Under Indian labour law, fixed term contract employees are eligible for proportionate gratuity even if they complete only one year of service. This rule was introduced through the Industrial Employment (Standing Orders) Amendment Rules, 2018 and reinforced under the Code, Section 2(34) of the Social Security, 2020, removing the traditional five-year requirement for such employees.
When Were Fixed Term Gratuity Rules Introduced?
The concept of gratuity eligibility for fixed term employees was formally introduced through the Industrial Employment (Standing Orders) Central Amendment Rules, 2018. These rules legally recognised fixed term employment as a category of employment in India.
Later, the Code on Social Security, 2020 consolidated multiple labour laws and reaffirmed that fixed term employees are eligible for gratuity even without completing five years of service.
Although the labour codes are yet to be fully implemented across all states, many companies have already updated their HR policies to align with these provisions.
Why Was This Law Introduced?
The reform was introduced to address gaps in labour protection. Previously, employees working on short-term contracts often did not qualify for gratuity because they could not complete the five-year continuous service requirement.
This created a situation where employers could repeatedly hire workers on short contracts and avoid gratuity obligations.
The new rule aims to:
- Provide social security benefits to short-term employees
- Encourage formal employment practices
- Ensure equal treatment between fixed term and permanent employees performing similar work
- Prevent misuse of contract employment structures
Who Does the Law Apply To?
The gratuity provisions apply to fixed term employees working in establishments covered under the Payment of Gratuity Act.
A fixed term employee is someone who is hired through a written employment contract for a specific duration. These employees are entitled to the same wages, allowances, and benefits as applicable to permanent employees performing similar work.
Industries that commonly employ fixed term workers include manufacturing, infrastructure projects, construction, retail chains, and IT services.
Key Provisions of the Gratuity Law
Important provisions under the Payment of Gratuity Act and related labour regulations include:
- Employers must pay gratuity to eligible employees when employment ends after qualifying service.
- The Act applies to establishments with ten or more employees.
- Gratuity is payable on resignation, retirement, death, or disability.
- Fixed term employees are eligible for gratuity without completing five years of service.
- Gratuity is calculated proportionately based on the duration of employment.
The standard formula for calculating gratuity is:
Gratuity = (Basic /D.A/F.D.A/ Special Allowance × 15 × years of service) ÷ 26
For the purpose of calculation, salary generally includes basic pay and dearness allowance.
Before vs After: Changes in Gratuity Rules
Before the Reform
Under the Payment of Gratuity Act, 1972:
- Minimum 5 years of continuous service required
- Fixed-term and contract employees were usually not eligible
- Employers could structure contracts to avoid gratuity liability
- Social security coverage was limited to long-term employees
After the Reform
Under the Industrial Employment Rules, 2018 and Code on Social Security, 2020:
- No 5-year requirement for fixed-term employees
- Eligibility even after 1 year of service
- Gratuity paid proportionately on year of Service
- Equal benefits for fixed-term and permanent employees
| Factor | Before | After |
| Minimum Service | 5 years | No minimum (for fixed-term) |
| Contract Employees | Not eligible | Eligible |
| Calculation | Long-term basis | Pro-rata basis |
| Coverage | Limited | Expanded |
Real-World Application
Consider an employee hired on a one-year fixed term contract in a manufacturing company with a monthly basic salary of ₹40,000.
Under traditional rules, the employee would not have qualified for gratuity due to the five-year requirement.
Under the fixed term employment rule, the employee becomes eligible for proportionate gratuity after completing the contract period. The amount would be calculated based on the standard gratuity formula using the employee’s last drawn salary and the duration of service.
This ensures that even short-term employees receive financial recognition for their contribution.
Penalties for Non-Compliance
Failure to pay gratuity can attract penalties under both the Payment of Gratuity Act, 1972 and the Code on Social Security, 2020.
However under the Code of Social Security 2020 , Section 133 explicitly criminalizes the non-payment of gratuity to employees, making it a punishable offence under Indian labour law
Penalties for Non-Payment of Gratuity
- Fine: Employers may be fined up to ₹50,000.
- Imprisonment: In serious or repeated cases, imprisonment up to 1 year may be imposed.
- Both: Courts may impose both fine and imprisonment depending on the gravity of default
Recent Legal Developments
Recent labour law reforms have expanded employee protections. The Code on Social Security, 2020 consolidates several labour laws and confirms gratuity eligibility for fixed term employees without the five-year service requirement.
Indian courts have also increasingly emphasised equal treatment between fixed term and permanent employees performing similar roles.
As a result, many organisations have updated their HR policies to ensure compliance with the evolving legal framework.
How will gratuity be calculated if basic pay increases due to 50% rule?
Frequently Asked Questions
Is gratuity payable after one year in a fixed term contract?
Yes. Fixed term employees are eligible for proportionate gratuity after completing their contract period, even if they have not completed five years of service.
Does the five-year rule apply to fixed term employees?
No. The five-year continuous service requirement primarily applies to permanent employees. Fixed term employees can receive gratuity based on the duration of their contract.
How is gratuity calculated for fixed term employees?
Gratuity is calculated using the standard formula based on the employee’s last drawn salary and the duration of service. The amount is paid proportionately.
Which organisations must pay gratuity?
The Payment of Gratuity Act applies to establishments that employ ten or more workers.
What happens if an employer refuses to pay gratuity?
Employees can file a claim before the Controlling Authority under the Payment of Gratuity Act. The authority can order payment along with interest.
Is gratuity taxable in India?
Gratuity received under the Payment of Gratuity Act is tax-exempt up to ₹20 lakh under the Income Tax Act.