Gratuity Rules for Fixed-Term/Contract Employees Explained

For decades, gratuity in India was seen as a benefit reserved for employees who stayed with the same company for at least five years. If you were on a fixed-term contract, a project-based role, or a short assignment, you likely assumed gratuity simply did not apply to you. That assumption is no longer accurate.

With the introduction of India’s new labour codes, fixed-term employees now have a legal right to gratuity, and the eligibility period has been cut down dramatically. If you are on a contract job, or if you run a business that hires fixed-term staff, understanding these updated rules is essential, both to know your rights and to stay compliant. This article walks through exactly what has changed, how the calculation works, and what you should check before assuming you do or do not qualify.

Who Is a Fixed-Term Employee?

A fixed-term employee is someone hired for a specific, predetermined period, whether that is a project, a season, or a defined contract duration, rather than being on the permanent payroll of the organisation. This is different from a permanent employee, whose employment continues indefinitely unless terminated or resigned from, and it is also different from a contract worker hired through a third-party staffing agency or contractor.

Fixed-term employment has grown rapidly across sectors like IT, e-commerce, manufacturing, and retail, largely because it gives companies flexibility to scale their workforce up or down based on project demand. Until recently, this flexibility came at a cost to the employee, since fixed-term staff were often excluded from long-service benefits like gratuity simply because their tenure rarely crossed the five-year mark.

The Old Rule: Five Years of Continuous Service

Under the original Payment of Gratuity Act, 1972, the eligibility rule was straightforward and applied uniformly. An employee needed to complete at least five years of continuous service with the same employer to claim gratuity, except in cases of death or permanent disablement, where this condition was waived.

For a large share of fixed-term employees, this rule meant gratuity was practically out of reach. A one-year or two-year contract, however long it was renewed, often did not add up to the required five years in the eyes of many employers, particularly if contracts were structured as fresh agreements rather than continuous extensions.

What Changed: The Code on Social Security, 2020

India’s four labour codes, including the Code on Social Security, 2020, subsume and update the Payment of Gratuity Act, 1972. These codes were notified as effective law on 21 November 2025, with full central and state-level enforcement expected to be completed through 2026 as individual state governments finalise their own rules.

One of the most significant changes under this code is specifically aimed at fixed-term employees.

Pro-Rata Gratuity After Just One Year

Under the new framework, fixed-term employees are entitled to gratuity on a pro-rata basis after completing just one year of continuous service with the same employer, rather than the five years required of permanent staff. This is a major shift, since it recognises that fixed-term and contract roles deserve proportional long-service benefits too, even if the overall tenure is shorter than a traditional permanent role.

It is worth being clear about one distinction here. The five-year rule has not been scrapped altogether. It still applies to permanent employees. What has changed is that fixed-term employees now have a separate, shorter qualifying period, calculated on a pro-rata basis relative to the length of their contract and service.

How Gratuity Is Calculated for Fixed-Term Employees

The underlying formula used for fixed-term employees remains similar in structure to the standard gratuity formula, but it is applied proportionally based on the actual period of service rather than requiring a full five-year block.

For employers covered under the Act, the standard formula is:

Gratuity = (Last Drawn Salary x 15 x Number of Years of Service) / 26

Here, Last Drawn Salary refers to basic pay plus dearness allowance, 15 represents 15 days of wages for each completed year of service, and 26 is the number of assumed working days in a month.

For a fixed-term employee who has completed, say, 2 years and 3 months of continuous service, the gratuity is calculated on a pro-rata basis for that actual period, rather than being denied altogether for falling short of five years, as would have happened under the earlier rule.

Example: Suppose a fixed-term employee has a last drawn basic salary plus DA of 35,000 and has completed 2 years of continuous service under a fixed-term contract. Using the standard formula: Gratuity = (35,000 x 15 x 2) / 26 = approximately 40,385.

This is a meaningful benefit that simply did not exist for most fixed-term staff before the new labour codes came into force.

Also Watch the New Definition of Wages

Alongside the change in eligibility, the new labour codes also redefine what counts as wages for the purpose of calculating gratuity, provident fund, and other statutory dues. Under the updated definition, basic pay plus dearness allowance plus retaining allowance must together make up at least 50 percent of an employee’s total Cost to Company. If allowances such as HRA and special pay push this ratio above 50 percent of CTC, the excess portion is now treated as wages for calculation purposes.

This matters for fixed-term employees as much as permanent staff, since many contract roles are structured with a lower basic pay and higher allowances to reduce upfront statutory costs. With the new wage definition, this structuring has less room to reduce the gratuity calculation base, which can mean a higher payout for a given length of service compared to the old structure.

Key Conditions Fixed-Term Employees Should Check

Not every fixed-term arrangement automatically qualifies in the same way, so it is worth confirming a few details with your employer or HR team.

• Confirm whether your organisation employs ten or more people, since the Act, and now the Code on Social Security, generally applies to establishments above this threshold.
• Check whether your contract has been renewed continuously with the same employer, as continuity of service is usually what counts, rather than the individual duration of each renewed agreement.
• Ask whether your state has fully notified and enforced the new labour code provisions yet, since implementation timelines vary by state and some rules may still be transitioning through 2026.
• Review your appointment letter or contract terms, since some employers may have already updated their HR policies to reflect the pro-rata gratuity requirement, while others may still be catching up.

Tax Treatment for Fixed-Term Employees

The tax treatment of gratuity received by fixed-term employees follows the same broad principles as other private sector employees. If you are covered under the Act, the exemption available is the lowest of the actual gratuity received, the statutory cap of 20 lakh, or the amount computed using the formula above. Any amount received beyond the exempt limit is added to your taxable income under the head Income from Salary and taxed according to your applicable slab.

Why This Change Matters

For millions of employees working on fixed-term contracts across India’s IT, retail, logistics, and manufacturing sectors, this update effectively extends a long-service benefit to a workforce segment that previously had little access to it. It also puts more responsibility on employers to track continuous service accurately for fixed-term staff, since gratuity liability can now begin accruing much earlier than before.

If you are on a fixed-term contract and want to know exactly what you may be entitled to, it helps to run the numbers rather than rely on assumptions. Our Gratuity Calculator lets you enter your last drawn salary and years of service to get an instant estimate, updated in line with the new labour code rules. Once you know your expected payout, it is also worth thinking ahead about where that lump sum could go, whether that means parking it in a Fixed Deposit Calculator for near-term safety or exploring a SIP Calculator if you want to grow it over a longer horizon.

Conclusion

The days of fixed-term employees being excluded from gratuity are ending. With pro-rata gratuity now available after just one year of continuous service, and a revised wage definition that could raise the calculation base for many contract workers, it is more important than ever to understand where you stand. Whether you are an employee tracking your entitlement or an employer updating internal policy, checking your specific contract terms against these updated rules, rather than relying on the old five-year assumption, is the safest way forward.