Understanding Severance Costs vs. Retrenchment Compensation in India: What's the Real Difference?

What are the differences between severance costs and retrenchment compensation? In India, is severance pay also called gratuity pay?

Severance costs and retrenchment compensation are two distinct terms used in the context of employment terminations. Severance costs typically refer to the expenses incurred by a company when letting go of employees, which may include severance pay, benefits continuation, and other related expenses. On the other hand, retrenchment compensation specifically pertains to the compensation provided to employees who are laid off due to factors such as redundancy or restructuring.

In India, severance pay is often referred to as gratuity pay. Gratuity is a statutory benefit mandated by the Payment of Gratuity Act, 1972, which requires employers to pay a lump sum amount to employees as a token of appreciation for their services rendered upon retirement, resignation, or termination, provided certain eligibility criteria are met.

It's important for employers and employees to understand the distinctions between these terms to ensure compliance with relevant labor laws and to handle employment terminations effectively and ethically.

In India, severance pay means severance pay or retrenchment compensation only. Gratuity is different, and it is not available to all employees but restricted to those who are leaving the organization after rendering at least five years of service.

Severance pay or retrenchment compensation in India is available only to workmen, and no manager needs to be paid this compensation. On the other hand, gratuity is available to all employees irrespective of their roles and functions.

Retrenchment Compensation and Severance Costs

Generally, retrenchment compensation is payable to those covered under applicable acts like the ID Act, as a statutory payment. Apart from this, there are certain terms and conditions of appointment providing such compensation in case of 'retrenchment' under contractual obligations. Many times, this is resorted to when the closure of operations of units occurs.

Severance Costs

'Severance cost' is payable mostly to those in top management positions, e.g., Board members (Chairman, President/VP, Directors, etc.) who may have shareholding or otherwise be paid some sort of profit-sharing percentage from the company. Very senior-level executives below board level, such as Executive Directors, Chief GMs, etc., are also eligible for such payments. These payments are integrated into well-defined terms and conditions executed in this regard. This measure may also address the settlement of shareholdings at the time of separation. It helps entities amicably sever ties with top management personnel who have been instrumental in the company's policies and performances and possess in-depth knowledge of the existing company.

Golden Handshake Schemes

In the past decades post-1991 liberalization, many PSUs were closed down combining both 'Termination compensation' and 'Severance cost' through what is said to be a 'golden handshake' - VRS & VSS (Voluntary Separation Scheme), STBP (Special Termination Benefit Package), etc. These schemes involved additional benefits beyond Termination Compensation to encourage affected employees to avail themselves of these benefits.