Transitioning to Pvt Ltd: Should We Pay Gratuity Now or Transfer Staff Without It?

Transitioning from Proprietorship to Pvt Ltd Company

Our company is a proprietorship company. The owner has now decided to create a new Pvt Ltd company with his family members under a new name. Both companies will continue working for some time. After approximately one year, the proprietorship will close, and all business activities will be conducted in the Pvt Ltd company. The entire staff will gradually shift to the new Pvt. Ltd. company.

Gratuity Payment Query

My question pertains to gratuity. Should we pay gratuity in the proprietorship company or transfer the entire staff to the new Pvt. Ltd. company without gratuity payment? The management is prepared to pay and ready to take over the entire staff in the new entity without payment. I would appreciate your legal opinion on this matter.

Dear Ajay, What you have described is the transfer of employees from one undertaking to another, and the compensation, if any, payable to the employees is discussed under Section 25FF of the Industrial Disputes Act, 1947. There are two ways of settlement:

(a) On the final closure of the proprietorship entity or the transfer of the services of any employee to the Pvt Ltd concern, the ownership concern may treat the separation as retrenchment and pay him retrenchment compensation as per Section 25F of the Act and the gratuity for the service, if any, rendered so far up to the date of transfer. His tenure in the Pvt Ltd concern thereafter would be considered as fresh service.

OR

(b) The services of the employees may be transferred to the newly formed entity. In such a case, the conditions of service in the new entity should not be less favorable to the employees, and the entire service rendered in the proprietorship entity should be carried forward. It would require an agreement between the two entities and the employees concerned to avoid any future disputes.

Service Continuity from Proprietorship to Private Limited Company

The advantage of continuing employee services from a proprietorship company to a newly formed private limited company is significant. By doing so, the payment of retrenchment compensation plus one month's notice pay, as required under the Industrial Disputes Act, and gratuity under the Payment of Gratuity Act by the private company, can be avoided. The newly formed private limited company must pass a board resolution and include a clause that they undertake the service continuity of employees transferred from the former proprietorship company. This means they assume the liability of paying a higher insurance premium to LIC for gratuity.

If an insurance policy for gratuity payment already exists in the proprietorship firm, it can be endorsed with a board resolution and transferred to the private limited company.

Gratuity Payment Based on Last Drawn Salary

The payment of gratuity is based on the last drawn salary or wages. When employees are transferred to the private limited company, at the time of their retirement or resignation, the gratuity amount will be higher. This is because the calculation is based on the last drawn salary or wages, considering the service continuity they have in the private limited company.