartered Accountants of India (ICAI) have clarified that increased gratuity liabilities must be recognized as past service costs in financial statements, potentially impacting reported profits.
Operational Adjustments
Companies will need to update payroll systems, employment contracts, and HR policies to reflect:
- The new wage definition,
- Gratuity eligibility criteria,
- Timely payout rules.
What This Means for Employees
Fairer Benefits for Fixed-Term Workers
Contract workers — who traditionally did not enjoy many statutory benefits — now become eligible for gratuity much earlier, bringing them closer to parity with regular staff.
Higher Overall Payouts
For many employees, especially at higher salary levels with significant allowances, the revised calculation base can result in larger gratuity payouts upon exit.
Greater Transparency
Clearer definitions of wages and entitlements help employees better understand and plan their benefits.
Summary of the New Gratuity Rules
| Feature | Old Rules | New Labour Codes |
|---|---|---|
| Minimum service for gratuity | 5 years for all employees | 5 years for permanent; 1 year for fixed-term |
| Wage definition for calculation | Basic + DA | Expanded definition with allowances if >50% of CTC |
| Tax-free gratuity limit | ₹20 lakh | ₹20 lakh |
| Payment timeline | Not strictly defined in Act | Within 30 days; 10% interest penalty if delayed |
| Applicability effective from | Legacy Act | From 21 Nov 2025 onwards |
Concluding Thoughts
The revision of gratuity rules under the new labour codes marks a significant shift in employment benefits in India — especially for fixed-term and contractual workers. While permanent employees still follow the traditional five-year rule, the one-year eligibility for fixed-term staff, expanded wage base, and stricter payout timelines enhance worker benefits and financial security.
For employers, these changes demand careful compliance, updated payroll practices, and strategic workforce planning.
As India continues to implement its labour reform agenda, gratuity reforms are a key step toward a more inclusive and equitable workplace benefits framework.
