Ask any Indian small business why its contracts run for eleven months and you will get the same answer, delivered with the confidence of something everybody knows. Eleven months, renewed. Never five years. Never gratuity. It was the most widely followed piece of payroll folk wisdom in the country, it was taught by consultants, and for fifty years it worked exactly as advertised.
It stopped working on 21 November 2025. Under the Code on Social Security, 2020, a worker engaged on fixed term employment earns gratuity after one year of continuous service, paid on a pro rata basis — not after five, and not rounded. The eleven-month contract is now a device that saves you nothing at eleven months and costs you a settlement at thirteen.
This guide covers the fixed-term gratuity rule end to end: what Section 53 actually says, the four tests that decide whether someone on your roll is legally a fixed-term employee, where the one-year line falls and why eleven months is no longer clever, how pro rata gratuity is calculated with the arithmetic worked through, what the 50% wage rule does to the same sum, the thirty-day payment clock and the interest that runs after it, the nomination and claim forms notified in May 2026, and what a 25-person business should expect this to cost.
What Changed in the Gratuity Rules, and When
Four dates matter. Confusing them is the main reason an owner believes they have more time than they do.
| Date | What happened | Effect on gratuity |
|---|---|---|
| 21 Nov 2025 | All four Labour Codes brought into force, repealing 29 central acts including the Payment of Gratuity Act, 1972 | Section 53 replaces the 1972 Act. The one-year fixed-term rule becomes live law |
| 8 May 2026 | Central Rules under all four Codes notified | Nomination, claim and notice forms prescribed. The old Form F, Form I and Form L are superseded |
| 29 Jun 2026 | EPF Scheme, 2026 supersedes the 1952 Scheme | No direct gratuity effect, but it settles the wages basis that gratuity is computed on |
| Today | Every fixed-term contract on your roll is governed by Section 53 | Liability accrues on service already rendered. There is no transition window |
That last row is the one people miss. There was no grandfathering. A fixed-term employee who joined in March 2024 and resigns next week has well over a year of continuous service behind them, and the qualifying test is applied at exit under the law in force at exit. The service does not have to have been rendered after commencement for the entitlement to arise.
Who Is Actually a “Fixed Term Employee”?
This is where most SMEs get it wrong in both directions — some assume every contract worker qualifies, others assume none of theirs do. Fixed term employment is a defined status, not a description of how temporary somebody feels. Four things have to be true at once.
- There is a written contract. Not a verbal understanding, not a renewal implied by the fact that they kept showing up. A written contract for a stated period.
- The period is fixed in advance. The contract states when it ends. An open-ended engagement that happens to end is not fixed-term employment.
- The engagement is direct. The contract is between the worker and you. Where a manpower contractor sits in the middle, that person is contract labour, which is a different regime with a different — and for you, uncomfortable — set of principal-employer consequences.
- The person falls within the definition of “employee”. A genuine independent professional invoicing you for a deliverable is not a fixed-term employee. Someone who works your hours, at your place, under your supervision, on a monthly figure, generally is — whatever the contract calls them.
Two practical consequences follow. First, a fixed-term employee is entitled to the same hours, remuneration and statutory benefits as a permanent worker doing the same job, proportionately, whether or not their tenure would otherwise qualify them. Second, the appointment letter is no longer optional paperwork: the Codes require one, it has to state the type of engagement, and the type of engagement is now the thing that decides whether gratuity is due at one year or five. We covered the appointment-letter obligation in the Labour Code compliance checklist for 2026.
Why Eleven Months Is No Longer a Loophole
The eleven-month contract worked because five years of continuous service was a long way away and a renewal cycle could be made to look like a series of unrelated engagements. Neither half of that survives the new rule.
The threshold is now one year, so the gap between “safe” and “liable” is four weeks rather than four years. A contract genuinely ending at eleven months still attracts nothing — the one-year line is a real line and it has to be crossed. But almost nobody actually ends at eleven months. They renew, and continuous service under the Code is uninterrupted service, expressly including periods interrupted by sickness, accident, leave, absence without leave, lay-off, strike, lock-out or a stoppage of work not caused by the employee. A gap you engineered between two contracts for the same person doing the same job is not obviously any of those things, and an inspector reading a renewal pattern will read it as one engagement.
So the practical position is this. If you renew, you are almost certainly running one continuous engagement and the clock has been ticking since the first joining date. If you genuinely stop at eleven months, you have avoided a gratuity bill of roughly two weeks’ wages and paid for it by retraining somebody every year, which in most businesses is the more expensive of the two.
How Pro Rata Gratuity Is Calculated
The rate is fifteen days’ wages for every completed year of service, on the rate of wages last drawn. For a monthly-rated employee the fifteen days are expressed against a twenty-six-day month, because the six weekly offs in a month are not counted:
Gratuity = (15 ÷ 26) × last drawn monthly wages × years of service
For a fixed-term employee, “years of service” is the actual completed service expressed as a fraction. For a regular employee it is completed years, with any part above six months rounded up to a full year.
That difference in the last line is the single most commonly mishandled part of the new rule, so here it is on real numbers. Take an employee whose statutory wages are Rs 20,000 a month. One year of gratuity is 15 ÷ 26 × 20,000 = Rs 11,538.
| Service at exit | Regular employee (5-year rule, rounded) | Fixed-term employee (pro rata) |
|---|---|---|
| 11 months | Nil | Nil — the one-year line is not crossed |
| 1 year 0 months | Nil | Rs 11,538 |
| 1 year 6 months | Nil | Rs 17,308 |
| 2 years 4 months | Nil | Rs 26,923 |
| 2 years 8 months | Nil | Rs 30,769 |
| 5 years 7 months | Rs 69,231 (rounded to 6 years) | Rs 64,423 (5.58 years) |
Illustrative figures on statutory wages of Rs 20,000, rounded to the rupee. Note the last row: at long tenure, strict pro rata pays less than the rounding rule, because rounding a part-year up is generous and proportion is not. The interaction between the rounding sentence in Section 53(2) and the pro rata proviso for fixed-term employees has not been settled by any authority we are aware of. The defensible position for an employer is to compute both and pay the higher: an underpayment carries simple interest and a claim before the competent authority, an overpayment carries neither.
What the 50% Wage Rule Does to the Same Calculation
Halving the qualifying period is only half the cost increase. The other half is that “wages” itself changed. Gratuity is computed on wages as the Code defines them, and the Code caps excluded allowances at half of total remuneration and adds back the excess. Your payslip can still say Basic is 40%. The gratuity base will read it as 50%.
Take a fixed-term employee on Rs 30,000 a month, structured the way almost everybody structures it:
| Component | Monthly | Treatment under the Code |
|---|---|---|
| Basic | Rs 12,000 | Wages |
| HRA | Rs 7,500 | Excluded |
| Conveyance | Rs 2,400 | Excluded |
| Special allowance | Rs 8,100 | Excluded |
| Excluded total | Rs 18,000 | 60% of remuneration — above the half-way cap |
| Add-back | Rs 3,000 | 18,000 − (50% of 30,000) |
| Statutory wages | Rs 15,000 | 12,000 + 3,000. This is the gratuity base |
At eighteen months, gratuity on the payslip Basic of Rs 12,000 would be Rs 10,385. On statutory wages of Rs 15,000 it is Rs 12,981 — a quarter more, for the same person on the same salary, because the base moved. The full mechanics of the add-back, with two complete before-and-after restructures, are in our guide to the new salary structure under the Labour Codes.
What This Costs a 25-Person Business
Numbers in the abstract do not land, so here is a small business of the shape this actually bites: 25 people, of whom 8 are on written fixed-term contracts, average statutory wages of Rs 18,000, and an average tenure at exit of 20 months because the contracts are renewed once and then not.
- One year of gratuity per head: 15 ÷ 26 × 18,000 = Rs 10,385
- At 20 months (1.67 years): Rs 17,308 per person
- Across 8 fixed-term staff: roughly Rs 1.38 lakh
- The same cohort under the old five-year rule: nil
It is a real number and it is not a catastrophic one. What makes it dangerous is that it does not arrive as an annual bill. It arrives as eight separate settlements, on eight unpredictable dates, each of which has to be paid within thirty days, and none of which was provisioned for. A business that has never accrued gratuity discovers it one resignation at a time.
The Payment Clock, and the Two Clocks That Are Not the Same
Gratuity becomes payable when the employment ends, and the employer has to arrange payment within thirty days of it becoming payable. Miss that and simple interest runs on the amount from the due date until payment, at the rate notified for repayment of long-term deposits. Interest is not discretionary and it is not waived by the employee having been slow to claim — the obligation to pay sits with the employer whether or not any application is made.
This is where a lot of SMEs trip, because there are now two exit clocks running at different speeds:
The two-working-day rule for wages is the bigger operational shock and we have written it up separately in the guide to full and final settlement under Section 17(2).
The Forms You Now Have to Use
The Central Rules notified on 8 May 2026 replaced the old Payment of Gratuity Act forms. If your HR folder still contains Form F for nominations, it is out of date. Under the Social Security (Central) Rules, 2026:
- Nomination — Form III. Every employee who completes one year of service makes a nomination, ordinarily within ninety days of completing that year. For staff already in service when the Rules commenced, the ninety days ran from commencement. The employer keeps the nomination in safe custody, which in practice means a scan filed against the employee record, not a sheet in a drawer.
- Claim — Form IV. Filed by the employee or nominee, ordinarily within thirty days of gratuity becoming payable; a legal heir has a year. A late claim does not extinguish the entitlement.
- Notice of payment or rejection — Form V.The employer’s written response, stating the amount and how it was computed, or the ground of rejection.
Two things follow from this that are easy to overlook. Nomination is now triggered at the one-year mark for everybody, which for a business running fixed-term contracts means it is triggered at exactly the point the entitlement crystallises. And Form V requires you to show the computation, which means the wages figure, the joining date and the last working day all have to be defensible from records rather than reconstructed from memory.
The Record You Will Be Asked For
Every dispute about gratuity reduces to three facts: when they started, when they stopped, and what they were last drawing. If those three are certain, the arithmetic is arithmetic. If any one of them is contested, the burden of showing the correct figure sits with the employer, and an employer whose attendance lives in a WhatsApp group and a notebook has nothing to show.
This is the specific gap Shiftelio was built for, so treat what follows as an interested party describing its own product — but the mechanics are worth understanding whatever you eventually buy:
- Date of joining is a field, not a memory. The employee record carries the joining date, the engagement type and the contract end date, so the one-year test is answerable for every person on the roll without opening a file.
- Continuous service is evidenced daily. Each in and out is a live selfie with GPS geo-fencing, so an unbroken engagement is provable by record rather than assertion — which matters most in exactly the case where a renewal pattern is being read as one continuous service.
- Wages are computed on the Code definition.The payroll engine totals the excluded components, runs the 50% test and applies the add-back, so the gratuity base is derived rather than remembered, and it does not quietly drift when somebody’s special allowance is topped up mid-year.
- Exit settlement is one screen. Wages to date, leave encashment, outstanding loans and advances, and gratuity, with a live per-employee balance — which is what makes a two-working-day settlement achievable rather than aspirational.
- The working is printable. Form V asks how the figure was arrived at. A settlement statement that already shows wages, tenure and rate answers that in one page.
All of it sits in the flat annual price with no per-employee fee. If you would rather just work out one person’s number right now, our free full and final settlement calculator takes the joining date, last working day and wages and shows the whole exit settlement including gratuity. No signup, no email.
Frequently Asked Questions
Does the five-year rule still exist for permanent employees?
Yes. The reduction to one year applies to fixed-term employees. A regular employee still needs five years of continuous service, and the long-standing position that four years plus 240 days of actual work (190 in a five-day-week establishment) counts as the fifth year has not been disturbed.
My contract worker comes through a manpower agency. Am I liable?
They are not your fixed-term employee — fixed term employment requires a direct written contract with you. But that is not the same as being safe. Where the contractor fails to pay statutory dues, liability travels to the principal employer, which is you. Check that your contractor is actually accruing and paying, and keep the evidence that you checked.
Do I have to fund gratuity in advance, or pay it out of cash flow?
The Code does not require a small employer to fund it. Paying from cash flow is lawful. It is also how businesses get caught: eight fixed-term staff leaving across a bad quarter is a six-figure cash event that nothing on your P&L warned you about. Accruing it monthly as a provision costs nothing and turns a shock into a line item.
Can I write into the contract that no gratuity is payable?
No. It is a statutory entitlement and a contract term purporting to waive it is void to that extent. Nor does labelling a fixed-term employee a “consultant” help if the working reality is employment — the test looks at substance, and getting it wrong costs you the gratuity plus interest plus every other statutory benefit you also did not pay.
What is the maximum gratuity payable?
The ceiling is Rs 20 lakh, which is also the limit for tax exemption in the employee’s hands. It is notified rather than written into the section, so it can move. At SME wage levels it is not a live constraint: at Rs 20,000 of statutory wages you would need roughly 43 years of service to reach it.
Does an employee who is dismissed for misconduct still get gratuity?
Usually yes. Forfeiture is available only in narrow circumstances — broadly, damage or loss caused by the employee, or riotous conduct or an offence involving moral turpitude committed in the course of employment — and even then only to the extent of the loss, following a proper process. Withholding gratuity as a general disciplinary measure is not lawful and will attract interest on top.
Is gratuity part of the two-working-day settlement window?
Strictly, no. Wages and other sums under the Code on Wages are due within two working days of exit; gratuity has its own thirty-day clock. In practice, paying both together is simpler and removes the risk of the wages payment being held up while somebody computes the gratuity.
The Bottom Line
The eleven-month contract solved a problem that no longer exists and creates one that does. It saves a gratuity payment of about two weeks’ wages, and it buys that saving by churning trained staff every year in a labour market where replacing them costs considerably more than Rs 11,538.
The honest response to Section 53 is not a cleverer contract. It is three unglamorous things: know the joining date and engagement type for every person on your roll, compute wages on the Code definition rather than the payslip label, and accrue the liability monthly so it is provisioned before it is payable. Do those and the fixed-term gratuity rule is a modest, predictable cost. Skip them and it is a surprise, arriving one resignation at a time, with interest running while you look for the joining date.
Sources
- Ministry of Labour and Employment — the four Labour Codes
- Press Information Bureau — factsheet on the Code on Social Security, 2020
- Ministry of Labour and Employment — FAQs on the Labour Codes
- India Code — the bare text of the Codes and the rules made under them
This guide is general information for Indian employers, not legal advice. Where your state has notified its own rules under the Codes, those govern your establishment. Every worked figure is illustrative.