At Wisemonk, we’ve guided global employers through India’s complex labor regulations, ensuring compliance while fostering employee trust. Below, we break down the legal frameworks, calculations, and compliance strategies for severance pay and bonuses under Indian law.
1. Severance Pay in India: Legal Framework
A. Retrenchment Compensation Under the Industrial Disputes Act, 1947
The Industrial Disputes Act (IDA) mandates severance pay for employees terminated due to retrenchment (not for misconduct or voluntary resignation).
Key Provisions:
- Eligibility: Employees with 1+ year of continuous service.
- Calculation: 15 days’ average pay per completed year of service.
- Formula:
- Severance Pay=((Last Drawn Basic + DA)/26)×15×Years of Service
- Notice Period: 1 month’s wages if retrenchment notice isn’t served.
Example:
An employee earning ₹50,000/month (Basic + DA) with 5 years of service:
Severance Pay=((50,000)/26)×15×5 = ₹ 1,44,231
Applicability:
- Factories, mines, plantations, and establishments with 50+ employees.
B. Gratuity Under the Payment of Gratuity Act, 1972
Gratuity is a statutory severance benefit for employees completing 5+ years of service.
Key Provisions:
- Eligibility: Employees in establishments with 10+ workers.
- Calculation: 15 days’ salary per year of service (capped at ₹20 lakh).
- Formula:
Example:
An employee earning ₹80,000/month (Basic + DA) with 20 years of service:
Gratuity=((80,000)/26)×15×20=₹9,23,077 (capped at ₹20 lakh)
Tax Exemption:
- Gratuity up to ₹20 lakh is tax-free under Section 10(10) of the Income Tax Act.
2. Bonuses Under the Payment of Bonus Act, 1965
A. Eligibility Criteria
- Establishments: Factories and organizations with 20+ employees (10+ in Gujarat).
- Employees: Earning up to ₹21,000/month (Basic + DA).
- Service Requirement: Minimum 30 days in a financial year.
B. Calculation of Statutory Bonus
Example 1:
Employee A earns ₹6,000/month (Basic + DA):
Bonus = 6,000 × 8.33% = ₹ 500/month (₹6,000/year)
Example 2:
Employee B earns ₹15,000/month (Basic + DA):
Bonus = 7,000 × 8.33% = ₹ 583/month (₹7,000/year)
Taxation:
- Bonuses are taxable under “Income from Salary” and subject to TDS.
3. Compliance Challenges
A. Severance Pay
- Misclassification: Confusing retrenchment with voluntary resignation.
- State Variations: Maharashtra mandates severance for gig workers; Kerala includes Ayurvedic treatments in medical coverage.
- Penalties: Up to ₹1 lakh fines or 3 months’ imprisonment for non-compliance.
B. Bonuses
- Salary Caps: Calculating bonuses on ₹7,000 even for higher earners.
- Disputes: Over eligibility or profit-sharing ratios.
- Record-Keeping: Maintaining allocable surplus records for 3+ years.
4. Recent Updates (2025)
- Severance Pay: Proposed inclusion of gig workers under IDA retrenchment rules.
- Bonuses: Digital compliance portals mandated for establishments with 50+ employees.
5. How Wisemonk Simplifies Compliance
- Automated Calculations: Real-time severance and bonus computations integrated with payroll systems.
- Legal Advisory: Navigate state-specific laws (e.g., Gujarat’s 10-employee threshold).
- Dispute Resolution: Handle gratuity claims and bonus disputes with EPFO/PFRDA.
- Tax Optimization: Structure severance packages to maximize exemptions under Section 10(10C).