Gratuity

A statutory lump-sum end-of-service benefit in Pakistan, calculated at one month's last-drawn basic wages per completed year of service for employees with 12+ months of continuous employment.

Detailed Definition

Gratuity in Pakistan is a statutory end-of-service entitlement that recognises long service by paying a lump sum on separation. It is one of the oldest pillars of Pakistani labour law and applies across most industrial and commercial establishments, with the legal basis split between the Industrial and Commercial Employment (Standing Orders) Ordinance 1968 (which governs workmen in covered establishments), the West Pakistan Shops and Establishments Ordinance 1969 (with provincial adoptions covering retail, services and offices), the Payment of Wages Act 1936, and various provincial labour codes that consolidate or amend these earlier statutes. The Sindh Terms of Employment (Standing Orders) Act 2015 and equivalent provincial enactments in Punjab and KP have further updated and codified gratuity rules.

**Eligibility and qualifying service.** Gratuity is payable to any 'workman' (under Standing Orders) or 'employee' (under provincial Shops Acts) who has completed at least 12 months of continuous service with the same employer at the time of separation. 'Continuous service' is interpreted broadly — periods of authorised leave, layoff, illness and statutory holidays are typically counted, and short breaks bridged by recall do not necessarily defeat continuity. Casual, badli and probationer employees can accrue gratuity once they cross the 12-month threshold even if they were not initially confirmed. Contract employees are generally entitled to gratuity unless their fixed-term contract clearly substitutes an equivalent terminal benefit.

**Triggering events.** Gratuity is payable on (1) resignation by the employee, (2) retirement on age or superannuation, (3) termination by the employer other than for misconduct established through proper enquiry, (4) death of the employee (paid to nominees or legal heirs), (5) permanent disablement preventing continued employment, and (6) closure or transfer of the establishment in many cases. The most contested category is termination for misconduct — employers cannot withhold gratuity on the basis of allegation alone; a domestic enquiry meeting natural-justice standards is generally required, and Labour Courts have repeatedly ordered payment where the enquiry was procedurally flawed.

**Calculation methodology.** The standard formula is: Gratuity = Last Drawn Basic Salary × Number of Completed Years of Service. For example, an employee leaving with PKR 150,000 last basic and 8 completed years of service would receive PKR 1,200,000 in gratuity. Several practical issues arise around this formula. First, 'last drawn basic' under the Standing Orders is normally the basic wage immediately before separation — but if the employee was on a reduced pay during a final illness or layoff, courts have sometimes used the last 'normal' basic. Second, partial years of service are commonly rounded to the nearest half-year or treated proportionately by progressive employers, although the strict statutory entitlement is for completed years only. Third, allowances are generally excluded — gratuity is computed on basic, not on gross — but where 'basic' has been artificially compressed and most pay is loaded into allowances, courts have occasionally redefined the calculation base to prevent abuse.

**Provident Fund in lieu of gratuity.** A common structure is that employers operating a recognised Provident Fund under the Provident Funds Act 1925 provide PF in lieu of gratuity — with the employer's matched contribution effectively replacing the statutory gratuity entitlement. This is permissible provided the PF benefit is not less favourable than the statutory gratuity over a typical career — most employers cross-check at separation and pay the higher of (a) PF employer share plus interest, or (b) statutory gratuity. Some progressive employers run both gratuity and PF, with PF as a top-up; the policy choice has implications for cost, retention and statutory exposure.

**Income-tax treatment.** Gratuity received from an unrecognised gratuity fund or under direct employer payment is exempt from tax up to PKR 300,000 under Clause (13)(iii) of Part I of the Second Schedule to the Income Tax Ordinance 2001 — amounts in excess are taxed as salary in the year of receipt, though averaging relief under Section 12(7) can reduce the marginal-rate impact. Gratuity from a fund approved by the Commissioner under Part III of the Sixth Schedule is fully exempt subject to the standard limits and conditions. Government-employee gratuity is exempt without limit. Employers should issue a salary tax certificate showing the gratuity component separately so the employee can claim relief on their personal return.

**Final-settlement timing and procedure.** Gratuity is typically paid within the full-and-final settlement (F&F) cycle that follows separation. Best practice is to release F&F within 30 days of the last working day, including: final salary for the part-month, leave encashment, gratuity, any pro-rata bonus, and recovery of advances or notice-period shortfall. Section 6 of the Payment of Wages Act and the various provincial Standing Orders Acts impose obligations to pay terminal dues without unreasonable delay; persistent non-payment is actionable before the Labour Court, which has powers to award the principal amount along with compensation and costs. Gratuity claims have a statutory limitation period (typically three years from accrual) but courts can extend in deserving cases.

**Common compliance traps.** Employers frequently miscalculate gratuity in three ways. First, computing on net or take-home rather than basic — the statute is clear that basic is the base, not gross or net. Second, denying gratuity to employees terminated for misconduct without conducting a proper domestic enquiry — this opens the door to a Labour Court claim that almost always succeeds. Third, applying a global formula like '15 days' wages per year' (which is the Indian gratuity formula under the Payment of Gratuity Act 1972) to Pakistani employees, where the statutory rate is one month per completed year. Fourth, failing to pay gratuity on death — many employers require nominee or succession-certificate paperwork that delays payment but is administratively manageable with planning.

**Liability accrual and provisioning.** From an accounting standpoint, gratuity is a defined-benefit liability that accumulates as service is rendered. International Accounting Standard (IAS) 19 and its Pakistani-adopted equivalent require actuarial valuation of the gratuity obligation, with the present value recognised on the balance sheet and current-service cost charged to the income statement each period. Many medium-sized Pakistani employers under-provision because they treat gratuity as a payable that crystallises only on separation — but the liability accrues every month, and an actuarial valuation is the disciplined way to recognise it. Approved gratuity funds set up with Commissioner approval allow tax-deductible contributions, smooth the cost over years, and eliminate the cash-flow shock of large terminal payments at the same time.

**Automation through Peoplifi.** Peoplifi tracks gratuity accrual continuously per employee, computes the correct figure at separation using the live last-basic and completed-years inputs, applies the PKR 300,000 income-tax exemption, generates F&F statements with gratuity broken out as a tax-relief-eligible line, and produces the audit trail required for actuarial valuation and Labour Court defence if challenged.

Automate Gratuity with Peoplifi

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