What is Gratuity Under Pakistani Law
Gratuity is a statutory end-of-service benefit payable to workers under the Industrial and Commercial Employment (Standing Orders) Ordinance, 1968. It is a recognition of long service and is payable on termination of employment, whether by resignation, dismissal, retirement, or death.
Gratuity is not a discretionary benefit. For covered establishments and qualifying employees, it is a legal obligation. Failure to pay gratuity on time exposes the employer to claims in the Labour Court, interest on delayed payments, and in some cases, criminal prosecution.
Who is Eligible for Gratuity
Gratuity is payable to workers who have completed a minimum of one year of continuous service with the same employer. The key conditions are:
- The worker must be a permanent employee (not a contractual, probationary, or casual worker, unless their tenure has effectively been permanent in nature)
- Continuous service means uninterrupted employment; short absences due to illness, leave, or lockout do not break continuity
- Gratuity is payable on termination regardless of the reason: resignation, retirement, retrenchment, dismissal, or death of the employee
In the case of death, gratuity is paid to the legal heirs or nominees of the deceased worker.
The Two Calculation Methods
Pakistani labour law and court practice recognizes two main gratuity formulas. Which applies depends on the terms of the employment contract or the applicable standing orders:
Method A: Last Drawn Basic Salary Divided by 26 Working Days, Per Year of Service
This is derived from treating the month as having 26 working days (excluding Sundays in a 6-day week). The formula is:
Gratuity = (Last drawn basic salary / 26) x 30 x Years of completed service
Some interpretations simplify this to one month's basic salary per year of service, which is effectively the same where the month is treated as 30 days. This is the most common formula applied in practice.
Method B: 30 Days of Wages Per Completed Year of Service
This formula directly applies 30 days of the last drawn basic salary for each completed year of service:
Gratuity = (Monthly basic salary / 30) x 30 x Years of completed service
This simplifies to: Gratuity = Monthly basic salary x Years of completed service
Both methods arrive at essentially one month's basic salary per year. The distinction becomes relevant in edge cases involving partial months, odd working days, or when standing orders specify a daily wage basis. Where the employment contract is silent, Method B (one month basic per year) is the prevailing standard in Pakistani labour courts.
Worked Examples
Example 1: 3 Years Service, PKR 50,000 Basic Salary
An employee leaves after 3 years with a last drawn basic salary of PKR 50,000 per month.
- Gratuity = PKR 50,000 x 3 years = PKR 150,000
Example 2: 5 Years Service, PKR 100,000 Basic Salary
An employee retires after exactly 5 years with a basic salary of PKR 100,000 per month.
- Gratuity = PKR 100,000 x 5 years = PKR 500,000
Example 3: 10 Years Service, PKR 200,000 Basic Salary
A senior employee resigns after 10 years with a basic salary of PKR 200,000 per month.
- Gratuity = PKR 200,000 x 10 years = PKR 2,000,000
Example 4: Partial Year Service (7 Years 8 Months)
Gratuity is calculated on completed years only. A worker with 7 years and 8 months of service is entitled to gratuity for 7 years, not 8. The 8 months do not count as an additional year unless the employment contract or company policy explicitly provides for pro-rata calculation of partial years.
Gratuity Calculation Reference Table
| Years of Service | Basic Salary (PKR) | Gratuity Payable (PKR) |
|---|---|---|
| 1 | 50,000 | 50,000 |
| 3 | 50,000 | 150,000 |
| 5 | 100,000 | 500,000 |
| 7 | 150,000 | 1,050,000 |
| 10 | 200,000 | 2,000,000 |
| 15 | 200,000 | 3,000,000 |
Tax Treatment of Gratuity in Pakistan
Gratuity received from an employer is treated as salary income under the Income Tax Ordinance, 2001. However, a significant exemption applies under the Second Schedule to the Income Tax Ordinance, 2001:
- Gratuity received is exempt from income tax up to PKR 300,000 in a tax year
- Any amount above PKR 300,000 is included in the employee's taxable income for the year of receipt and taxed at their applicable slab rate
- If gratuity is paid from an approved gratuity fund (registered with the FBR), the full amount may be exempt. Consult a tax advisor for fund-specific rules.
For the example of PKR 2,000,000 gratuity: PKR 300,000 is exempt, and PKR 1,700,000 is added to the employee's taxable income for the year. The employer should withhold tax under Section 149 on the taxable portion if paid through payroll.
Common Employer Pitfalls
- Not accruing monthly: Gratuity is a growing liability that should be accrued each month in the accounts. Many small businesses treat it as a cash item only when it is due, leading to cash flow problems at separation.
- Using gross salary instead of basic: Gratuity is calculated on basic salary only, not gross salary including house rent allowance, conveyance, or other allowances. Overpaying on gross is a common accounting error.
- Not paying on dismissal: Some employers mistakenly believe gratuity is forfeitable on dismissal for misconduct. Under the Ordinance, gratuity is generally payable even on dismissal unless the employee has been convicted of an offence involving moral turpitude and the employer has obtained a court order. Withholding gratuity without this authority exposes the employer to Labour Court claims.
- Not paying on death: Gratuity must be paid to the legal heirs of a deceased employee within the statutory timeframe. Delays after death are a common source of complaints and claims.
- Confusing gratuity with provident fund: These are separate entitlements. Employees may be entitled to both gratuity and provident fund contributions. One does not replace the other unless the employment contract explicitly provides an alternative scheme approved under the law.
Gratuity Calculator and Payroll Automation
Tracking gratuity liability across a growing workforce requires systematic accrual per employee. Inside the Peoplifi platform, you can view each employee's accrued gratuity liability in real time, based on their current basic salary and length of service. The gratuity calculator updates automatically when salaries change or employees pass service anniversaries, so your HR and finance teams always have an accurate liability figure without manual spreadsheet calculations.
Frequently Asked Questions
Is gratuity mandatory in Pakistan for all employers?
Gratuity is mandatory for establishments covered by the Industrial and Commercial Employment (Standing Orders) Ordinance, 1968. This covers most industrial and commercial establishments. Certain categories of workers and establishments may be excluded. Check the applicable standing orders for your sector and province.
What is the difference between gratuity and provident fund?
Gratuity is a one-time end-of-service payment funded entirely by the employer, calculated on years of service. Provident fund is a retirement savings scheme where both employer and employee contribute monthly throughout employment. Both may be payable on separation depending on the employment contract.
Can gratuity be forfeited if an employee resigns?
No. Gratuity is payable regardless of how the employment ends, including resignation, as long as the minimum one-year service requirement has been met. Some older employment contracts contain forfeiture clauses for resignation, but these are generally unenforceable under current labour law.
Is gratuity calculated on basic salary or gross salary?
Gratuity is calculated on basic salary only, not on gross salary. Allowances such as house rent, conveyance, medical, and utility allowances are excluded from the gratuity calculation base.
What happens if an employer does not pay gratuity on time?
The employee can file a claim in the Labour Court for recovery of gratuity along with interest on the delayed amount. The court can award the full gratuity, interest, and in some cases, costs. Persistent or willful non-payment may also result in prosecution under the applicable labour legislation.
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