Understanding Gratuity Charges: How Should Contract Staffing Companies Bill Employers?

Hi, Contract staffing companies provide manpower to the principal employer. When raising a bill on the principal employer, I understand that the bill includes the take-home salary of the provided manpower, PF, ESI, LWF, etc. However, it is silent about the gratuity amount.

What percentage of the salary (basic/DA, etc.) should be charged by the contract staffing company while billing the principal employer?

1. If the contractor is not charging you for gratuity, then you should not be worried as it is not the responsibility of the Principal Employer to ensure payment of gratuity.

2. Anyhow, the normal percentage of gratuity charged is in the range of 4.7% to 4.8% of Basic + DA + VDA.

Hope this helps.

Regards, Preetam Deshpande

Thanks for the prompt reply.

Statutory Compliance Responsibility

1) Somewhere I read that the onus of statutory compliance falls on the principal employer as well. Could you please clarify if this is correct?

Gratuity Calculation and Provisioning

2) The calculation of 4.81% on Basic and DA is accurate. However, using this formula may result in a shortfall at the end of the fifth year, as the Basic and DA amounts will be different (higher) by then. I would like to inquire about the amount the labor contractor can charge the principal employer for gratuity provisioning for the manpower supplied by the contractor.

Thank you.

Gratuity Reimbursement Query for Contractors

I have one more query here. Let me assume (which may be a fact in most cases) that the contractor is charging 4.81% (basic + DA + other applicable components), and the principal employer is also paying the same to the contractor.

For the gratuity received from the principal employer (P.E.) by the contractor for his employees, in the event that contractor employees resign within the period of five years of service, will the contractor reimburse the "Gratuity amount received from P.E." to the principal employer? Hence, there won't be any proof of payment of gratuity by the contractor to his contracted laborers. Is it still binding on the principal employer to encourage the payment of the gratuity amount on a monthly basis?

I look forward to experts' views and advice in this regard. This will enlighten many HR professionals on this specific query.

Regards,
Sundararaman

As a principal employer, while we are hiring contractors, it is a negotiation between both parties regarding commission, bonus, uniform allowances, etc. However, legal dues like ESI and PF have a set percentage. I have reviewed many contracts, and most principal employers do not pay gratuity to contractors. Gratuity becomes applicable after 5 years of service. The Karnataka High Court has given a decision regarding gratuity and bonus, stating that the principal employer is not responsible or liable to make these payments if the contractor does not make these payments to his employees.

My understanding is that both the principal employer and the contractor are responsible for the payment of Gratuity under the Gratuity Act 1972. In such a scenario, if the contractor is not billing the gratuity amount from the principal employer, how will he then make gratuity payments to the employees resigning or retiring after 5 years of continuous service? Therefore, the contractor has to either bill a percentage every month to the principal employer or the agreement should have a clause stating that the principal employer will ensure the payment of gratuity if any contract staff resigns or retires after continuous service of 5 years.

However, there is a small hitch here. The contract employee would have worked for more than 5 years with the same contractor but under different principal employers. In such a case, it is better to bill the principal employer every month. Could anyone shed some light on this?

In the beginning of employment, the management cannot predict whether the employee will be serving for 5 years or not. However, assuming that the employee will serve for 5 years, the Gratuity Act of 1972 stipulates that provision of gratuity amount has to be made every month/year from day one of the employee's date of joining.

Gratuity Calculation

The calculation is as follows: As per the Gratuity policy, the employee is entitled to half a month's salary (basic + DA) for every completed year of service. Assuming the basic + DA is 100 and a month is considered to have 26 days, not 30 days, the provision for each year should be calculated as 100 x 15/26 = 57.69. For every month, it would be 57.69/12 = 4.81% - where 12 represents the number of months in a year.

I have no information about gratuity in other countries.

Gratuity Responsibilities for Contract Workers

The Payment of Gratuity Act, 1972, does not provide for gratuity for contract workers (by the principal employer). They are employees of the contractor, so he will solely be responsible for gratuity, and hence he can't charge the principal employer for the same. However, for other compliances like PF and ESIC, the principal employer is responsible for adherence. The principal employer should, in fact, not be involved in the gratuity aspect of contract workers.

Regards,
Saurabh

Gratuity as Part of Wages in Contract Labor

In the case of Madras Fertilizers Ltd v. Controlling Authority under the Payment of Gratuity Act (2003, Madras High Court), the court held that any sum payable under the law upon the termination of employment is considered part of wages. Once gratuity becomes part of wages, it becomes the basic responsibility of the Principal Employer to pay gratuity to the contract labor, but they can recover the same from the contractor.

Regards,
CG

Hi Preetam, thanks for the prompt reply.

Clarification on Statutory Compliance

1) Somewhere I read that the onus of statutory compliance falls on the principal employer as well. Please clarify whether this is correct.

2) 4.81% on Basic and DA is perfectly correct. However, with this formula, there will be a shortfall at the end of the fifth year, as the Basic and DA will be different (higher) at the end of the fifth year. My query is, how much amount can the labor contractor charge the principal employer towards gratuity provisioning for the manpower supplied by the contractor?

Dear sir,

Yes, the legal position is that if the contractor fails to pay the dues of his employees, then the principal employer is ultimately held responsible for the payment. Therefore, it is wise to pay the gratuity. At the same time, please ensure that at the time of separation of the employee, it is paid to him. Alternatively, the contractor should give an indemnity bond.

If you have a copy of that judgment, please attach it because gratuity does not come under the definition of wages. However, according to you, as mentioned by the Madras High Court, it is considered wages. Please forward the judgment or provide the case reference so we can find it from LLR, etc.

Madras Fertilizers Ltd v. Controlling Authority under the Payment of Gratuity Act Case 2003

In the Madras Fertilizers Ltd v. Controlling Authority under the Payment of Gratuity Act case 2003 (Madras High Court), the court held that any sum payable under law on termination of employment of the employee is part of wages. Once gratuity thus becomes part of wages, it will be the basic responsibility of the Principal Employer to pay gratuity to the contract labor but recover the same from the contractor.

Regards,
CG

I do not have a copy of the judgment, but the Kerala High Court gave a judgment in Cominco Binani Zinc Ltd v. Pappachan, 1989 LLR 123. No doubt, a principal employer is liable to pay wages to employees of a contractor if the latter fails to make payment of wages to his employees. However, it has been held in the above-mentioned case that gratuity and bonus will not be payable by the principal employer since these do not come under the definition of wages.

In the case of a staffing company, if gratuity is charged to the Principal Employer (PE) and an employee leaves within 5 years, is the amount refundable to the PE?

Regards

I have another doubt. We are entering into a contract for one year and will be renewing it annually only if we feel that their services are good. In this scenario, the Gratuity deduction is not applicable to the principal employer. Please correct me if I am wrong.

Regards,
Mahesh V M