What is Retrenchment Compensation: Meaning, Eligibility and Taxation

As per the Industrial Disputes Act of 1947, employees who get laid off due to any reason apart from a disciplinary action are eligible to receive compensation from the employer. This is referred to as the retrenchment compensation.

Read on to know about the components and eligibility criteria of retrenchment compensation.

A monetary compensation which employees receive when they are terminated from service due to non disciplinary reasons is retrenchment compensation.

However, this compensation is not applicable when the employee opts for self-retirement, if they reach their superannuation age, if the contract gets terminated due to non-renewal, or if there's a prolonged absence due to illness.

Companies may lay off their employee due to a variety of reasons like restructuring, rationalisation of the workforce, automating several processes, etc. All these reasons require payment of retrenchment compensation. This compensation package differs from one company to another.

The computation of this compensation includes several factors like basic salary, years of employment, etc. Now that you know the meaning of retrenchment compensation let's move on to its other aspects.

Here are some conditions that employees must fulfil in order to be eligible for this compensation:

• The concerned employee should be a workman in the organisation.
• The employee must have provided continuous service for 240 days in the last 12 months, which will be taken upon as a year of regular service.

As per legal obligations, a company must pay the retrenched employee 15 days of average pay if they have served continuously for one year or any portion of the one-year timeline in excess of six months.

An employer can reimburse the compensation in the following ways:

• If an employee gets paid on a monthly basis, he/she will receive compensation based on three calendar months.
• If an employee gets paid on a weekly basis, he/she will receive compensation based on four completed weeks of service.
• If an employee gets paid on a daily basis, he/she will receive compensation based on the previous 12 working days.

An employer must adhere to the following compliance requirements during the compensation process:

• It is mandatory that employees should be informed about his/her retrenchment through an official notice.
• Employers must issue the official notice one month prior to its operation.
• The official notice must clearly specify the reasons for their termination.
• Companies must compensate their terminated workers at the time of retrenchment.

There are several components that companies consider while computing this compensation. Some of these are as follows:

• Basic wages
• DA or dearness allowance
• House rent allowance
• Conveyance allowance
• Attendance allowances
• Value of housing provided
• Value of amenities along with housing

Section 25F of the Industrial Disputes Act provides the process for carrying out retrenchment. There are some requisites for the process which will only be applicable if the said employee has completed 12 months of continuous service for the organisation.

The requisites for carrying out this process are as follows:

• After serving a notice of retrenchment, the company must come out with another written notification clearly explaining why the company has opted for this process. An employee can only be retrenched after he/she has been given a one-month notice for the same.
• If the company fails to provide the notice to its worker within the specified time period, it must pay a compensation amount to the same.
• Companies should pay compensation to their workers at the rate of the average pay of 15 days for his/her continuous service of one year.

The employee retrenchment compensation does not include the following cases:

• When the employee undertakes voluntary or self-retirement.
• When an employee retires on the attainment of superannuation age.
• When a company terminates an employee's contract due to non-renewal.
• When the company terminates an employee's contract gets terminated due to prolonged absence due to illness.

As per certain provisions of income tax rules and guidelines, the compensation will be exempt from taxation in the following scenarios:

• If the average pay received by employees is ₹5,00,000.
• In case total reimbursement received by an employee crosses the minimum threshold, it will be taken as profit while computing income tax.
• If the total net amount received by employees is the lowest among these three.

However, any retrenchment compensation paid as a part of a government-approved scheme is completely exempt from all provisions of taxation.

Retrenchment compensation is a monetary relief that employers pay their employees for termination of their service for reasons other than disciplinary action. This detailed guide will help readers gain in-depth knowledge about this monetary benefit which is a right that is enjoyed by terminated employees as per Indian laws.