If you’re an HR leader or finance professional in the UAE, end-of-service gratuity isn’t just a compliance checkbox, it’s a core part of financial planning and employee trust.
Under UAE Labor Law, employees who complete at least one year of service are entitled to a gratuity payout. But while the concept sounds simple, calculating it correctly can be a minefield.
From contract types to resignation scenarios, a single misstep can lead to overpayments, non-compliance, or even legal disputes.
In this guide, we’ll break it all down what the law says, how to calculate gratuity for each case, and how tech can help streamline the process for 2025 and beyond.
Why is gratuity calculation complex?
Key Drivers Behind Confusion
Even seasoned HR professionals struggle with UAE gratuity calculations.
Why?
Because of the many moving parts:
- Two contract types: Limited vs. unlimited with major differences in how exits are handled.
- Resignation vs. termination: Entitlements vary drastically.
- Exclusions: Gratuity is based on basic salary only, not total compensation.
- Legal updates: Federal Decree-Law No. 33, in effect since 2022, changed key definitions and processes.
This complexity leads to manual errors, inconsistent policies, and budget forecasting issues.
Mistakes Employers Often Make
Here are some of the most common and costly mistakes companies make when calculating gratuity:
- Using gross salary instead of basic salary
- Including allowances like housing or transport
- Not accounting for unpaid leave salary
- Misclassifying contracts (e.g., assuming all are “limited” by default)
These mistakes don’t just risk employee dissatisfaction they could expose you to legal scrutiny.
Takeaway: Gratuity calculation is a legal obligation that demands accuracy and clarity.
How does gratuity affect payroll and HCM systems?
Automation and Compliance Benefits
Let’s be real calculating gratuity manually in spreadsheets isn’t sustainable. Especially when you’re managing tens or hundreds of employees.
Here’s where HCM tools like Paydaysuite make a difference:
- Eliminate manual errors by automating UAE-compliant calculations
- Simulate payouts instantly during exit interviews or budget planning
- Enforce legal logic, including caps, exclusions, and service period rules
Business Impact
A miscalculated gratuity isn’t just a spreadsheet error it’s a business risk:
- Inaccurate provisioning can throw off financial forecasts
- Trust issues arise when payouts don’t match expectations
- Audits may reveal non-compliance, triggering penalties
Tip: Treat gratuity provisioning as a strategic liability, not a last-minute calculation.
Gratuity Payout Rules by Contract & Separation
Understanding UAE gratuity entitlements requires a clear grasp of how contract types and separation methods interact. The calculation isn’t one-size-fits-all – your approach depends entirely on whether the employee holds a limited or unlimited contract and how their employment ends.
Contract Type | Exit Type | Years of Service | Gratuity Entitlement | Daily Rate Formula |
Unlimited | Resignation | 1-3 years | 1/3 of 21 days per year | Basic Salary ÷ 30 × 7 days per year |
Unlimited | Resignation | 3-5 years | 2/3 of 21 days per year | Basic Salary ÷ 30 × 14 days per year |
Unlimited | Resignation | 5+ years | 21 days/year (first 5) + 30 days/year (after) | Full calculation applies |
Unlimited | Termination | 1-5 years | 21 days per year | Basic Salary ÷ 30 × 21 days per year |
Unlimited | Termination | 5+ years | 21 days/year (first 5) + 30 days/year (after) | Full calculation applies |
Limited | Any | 1-5 years | 21 days per year | Basic Salary ÷ 30 × 21 days per year |
Limited | Any | 5+ years | 21 days/year (first 5) + 30 days/year (after) | Full calculation applies |
Important Note: Total gratuity payout is capped at two years of basic salary across all scenarios.
Understanding Contract Types
Limited Contracts
Limited contracts have a predetermined end date, typically ranging from one to three years. These contracts automatically expire on their specified end date, and employees working under limited contracts generally receive full gratuity entitlements regardless of who initiates the separation.
Key characteristics:
- Fixed duration with clear start and end dates
- Automatic termination upon contract expiry
- Full gratuity entitlement regardless of resignation or termination
- Cannot be renewed more than twice consecutively
Unlimited Contracts
Unlimited contracts have no predetermined end date and continue indefinitely until terminated by either party. These contracts offer more flexibility but come with different gratuity rules, particularly when employees resign voluntarily.
Key characteristics:
- No fixed end date
- Ongoing employment relationship
- Reduced gratuity for early resignations (within first 5 years)
- Full entitlement for terminations initiated by employer
Detailed Payout Matrix
Unlimited Contracts – Resignation Scenarios
When an employee on an unlimited contract chooses to resign, their gratuity entitlement follows a tiered structure that rewards longer service:
Years 1-3: Reduced Entitlement
- Formula: 1/3 of 21 days basic salary per year
- Rationale: Early resignation penalty to discourage high turnover
- Example: Employee with 2 years service = (21 days ÷ 3) × 2 years = 14 days basic salary
Years 3-5: Partial Entitlement
- Formula: 2/3 of 21 days basic salary per year
- Rationale: Increased entitlement recognizing moderate tenure
- Example: Employee with 4 years service = (21 days × 2/3) × 4 years = 56 days basic salary
Years 5+: Full Entitlement
- Formula: 21 days per year (first 5 years) + 30 days per year (subsequent years)
- Rationale: Full benefits for committed long-term employees
- Example: Employee with 7 years service = (21 × 5) + (30 × 2) = 165 days basic salary
Unlimited Contracts – Termination Scenarios
When the employer terminates an unlimited contract employee (excluding gross misconduct), full gratuity applies regardless of service length:
Years 1-5: Standard Rate
- Formula: 21 days basic salary per year
- Protection: Employees receive full entitlement even if they would have gotten less by resigning
Years 5+: Enhanced Rate
- Formula: 21 days per year (first 5 years) + 30 days per year (subsequent years)
- Consistency: Same calculation as long-term resignations
Limited Contracts – All Separation Types
Limited contract employees receive consistent treatment regardless of how their employment ends:
Years 1-5: Standard Calculation
- Formula: 21 days basic salary per year
- Uniformity: No penalty for contract completion vs. early termination
Years 5+: Enhanced Calculation
- Formula: 21 days per year (first 5 years) + 30 days per year (subsequent years)
- Equity: Same enhanced rate as unlimited contracts for long-term service
Critical Calculation Factors
Service Period Determination
- Start Date: First day of actual work (not contract signing date)
- End Date: Last working day (not notice period end)
- Exclusions: Unpaid leave periods must be deducted from total service
- Rounding: Partial years are typically calculated proportionally
Basic Salary Definition
Gratuity calculations use basic salary only, which includes:
- Base monthly salary
- Fixed monthly allowances (if specifically designated as basic salary components)
Excluded from basic salary:
- Housing allowances
- Transportation allowances
- Variable bonuses
- Overtime payments
- Commission payments
Two-Year Cap Rule
Regardless of service length or calculation method, total gratuity cannot exceed two years of the employee’s final basic salary. This cap applies universally across all contract types and separation scenarios.
Special Circumstances
Probationary Period
Employees still serving their probationary period receive no gratuity entitlement, regardless of time served. The one-year minimum service requirement begins after successful completion of probation.
Gross Misconduct Termination
Employees terminated for gross misconduct forfeit all gratuity entitlement, regardless of their years of service or contract type. Gross misconduct typically includes:
- Theft or fraud
- Violence or harassment
- Serious breach of confidentiality
- Repeated policy violations after warnings
Contract Conversion
When converting from limited to unlimited contracts (or vice versa), service continuity is maintained for gratuity calculation purposes, provided there’s no break in employment.
Practical Examples
Example 1: Unlimited Contract Resignation (3.5 years)
- Contract Type: Unlimited
- Separation: Resignation
- Service: 3 years, 6 months
- Basic Salary: AED 8,000
- Calculation: (21 days × 2/3) × 3.5 years = 49 days
- Gratuity: (AED 8,000 ÷ 30) × 49 days = AED 13,067
Example 2: Limited Contract Completion (6 years)
- Contract Type: Limited
- Separation: Contract expiry
- Service: 6 years
- Basic Salary: AED 12,000
- Calculation: (21 days × 5 years) + (30 days × 1 year) = 135 days
- Gratuity: (AED 12,000 ÷ 30) × 135 days = AED 54,000
Example 3: Unlimited Contract Termination (8 years)
- Contract Type: Unlimited
- Separation: Employer termination
- Service: 8 years
- Basic Salary: AED 15,000
- Calculation: (21 days × 5 years) + (30 days × 3 years) = 195 days
- Cap Check: 2 × AED 15,000 × 12 months = AED 360,000
- Calculated Gratuity: (AED 15,000 ÷ 30) × 195 days = AED 97,500
- Final Gratuity: AED 97,500 (within cap)
Best Practices: How to Calculate Gratuity Accurately
Step-by-Step Checklist
- Determine contract type – Limited or unlimited?
- Verify exit reason – Resignation or termination?
- Confirm years of service – Exclude unpaid leave.
- Check final basic salary – Not gross.
- Apply legal formula – Based on the table above.
- Ensure cap enforcement – No more than 2x basic salary.
Want to simplify gratuity calculations? Learn how our Payday’s payroll engine automates end-of-service settlements.
Expert Tips and Common Misconceptions
Don’t Fall for These Myths:
- “Housing allowance counts in gratuity” → ❌ False
- “Employees under probation get gratuity” → ❌ False
- “Free zone laws are different” → ❌ False (post-2022, laws are unified)
Expert Advice:
- ✔ Use audited HR data for tenure
- ✔ Reconcile gratuity liabilities quarterly
- ✔ Automate notices and workflows through your HRMS
“Gratuity should be part of your liability provisioning model, not an afterthought.” — UAE Payroll Compliance Expert
FAQs
What is end-of-service gratuity in the UAE?
It’s a lump-sum payout given to employees at the end of their contract, based on basic salary and years of service.
How is gratuity calculated under UAE labor law?
21 days of basic salary per year for the first 5 years, then 30 days per year after that.
What’s the difference between limited and unlimited contracts?
In unlimited contracts, resigning early reduces entitlement. In limited contracts, payout is standard regardless of exit type.
Is unpaid leave included in gratuity calculation?
No, only paid service days count toward gratuity.
Are allowances like housing or transport included?
No. Gratuity is calculated on basic salary only.
Can probationary employees receive gratuity?
No. Employees must complete at least 1 full year to be eligible.
When is gratuity not paid?
If the employee resigns before completing one year or is terminated for gross misconduct.
Can HR software handle gratuity calculations?
Yes. Tools like Paydaysuite are built for UAE compliance and eliminate manual errors.
From Calculation to Confidence
Gratuity isn’t just a line item, it’s a key piece of your people and financial strategy.
Whether you’re processing a single exit or planning for a growing workforce, accuracy matters. And in today’s digital era, manual calculations are no longer enough.
Modern payroll platforms like Paydaysuite help you:
- Automate UAE-compliant gratuity rules
- Reduce overpayments and legal risks
- Increase transparency and trust
Ready to take the guesswork out of gratuity?
Explore how Paydaysuite makes compliance simple.
