Retrenchment compensation is an important legal requirement for employers in India. Employers who fail to provide the appropriate notice and compensation can face legal action, including fines and penalties. For workers who have been retrenched, this compensation can provide a financial safety net during a period of unemployment and can help them to transition to new employment opportunities. In this article we shall discuss regarding the concept of retrenchment compensation, its eligibility criteria and also situation of tax exemptions.
What Is Known As Retrenchment Compensation?
Under the Industrial Disputes Act, retrenchment is defined as the termination of a worker’s employment by an employer for any reason other than voluntary retirement, reaching retirement age, or disciplinary action. This includes layoffs due to downsizing, closure of a business, or a reduction in the workforce for any other reason.
It is a form of financial compensation provided to employees who have been retrenched from their jobs. This compensation is mandated by the Industrial Disputes Act of 1947[1], which outlines the legal requirements for retrenchment and compensation in India.
When an employer retrenches a worker, they are required to provide the worker with notice of the termination/pay in lieu of notice. The amount of notice/pay in lieu of notice varies depending on the length of the worker’s service with the company. For workers who have been employed for less than one year, the employer must provide at least two weeks’ notice or pay in lieu of notice. For workers who have been employed for more than 1 year, but less than 5 years, the employer must provide at least one month’s notice or pay in lieu of notice. For workers who have been employed for more than five years, the employer must provide at least six months’ notice or pay in lieu of notice. In addition to notice or pay in lieu of notice, the employer is also required to provide retrenchment compensation to the worker. Retrenchment compensation is equal to fifteen days’ average pay for every completed year of service. Average pay includes the basic salary, dearness allowance, and any other payments that the worker is entitled to.
Say for example, Retrenchment compensation is capped at ten lakh rupees. This means that the maximum amount of compensation that an employee can receive is ten lakh rupees, regardless of how many years of service they have completed or how much their average pay is.
It’s worth noting that retrenchment compensation is not applicable in certain circumstances, such as when an employee has been terminated for disciplinary reasons or has voluntarily resigned. Additionally, the Industrial Disputes Act only applies to companies that employ more than 100 workers. Companies with fewer than 100 workers are not required to provide retrenchment compensation.
Eligibility Criteria for Retrenchment Compensation
Under the Industrial Disputes Act, 1947, retrenchment compensation is payable to eligible employees who are retrenched by their employer. Thus to get the retrenchment compensation from the employers the eligibility criteria which are discussed as follows:
- The employee must have been employed for a regular period of not less than one year under the employer who is retrenching the employee.
- The employee must have been terminated on account of retrenchment, which means the termination is due to surplus labour or the closure of the establishment.
- The employer must have at least 100 employees in the establishment before the retrenchment.
- The employer must have followed the procedure laid down under Section 25F of the Industrial Disputes Act, 1947, which mandates that the employer must give 1 months’ notice/pay in lieu of notice to the employee prior to retrenchment.
- The employee must not have been retrenched due to any misconduct or a voluntary retirement scheme.
If all of the above conditions are met, then the employee is eligible for retrenchment compensation, which is calculated as 15 days average pay for every year of service/any part thereof in excess of 6 months.
Average Pay of Retrenchment Compensation as Per the Industrial Dispute Act, 1947
Under the Industrial Disputes Act, 1947, the amount of compensation payable to a retrenched employee depends on the nature of the retrenchment and the terms of employment.
- If the retrenchment is due to the establishment closure, the employer is required to pay compensation to the retrenched employees at the rate of 15 days’ average pay for every year of continuous service/any part thereof in excess of six months.
- If the retrenchment is not due to the closure of the establishment, the employer is required to pay compensation to the retrenched employees at the rate of 15 days’ average pay for every year of the continuous service/any part thereof in excess of six months.
The “average pay” for the purpose of calculation of compensation is the average of the wages earned by the employee during the last twelve months of his employment in the establishment. It is vital to note that the above is the minimum amount of compensation payable under the Industrial Disputes Act, and employers may choose to provide higher compensation to their retrenched employees. Additionally, there may be other legal requirements and collective bargaining agreements that affect the amount of compensation payable to retrenched employees.
Calculation of the Retrenchment Compensation as per the Act
By taking into consideration of the employee’s last drawn salary, companies calculate the retrenchment compensation of the particular employee. The charge for the compensation of the employee is set on the basis of the wage of the employee for 15 days. The calculation is explained below in the table:
| Payment status of the employee | Amount of average pay under Retrenchment Compensation plan |
| Daily basis payment | Last 12 working days to be considered |
| Weekly basis payment | Last 4 weeks to be considered |
| Monthly basis payment | Last 3 months to be considered |
In this calculation process of the retrenchment compensation, companies also take into consideration of the notice period of the employee.
Essential Compliance Requirements to Be Done For Retrenchment Compensation
The Industrial Disputes Act, 1947 lays down the legal framework for the compensation payable to employees in case of retrenchment. The act defines retrenchment as the employment termination by the employer for any reason whatsoever, except in the case of punishment inflicted by way of disciplinary action. An employer must abide by the following compliance requirements in the process of retrenchment compensation:
- The act mandates that an employer must pay retrenchment compensation to an employee who has been in continuous service for at least 1 year before being retrenched. The compensation payable to the employee shall be equal to 15 days average pay for every completed year of continuous service/any part thereof in excess of 6 months.
- The act also provides for certain conditions that must be fulfilled by the employer before retrenching an employee, such as giving notice in writing to the appropriate government authority, giving notice to the employee at least one month before, paying compensation to the employee, etc.
- It is crucial to note that the provisions of the act apply to industrial establishments employing 100 or more workmen. In case of establishments employing less than 100 workmen, the state government may prescribe the conditions under which retrenchment may be undertaken.
It is recommended for employers to consult with legal experts and comply with all the requirements of the Industrial Disputes Act, 1947 before undertaking any retrenchment. Non-compliance can lead to legal action, penalties, and damage to the reputation of the organization.
Necessary Components of Retrenchment Compensation
The Industrial Disputes Act, 1947 in India provides for the payment of compensation to employees who are retrenched by their employers. The components of retrenchment compensation under the Act are as follows:
- Basic compensation: The basic compensation payable to the retrenched employee is half a month’s average pay for every completed year of regular service/any part thereof in excess of 6 months.
- Additional compensation: The employer may also pay additional compensation to the retrenched employee at his discretion. The amount of additional compensation may be higher than the basic compensation and is based on factors such as the financial position of the company, the nature of the industry, the size of the establishment, and the number of employees affected.
- Notice pay: The employer must give notice of retrenchment to the retrenched employee or pay him in lieu of notice. The notice period is determined by the length of service of the employee and varies from one week to three months.
- Retrenchment benefits: The employer may provide retrenchment benefits to the retrenched employee in addition to the above components of compensation. These benefits may include payment of unpaid wages, gratuity, bonus, and any other dues owed to the employee.
It is important to note that retrenchment compensation is applicable only to employees who have completed at least one year of continuous service with the employer. The Act also specifies certain conditions that must be met before an employer can retrench an employee, such as giving notice of retrenchment to the employee and the appropriate government authorities, and following the procedures set out in the Act.
Essential Requisites to Be Fulfilled For the Retrenchment Compensation
The Industrial Disputes Act, 1947 lays down the provisions for retrenchment compensation in India. According to Section 25C of the Act, an employer must fulfill the following requirements for the retrenchment compensation process:
- The employee must have been employed for a regular period of not less than one year in the establishment prior to retrenchment.
- The employee must have been given a notice of not less than one month in writing, or he must have been paid wages in lieu of such notice.
- The employee must be paid compensation which shall be equivalent to 15 days’ average pay for every completed year of continuous service/any part thereof in excess of six months.
- The compensation payable to an employee under the Act cannot exceed his average pay for fifteen months.
What Is Not Included In Retrenchment Compensation As Per Industrial Dispute Act?
Regarding the Industrial Dispute Act, 1947, retrenchment compensation refers to the compensation payable to a worker who is laid off due to the closure of the establishment or reduction in the workforce. The amount of compensation to be paid is generally based on the worker’s length of service and last-drawn wages.
Under Section 25F of the Industrial Dispute Act, the following amounts are excluded from the computation of retrenchment compensation:
- Any gratuity payable to the worker on the termination of his employment, as per the Payment of Gratuity Act, 1972.
- Any amount paid to the worker to reduce the incidence of unemployment.
- Any other amount that may be prescribed by the appropriate government.
What Are The Exemption Available For Retrenchment Compensation Under The Industrial Dispute Act, 1947?
As per the Income Tax Act, 1961, retrenchment compensation is treated as income and is therefore taxable under the head ‘Income from Salaries’. However, certain exemptions are available on retrenchment compensation under the Industrial Dispute Act, 1947.
Under section 10(10B) of the Income Tax Act, retrenchment compensation received by an employee is exempt from tax to the extent of the least of the following:
- An amount calculated in accordance with the provisions of the Industrial Disputes Act, 1947
- Rs. 5, 00,000 is the average pay that is received by the employee
- The amount actually received as retrenchment compensation
- The amount exempt from tax under this section is limited to the amount of compensation received by the employee as a result of retrenchment. Any additional amount received by way of voluntary retirement or other means would not be eligible for exemption under this section.
It is crucial to note that the exemption under section 10(10B) is available only in the case of retrenchment and not in the case of resignation or voluntary retirement. Also, the exemption is available only to employees and not to partners of a firm or shareholders of a company.
Conclusion
It is important to note that retrenchment compensation is not required in certain situations, such as when the termination of employment is due to misconduct or when the employee is employed on a contract basis for a specific period.
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