Gratuity in India Is a Liability, Not a Payout

Most foreign employers budget for gratuity as a cheque written at exit. Under the Payment of Gratuity Act it is a liability that accrues from day one — and it belongs on your balance sheet long before anyone resigns.

Ask most foreign employers how they budget for gratuity in India and you get a version of the same answer: it's a payment made when someone leaves after five years, so it gets dealt with then. That answer is wrong in a way that quietly distorts your accounts, and it is one of the most common gaps we see when companies move onto a proper India payroll.

Gratuity is not an exit payment. It is a defined-benefit obligation that begins accruing the day an employee joins.

What the Act actually requires

The Payment of Gratuity Act, 1972 applies to establishments with ten or more employees. For regular employees, gratuity becomes payable on separation once the employee has completed five years of continuous service — on resignation, retirement, or termination other than for gross misconduct. Death and disablement are treated separately, and the five-year condition does not apply in those cases.

The statutory calculation is straightforward:

Gratuity = (15 × last drawn salary × completed years of service) ÷ 26

"Last drawn salary" here means basic plus dearness allowance, not gross. The 26 represents working days in a month, and the 15 represents fifteen days' wages for each completed year. Payment is capped at the statutory ceiling in force at the time — confirm the current ceiling, as it has been revised more than once.

The part that trips people up: it accrues from day one

The five-year rule governs when gratuity becomes payable. It does not govern when the cost is incurred. Each month an employee works, they move closer to a benefit you will owe, and accounting standards require you to recognise that as it builds — not in one lump when it crystallises.

In practice, employers accrue roughly 4.81% of basic each month. That figure is simply the formula expressed monthly: fifteen days over twenty-six working days, spread across twelve months. It is an approximation for budgeting, not a valuation.

Why a real valuation is different from an accrual

A flat 4.81% accrual assumes every employee stays long enough to qualify, that salaries never change, and that a rupee owed in seven years costs the same as a rupee owed today. None of that is true.

Under AS 15 and Ind AS 19, gratuity is a defined-benefit obligation and companies with audited financials are expected to measure it actuarially. That means projecting each employee's benefit using assumptions about salary growth, attrition, mortality and a discount rate, then discounting the result back to a present value. Two companies with identical headcount and identical payroll can carry materially different gratuity liabilities depending on how long their people actually stay.

The practical consequence: if your India entity is audited, consolidated into a group, or being prepared for diligence, a spreadsheet accrual will not survive contact with your auditors.

What changed for fixed-term employees

India's consolidated labour codes changed the position for fixed-term employment. Fixed-term employees now become eligible for gratuity on a pro-rata basis after one year of service, rather than the five years that continues to apply to regular employees.

If you use fixed-term contracts in India — common for project-based hiring and for GCC ramp-ups — this materially changes the accrual, because a category of worker you may have assumed would never qualify now does. Implementation of the codes has been uneven across states, so confirm the position that applies to your establishments.

What goes wrong when it isn't tracked

• The liability is invisible until someone resigns, and then it lands as an unbudgeted cost in a single month.
• Audit adjustments at year end, because the accrued figure doesn't reconcile to a defensible valuation.
• Cost-of-employment models understate the true cost of an India team, sometimes for years.
• Full-and-final settlements get delayed while the correct figure is worked out — and the labour codes tighten the window for settling dues on exit.
• In a transaction, an unquantified employee-benefit obligation becomes a diligence finding.

How this should be handled

Gratuity should be visible in three places: accrued per employee every payroll cycle, aggregated as a liability you can see at any point without asking anyone, and valued properly when your accounts require it.

Connect by Vinpro includes a dedicated actuarial gratuity valuation module rather than a payout estimator — the ongoing obligation, not just the cheque at the end. It is a genuinely India-specific requirement, and it is one of the clearer places where a platform built for India differs from a global platform that treats India as one country among many.

If you are budgeting an India team, treat gratuity as a cost of employment from month one. It already is one — the only question is whether your accounts show it.