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Gratuity, bonus and leave encashment in payroll software: 2026 rules and worked calculations
How payroll software should calculate gratuity (including fixed-term staff after one year), statutory bonus at ₹21,000 eligibility and leave encashment, with worked rupee examples.
Three annual or exit-time payments test payroll software more than any monthly run: gratuity, statutory bonus and leave encashment. Under the labour codes in force since 21 November 2025, gratuity remains 15 days' wages for each completed year of service, but fixed-term employees qualify after one year; bonus applies to employees with wages up to ₹21,000 a month, calculated as if wages were ₹7,000 or the minimum wage, whichever is higher, at 8.33% to 20%; and leave encashment depends on the OSH Code, state rules and your policy. All three now use the code definition of wages, so the 50% rule can raise them. Worked examples below are illustrative.
This guide belongs to the best-fit selection method. For the wider changes, see labour codes and payroll.
Gratuity
Rule of thumb under the Code on Social Security, 2020: gratuity = 15 days' wages × completed years of service, with 15/26 of monthly wages used for monthly-rated employees. It is payable on leaving after five years of continuous service (no minimum for death or disablement), and for fixed-term employees after one year. Service of more than six months in the final year is generally rounded up to a full year. The statutory ceiling was reported as ₹20 lakh in 2026; employers may pay more under contract or settlement.
Example 1, permanent employee. Last drawn code wages ₹30,000 a month, service 7 years.
Gratuity = 15 × ₹30,000 × 7 ÷ 26 = ₹31,50,000 ÷ 26 = ₹1,21,154.
Example 2, fixed-term employee. Contract of 1 year 8 months, last code wages ₹25,000. Service rounded to 2 years: rule 33 of the Social Security (Central) Rules, 2026 rounds a fixed-term period of more than six months after the first year up to one additional year.
Gratuity = 15 × ₹25,000 × 2 ÷ 26 = ₹28,846.
Example 3, effect of the 50% rule. Basic + DA ₹12,000 on a gross of ₹40,000, service 6 years. On basic only, gratuity would be 15 × ₹12,000 × 6 ÷ 26 = ₹41,538. With code wages of ₹20,000 (excess allowances added back), it becomes 15 × ₹20,000 × 6 ÷ 26 = ₹69,231. Employers with allowance-heavy structures should revisit gratuity provisions.
Gratuity is not "wages" for the two-working-day settlement rule and has its own timeline under the code; pay it promptly to avoid interest. Tax exemption limits for gratuity under the Income-tax Act, 2025 differ for government and other employees; check the current limit before you compute TDS on the payment.
What the software should do
- Track continuous service from joining date, including fixed-term contracts and renewals.
- Use code wages, not just basic, as the gratuity base.
- Calculate an accrual or provision each month for accounts, and the actual payout on exit.
- Handle the ₹20 lakh statutory ceiling and any higher company scheme.
- Produce the gratuity payment and tax treatment in the full and final settlement.
Statutory bonus
Under notifications issued in August 2026 under the Code on Wages (S.O. 4710(E) and 4711(E), both dated 25 August 2026 and deemed effective from 21 November 2025), for establishments where the Centre is the appropriate government:
- employees with wages up to ₹21,000 a month who worked at least 30 days in the accounting year are eligible;
- if wages exceed ₹7,000, bonus is calculated as if wages were ₹7,000 or the minimum wage fixed by the Central Government, whichever is higher;
- the minimum bonus is 8.33% and the maximum 20%, depending on the allocable surplus.
States may notify their own figures for establishments under them. Confirm for your state.
Example 4. Monthly wages ₹18,000 (eligible). Applicable minimum wage, illustratively ₹12,000 a month, is higher than ₹7,000.
| Line | Calculation | Amount |
|---|---|---|
| Calculation base | ₹12,000 × 12 months | ₹1,44,000 |
| Minimum bonus 8.33% | 8.33% × ₹1,44,000 | ₹11,995 |
| Maximum bonus 20% | 20% × ₹1,44,000 | ₹28,800 |
An employee earning ₹22,000 is not eligible for statutory bonus, though you may pay a policy bonus. Software must apply eligibility per employee per year, prorate for days worked, deduct permissible advances and record the payment in the bonus register.
Leave encashment
The OSH Code provides annual leave with wages for workers (broadly, one day for every 20 days worked, for those with at least 180 days of work in a calendar year), with carry-forward limits and a right to encash leave in specified situations; state shops and establishments rules and your policy add to this. Because the details vary, configure leave encashment from your policy and the rules that apply to you.
Example 5. Unused leave of 10 days on exit; monthly code wages ₹20,000; policy uses 26 working days.
Encashment = ₹20,000 ÷ 26 × 10 = ₹7,692. If the policy uses 30 days, it is ₹6,667. The software should let you choose the divisor per policy and keep it consistent.
Leave encashment paid with a full and final settlement is part of the wages due within two working days, so it must be computed fast. Tax exemption for leave encashment on retirement has its own limit; check it under the 2025 Act.
Demo tests
- Gratuity for a permanent employee with 4 years 7 months (check how the software treats the five-year eligibility test and the rounding; see the FAQ below).
- Gratuity for a fixed-term employee with 1 year 3 months.
- Bonus run for 50 employees, including one who crossed ₹21,000 mid-year.
- Leave encashment in a full and final settlement processed the same day.
- Gratuity provision report for the accounts team.
Add the results to the selection checklist.
Frequently asked questions
Does a resignation after four years and seven months qualify for gratuity?
Many employers and some court rulings treat it as five years, but whether rounding applies to the five-year eligibility test, and not only to the amount, depends on the facts and case law. Check with your adviser.
Is the bonus ceiling the same in every state?
The central notification covers the central sphere. States may set their own; confirm for your establishment.
Do we pay bonus to contract workers?
The contractor is generally responsible, but principal employers have oversight duties. Check the contract and the OSH Code rules.
Are the minimum wages in the examples real?
No, they are illustrative. Use the rates notified for your state and category.
Sources
- Ministry of Labour and Employment — Code on Social Security, Code on Wages, OSH Code and FAQs
- e-Gazette of India — bonus notifications and rules
- Income Tax Department — tax treatment of gratuity and leave encashment
- India Code — text of the codes and state Acts
