Gratuity in India: How It Works and What It Costs US Employers

Most US founders hiring in India know about PF. Fewer think about gratuity until someone on their team hits five years of service and an invoice arrives that wasn't in the budget.

Gratuity is a statutory payment under Indian law. It is not optional, not negotiable, and not a bonus. Every Indian employee who completes five continuous years of service with the same employer is entitled to it. If you hire in India, either directly or through an Employer of Record, gratuity is a cost you are accruing from day one of every hire.

This article explains how gratuity works in India, what it costs US employers, and how to account for it properly from the start.

What Is Gratuity in India?

Gratuity is a lump-sum payment an employer makes to an employee at the end of their service, provided the employee has worked for at least five continuous years. It is governed by the Payment of Gratuity Act, 1972.

The law applies to every establishment in India with 10 or more employees. Once an establishment crosses that threshold, the Payment of Gratuity Act applies permanently, even if headcount later drops below 10.

For US companies hiring in India through an EOR, the EOR is the legal employer on paper. That means the EOR carries the gratuity liability. But the cost ultimately flows back to you as part of the employment cost structure. Understanding how it is calculated and accrued matters for your financial planning regardless of how you are set up.

The Gratuity Act India: Who Is Covered

The Payment of Gratuity Act covers employees across factories, mines, oilfields, plantations, ports, railway companies, shops, and "other establishments." In practice, this covers nearly every organized-sector employer in India, including technology companies, product firms, and professional services businesses.

An employee qualifies for gratuity when:

• They have completed five years of continuous service with the same employer
• Their service ends through resignation, retirement, termination, or death or disablement

The five-year rule has one important exception: if an employee dies or becomes disabled before completing five years, gratuity is still payable to their nominee or legal heirs regardless of tenure.

"Continuous service" under the Act includes periods of leave, illness, accident, lay-off, strike, lock-out, or cessation of work not due to the employee's fault. An employee who has worked for more than 240 days in a year is treated as being in continuous service for that year.

How Gratuity Is Calculated in India

The formula under the Payment of Gratuity Act is:

Gratuity = (Last drawn basic salary + Dearness Allowance) x 15/26 x Number of years of service

Breaking that down:

• Last drawn basic salary + DA is the monthly figure, not the full CTC (Cost to Company). In India, CTC includes many components: HRA (House Rent Allowance), special allowances, PF contributions, and other elements. Gratuity is calculated only on basic salary plus Dearness Allowance (DA), which in private companies is typically zero. This makes the calculation more straightforward for tech companies but is worth confirming in each employment contract.
• 15/26 represents 15 days of salary per year of service, using 26 as the number of working days in a month.
• Number of years of service uses the completed years. A period of six months or more in the last year rounds up to a full year. Less than six months is not counted.

A Worked Example

An engineer with a basic salary of INR 80,000 per month completes 6 years and 8 months of service.

• Years of service: 6 years + 8 months = rounds up to 7 years (since 8 months exceeds 6)
• Gratuity = 80,000 x 15/26 x 7
• Gratuity = 80,000 x 0.5769 x 7
• Gratuity = INR 3,23,077 (approximately $3,870 USD at current rates)

For a senior engineer on a basic salary of INR 1,50,000 per month with 8 years of service:

• Gratuity = 1,50,000 x 15/26 x 8
• Gratuity = INR 6,92,308 (approximately $8,300 USD)

These are not hypothetical edge cases. They are realistic numbers for mid-to-senior engineers in Bengaluru or Hyderabad, which is exactly the talent pool most US tech companies are hiring from.

The Statutory Cap on Gratuity Payment

Under the Payment of Gratuity Act, the maximum gratuity payable is INR 20 lakh (INR 2,000,000, or approximately $24,000 USD). This cap applies regardless of the actual formula calculation.

In practice, this cap affects only high-salary employees with long tenures. Most tech hires will not approach it within a standard employment relationship. But for CXO-level hires or long-serving technical leads, the cap is worth knowing.

Employers can pay gratuity above the statutory cap voluntarily. Any amount above INR 20 lakh is taxable in the hands of the employee; the statutory portion up to INR 20 lakh is tax-exempt for the employee.

How Gratuity Fits Into Your India Hiring Cost

This is where most US employers get surprised. Gratuity is not a one-time charge that arrives at the end of someone's tenure. It is a liability that accrues from day one of employment.

The standard accounting treatment is to provision for gratuity monthly as part of the employee's total cost. The accrual rate is roughly 4.81% of basic salary per year, which corresponds to the 15/26 x 1/12 monthly fraction.

For a straightforward cost model:

USD conversions are approximate at INR 83.5 per USD. Basic salary is typically 40 to 50% of gross CTC for mid-to-senior roles in India's private tech sector.

Over a 5-year relationship, these accruals compound. An engineer on a basic salary of INR 1,20,000 per month for five years generates a gratuity liability of approximately INR 3,46,154, or around $4,150 USD. This is money you owe them the day they complete five years, payable within 30 days of their last working day.

When Gratuity Must Be Paid

Under the Payment of Gratuity Act, gratuity becomes due within 30 days of the date it becomes payable, which is the last working day of the employee.

If an employer fails to pay within 30 days, simple interest at the rate specified by the government applies on the outstanding amount from the due date until the date of payment.

Disputes on gratuity entitlement or calculation are adjudicated by a Controlling Authority, which is typically a labour commissioner designated under the Act. Employees can file a complaint for non-payment. For US employers operating through an EOR, the EOR manages this process, but an unresolved gratuity dispute can affect your company's ability to make future hires in India through the same employer entity.

What This Means for US Employers Using an EOR in India

If you are hiring in India through an Employer of Record (EOR), the EOR is the legal employer. Gratuity liability sits with the EOR on paper.

But the cost flows back to you in one of two ways:

1. Built into the EOR fee structure. Some EORs build a gratuity provision into their monthly invoicing. This means you are effectively paying into a gratuity reserve every month. You never face a large one-time charge, but the EOR fee is correspondingly higher.
2. Invoiced separately at the point of exit. Other EORs handle gratuity as a pass-through cost when an employee crosses the five-year threshold or exits. In this case, your monthly costs are lower, but a large lump-sum invoice can arrive unexpectedly.

Ask your EOR explicitly: "How do you handle gratuity accrual and payment, and at what point does the cost hit our invoice?" The answer will significantly affect how you model India employment costs over a multi-year horizon.

Frequently Asked Questions

1. What is gratuity in India, and is it mandatory?
   Gratuity is a statutory end-of-service payment governed by the Payment of Gratuity Act, 1972. It is mandatory for every establishment in India with 10 or more employees. An employee who completes five years of continuous service is entitled to receive it within 30 days of their last working day. There is no opt-out provision.
2. How many years of service are required for gratuity in India?
   Five years of continuous service is the standard threshold. The exception is death or permanent disability: in either case, gratuity is payable to the employee's nominee or legal heirs regardless of how long the employee worked.
3. Is gratuity calculated on basic salary or CTC?
   Gratuity is calculated on basic salary plus Dearness Allowance (DA), not on the full CTC. In private Indian companies, DA is usually zero, so for most tech hires, gratuity is calculated on basic salary alone. Basic salary in India is typically 40 to 50% of gross CTC.
4. What is the maximum gratuity payable under the Gratuity Act India?
   The statutory cap is INR 20 lakh (INR 2,000,000). Amounts up to this ceiling are tax-exempt for the employee. Employers can pay more voluntarily, but the excess is taxable in the employee's hands.
5. Does a US company need to pay gratuity if it uses an EOR in India? The EOR is the legal employer and carries the statutory liability for gratuity. In practice, however, the cost is passed back to the client company either through monthly accrual invoicing or as a lump-sum charge at exit. The liability does not disappear because you use an EOR. It changes how and when the cost is invoiced.
6. What happens if gratuity is not paid on time?
   If gratuity is not paid within 30 days of the date it becomes due, interest accrues on the outstanding amount. The employee can also file a complaint with the Controlling Authority under the Act, typically a designated labour commissioner. Persistent non-payment can result in legal action against the employer entity.
7. How should US startups budget for gratuity in India?
   The standard approach is to provision approximately 4.81% of each employee's monthly basic salary as a gratuity accrual. This spreads the cost evenly across the employment period rather than creating a large one-time liability at the five-year mark. Ask your EOR whether they handle this provisioning on your behalf or whether it arrives as a separate charge at exit. Kaamwork builds gratuity handling into the employment cost structure so US clients have a clear, predictable cost model from day one.

The Bottom Line

Gratuity in India is not a surprise expense if you plan for it. The formula is straightforward, the accrual rate is predictable, and the liability only crystallizes at five years or at exit.

What catches US employers off guard is not the calculation. It is the assumption that EOR fees cover everything, which they often don't. Get clarity from your EOR on how gratuity is provisioned and invoiced before you hire. Build the 4.81% monthly accrual into your cost model from the first hire. And understand that the five-year mark is not the end of a relationship but a financial milestone you should have planned for long before it arrives.

For US and UK companies hiring engineers in India with a clear, fully loaded cost structure from day one: kaam.work