AS | Ankit Sarawagi|Founder, CFOmatrix·August 2026·10 min read | Payroll & Labour Law |
Gratuity is the quietest liability on a startup’s books: nobody pays it for years, then one long-serving employee resigns and the finance team scrambles to fund a number nobody had provided for.
The gratuity act (formally the Payment of Gratuity Act, 1972) turns loyalty into a legal payout. This guide covers when it applies to your startup, the 15/26 formula with real rupee maths, the 5-year rule and its death waiver, the ₹20 lakh tax cap, the forms you file, the 30-day payment clock, and why a CFO funds the whole thing through an insurer scheme rather than from cash.
- When it applies
- Once you employ 10 or more people on any day in the last 12 months. It does not switch off if headcount later drops.
- Amount
- (15 / 26) x last drawn (basic + DA) x completed years. Rounds up if the final year crosses 6 months.
- Eligibility
- 5 years of continuous service, waived on death or disablement.
- Filing & due date
- Employer files Form A (notice of opening); employees file Form F (nomination). Payout due in 30 days.
- Tax & penalty
- Exempt up to ₹20,00,000. Delay past 30 days attracts simple interest on the amount.
1 Does the gratuity act apply to you?
The Payment of Gratuity Act, 1972 applies to any establishment (factory, shop, company, LLP) that has employed 10 or more people on any day in the preceding 12 months. The moment you cross that line, the Act is switched on for good.
- 10 or more employees: the Act applies. You must file a notice of opening, allow nominations, and pay gratuity to anyone who qualifies.
- The one-way door: if you later shrink below 10, the obligation does not lapse. A founder who scaled up during a growth phase stays covered afterwards.
2 Who is eligible, and the 5-year rule
An employee earns the right to gratuity after five years of continuous service with you. It is paid on resignation, retirement, superannuation, or the end of employment after that five-year mark.
The one big exception: the five-year condition is waived if service ends due to death or disablement. If an employee dies or is permanently disabled by accident or disease, gratuity is payable for whatever period they actually served, even if that is under five years. On death, it goes to the nominee or, absent one, the legal heirs.
3 The 15/26 formula, with real maths
For an employee covered by the Act, gratuity is:
Three things drive the number:
- 15 / 26: the Act treats gratuity as 15 days of wages for each completed year, and fixes a month at 26 working days (Sundays excluded). So each year earns you 15/26 of a month’s basic + DA.
- Basic + DA: only basic pay plus dearness allowance count. HRA, bonuses and other allowances are excluded.
- Completed years: service beyond six months in the final year rounds up to a full year; six months or less is dropped.
Brewly‘s operations lead resigns after 7 years and 8 months. Her last drawn basic + DA is ₹60,000 a month.
Step 1: Round the service. 8 months is more than 6, so 7 years 8 months rounds up to 8 completed years.
Step 2: Apply the formula. (15 / 26) × 60,000 × 8.
Step 3: Do the maths. 15 × 60,000 = 9,00,000. Times 8 = 72,00,000. Divide by 26 = ₹2,76,923 (rounded).
Brewly owes her ₹2,76,923, and must pay it within 30 days of her last working day.
Kaveri Labs loses an engineer to a road accident after only 2 years of service. His last drawn basic + DA was ₹40,000.
The five-year rule does not apply on death, so gratuity is still due for the 2 years served.
(15 / 26) × 40,000 × 2 = (15 × 40,000 × 2) / 26 = 12,00,000 / 26 = ₹46,154 (rounded).
Kaveri pays ₹46,154 to his registered nominee (from his Form F) within 30 days.
4 Tax treatment and the ₹20 lakh cap
For a private-sector employee covered by the Act, gratuity is exempt from income tax under Schedule II of the Income-tax Act, 2025 (old Section 10(10)) up to the lowest of these three:
| # | Limit |
|---|---|
| 1 | The lifetime cap of ₹20,00,000 (across all employers) |
| 2 | The amount worked out by the 15/26 formula |
| 3 | The actual gratuity received |
Whatever exceeds the exempt figure is taxed as salary in the employee’s hands. The ₹20 lakh is a lifetime ceiling, so a person who used part of it at a previous job only has the balance left.
A Brewly founding employee retires after 22 years and, on a high final salary, the formula throws up ₹22,00,000. The exemption is capped at ₹20,00,000. So ₹20 lakh is tax-free and the remaining ₹2,00,000 is added to her taxable salary for the year.
5 The forms and the payment clock
Gratuity compliance is light on paperwork but strict on timing. Three touch points matter.
6 The CFO reason to fund via a group gratuity scheme
Here is where gratuity stops being an HR form and becomes a finance decision. The liability builds silently on the balance sheet, then lands as a lumpy cash outflow at the exact moment you least control: whenever a senior, long-tenured person leaves.
A startup has two ways to meet it:
| Approach | What it means for cash |
|---|---|
| Pay from cash on exit | No annual outflow, but a large, unpredictable hit each time a five-year employee leaves. Several senior exits in one quarter can dent runway. |
| Fund a group gratuity scheme (LIC or another insurer) | You pay a smoother, tax-deductible annual contribution into an approved fund that grows with interest. The insurer pays out on each exit, so cash flow is planned, not ambushed. |
Under an LIC group gratuity cash accumulation plan, the company sets up an approved gratuity trust, makes annual contributions based on an actuarial valuation, and the fund earns a return. When an employee leaves, the claim is settled from the fund rather than from working capital.
Kaveri Labs has 40 employees and a modelled gratuity liability of about ₹18,00,000 over the next few years. Rather than risk paying ₹2 to ₹3 lakh in a single quarter when a senior engineer resigns, Kaveri sets up an approved trust and contributes roughly ₹3,50,000 a year into an LIC group gratuity scheme. The contribution is deductible, the fund earns interest, and each future payout comes from the fund, not from that quarter’s operating cash.
7 Your gratuity compliance checklist
- Confirm applicability: have you had 10+ employees on any day in the last 12 months? If yes, the Act applies for good.
- File Form A (notice of opening) with the controlling authority within 30 days of applicability.
- Collect a signed Form F nomination from every employee and keep it current.
- Track each employee’s continuous service and flag anyone approaching the five-year mark.
- Get an annual actuarial valuation of the gratuity liability and provide for it in your accounts.
- Set up an approved gratuity trust and fund it through an insurer scheme to smooth the cash outflow.
- On any exit, compute gratuity with the 15/26 formula and pay within 30 days to avoid interest.
- On death or disablement, pay without applying the five-year rule, to the registered nominee.
Not sure which rules apply at your headcount?
Use our free Compliance Applicability Checker: enter your team size, state and set-up, and see exactly which labour, payroll and HR filings you owe now, and which switch on as you grow.
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When does the Payment of Gratuity Act apply to a startup?
How is gratuity calculated under the 15/26 formula?
Does the 5-year rule apply if an employee dies?
How much gratuity is tax exempt?
By when must gratuity be paid?
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ESI registration & filing for startups →
Payment of Bonus Act: a startup guide →
Which compliances apply to your company? (free tool) →
AS | Founder, CFOmatrix | Finance Strategy & Compliance CFOmatrix helps Indian startups build finance, tax and compliance functions that stand up to investor due diligence, from process and controls to the filings and the numbers behind them. |
Disclaimer: This article is general information as of August 2026 and is not legal, tax or actuarial advice. The Payment of Gratuity Act, its rules, tax limits and interest rates can change and vary by situation. Confirm your specific obligations with a qualified professional before acting.