Facing a Shutdown: How Do I Calculate Retrenchment Compensation and Understand Gratuity?

Hi all, I am working in 3P of HUL based in Gujarat as an Officer-HR. Due to some reasons, the company may shut down permanently. Please give me suggestions for the retrenchment compensation calculation and also explain the difference between retrenchment and gratuity.

Hi Chetan T, I presume your company is covered under the Factories Act, and if so, the ID Act would apply. There may be a requirement for approval from competent authorities of the state government. We have discussed closure and retrenchment in these forums, which you can consult for guidance, formalities, and computation of retrenchment compensation.

ID Act

2[25F. Conditions precedent to retrenchment of workmen. — No workman employed in any industry who has been in continuous service for not less than one year under an employer shall be retrenched by that employer until—

(a) the workman has been given one month's notice in writing indicating the reasons for retrenchment and the period of notice has expired, or the workman has been paid in lieu of such notice, wages for the period of the notice;

(b) the workman has been paid, at the time of retrenchment, compensation which shall be equivalent to fifteen days' average pay for every completed year of continuous service or any part thereof in excess of six months; and

(c) notice in the prescribed manner is served on the appropriate Government or such authority as may be specified by the appropriate Government by notification in the Official Gazette].

25-O. Procedure for closing down an undertaking

(1) An employer who intends to close down an undertaking of an industrial establishment to which this Chapter applies shall, in the prescribed manner, apply for prior permission at least ninety days before the date on which the intended closure is to become effective, to the appropriate government, stating clearly the reasons for the intended closure of the undertaking and a copy of such application shall also be served simultaneously on the representatives of the workmen in the prescribed manner:

PROVIDED that nothing in this sub-section shall apply to an undertaking set up for the construction of buildings, bridges, roads, canals, dams, or for other construction work.

(2) Where an application for permission has been made under sub-section (1), the appropriate government, after making such enquiry as it thinks fit and after giving a reasonable opportunity of being heard to the employer, the workmen, and the persons interested in such closure may, having regard to the genuineness and adequacy of the reasons stated by the employer, the interests of the general public, and all other relevant factors, by order, and for reasons to be recorded in writing, grant or refuse to grant such permission and a copy of such order shall be communicated to the employer and the workmen.

(3) Where an application has been made under sub-section (1) and the appropriate government does not communicate the order granting or refusing to grant permission to the employer within a period of sixty days from the date on which such application is made, the permission applied for shall be deemed to have been granted on the expiration of the said period of sixty days.

(4) An order of the appropriate government granting or refusing to grant permission shall, subject to the provisions of sub-section (5), be final and binding on all the parties and shall remain in force for one year from the date of such order.

(5) The appropriate government may, either on its own motion or on the application made by the employer or any workman, review its order granting or refusing to grant permission under sub-section (2) or refer the matter to a Tribunal for adjudication:

PROVIDED that where a reference has been made to a Tribunal under this sub-section, it shall pass an award within a period of thirty days from the date of such reference.

(6) Where no application for permission under sub-section (1) is made within the period specified therein, or where the permission for closure has been refused, the closure of the undertaking shall be deemed to be illegal from the date of closure and the workmen shall be entitled to all the benefits under any law for the time being in force as if the undertaking had not been closed down.

(7) Notwithstanding anything contained in the foregoing provisions of this section, the appropriate government may, if it is satisfied that owing to such exceptional circumstances as an accident in the undertaking or death of the employer or the like, it is necessary so to do, by order, direct that the provisions of sub-section (1) shall not apply in relation to such undertaking for such period as may be specified in the order.

(8) Where an undertaking is permitted to be closed down under sub-section (2) or where permission for closure is deemed to be granted under sub-section (3), every workman who is employed in that undertaking immediately before the date of application for permission under this section shall be entitled to receive compensation which shall be equivalent to fifteen days’ average pay for every completed year of continuous service or any part thereof in excess of six months.

25R. Penalty for closure

(1) Any employer who closes down an undertaking without complying with the provisions of sub-section (1) of section 25-O shall be punishable with imprisonment for a term which may extend to six months or with a fine which may extend to five thousand rupees, or with both.

(2) Any employer who contravenes an order refusing to grant permission to close down an undertaking under sub-section (2) of section 25-O or a direction given under section 25P shall be punishable with imprisonment for a term which may extend to one year, or with a fine which may extend to five thousand rupees, or with both, and where the contravention is a continuing one, with a further fine which may extend to two thousand rupees for every day during which the contravention continues after the conviction.

Also, please go through these links:

https://www.citehr.com/224715-retren...ml#post1012676

https://www.citehr.com/342152-retren...ml#post1575805

Hi Loginmiraclelogistics, can you please share the following points:

1) Are retrenchment benefits based on basic salary or overall salary?

2) If the employer is planning to shut operations by mid-February, then in that case, income tax deducted on retrenchment and leave encashment will be huge. Is there any way out beneficial to both parties?

Thanks in advance.

Dear Chetan and Aditya,

In view of the elaborate answer by Mr. Kumar on the procedural formalities of retrenchment, let me address your queries directly.

Definition of Retrenchment

The essence of the definition of the term "retrenchment" under section 2(oo) of the IDA, 1947, is the unilateral termination of the employee by the employer for any reason other than formal dismissal based on misconduct, non-renewal of the employment contract as stipulated, or due to the continued ill-health of the employee, resignation, or voluntary retirement.

On the other hand, gratuity is a terminal benefit resulting from unilateral termination by either the employer or employee after completing the minimum qualifying service through discharge, retrenchment, or dismissal, excluding cases of riotous behavior or moral turpitude. It also applies to automatic termination of the employment contract due to the employee's death or disablement from accident or disease while in service, regardless of completing the minimum qualifying service or reaching the predetermined age of superannuation.

The minimum qualifying service for retrenchment is the completion of 240 days of continuous service in the preceding 12-month period.

Difference in Calculation Methods

Retrenchment compensation and gratuity differ in the method of calculating the amount to be paid.

Retrenchment Compensation is calculated based on the "average pay" as defined in section 2(aaa) of the IDA, 1947, which refers to the gross pay minus specific allowances provided to cover special expenses related to the job.

Gratuity, on the other hand, is based solely on the sum of basic pay and Dearness Allowance (D.A) last drawn.

Tax Exemption on Retrenchment Compensation

Aditya, please note that retrenchment compensation up to Rs. 5 lakh is exempt under section 10(10B) of the IT Act, if I remember correctly.

Thank you.

Thanks, Mr. Umakanthan, for making my rejoinder simpler. I may add, there are two issues: one is the compensation calculation, and the other is IT on the sums employees paid consequent to retrenchment.

Retrenchment compensation

Under retrenchment compensation, the minimum is 15 days' salary for every year of service rendered. During the recent past (post-liberalization), the Government of India introduced the concept of STPI (Special Terminal Package) and VSS (Voluntary Separation of Services). These two schemes were in government and quasi-government entities, which may not apply automatically to every entity, but willing entities can adopt more beneficial schemes so that employees can smoothly implement the changes and receive more. In short, these schemes are specially designed to enable employees to enjoy additional benefits such as a special package, even though it's a form of retrenchment scheme. However, as optees are entitled to 'retrenchment'-associated issues, they are not considered voluntarily retired. Entities are permitted to add on benefits over and above the statutorily entitled benefits, such as no cap on leave encashment, retention of quarters at normal rent for extended terms, eligibility to engage on different terms, and above all, IT benefits extraordinarily under a special section. Compensation is computed based on past service versus future salary, whichever is more beneficial. I'll provide an example in my next posting.

Regarding IT - Chapter III: Incomes which do not form part of total income

Compensation, gratuity, leave encashment, etc., received under this special package will benefit the recipients by way of higher exemption limits, almost fully tax-free in the year of receipt, in addition to the benefits/methods of computation under sec. 89(1) of IT. This would enable the option to spread/distribute incomes received in the year of receipt over the past years, by which the net IT liability is expected to provide better reliefs when distributed over many past years, rather than accounting for it in the year of receipt, whichever is more beneficial. There is a prescribed form 10E for this purpose. Let me take a little more time to explain this option in my next post.

Correction Notice

Please note the corrections in my previous post. Please read STBP (Special Terminal Benefit Package) instead of STPI, and Voluntary Separation Scheme (VSS). This should be read with exemptions at higher levels under section 10BB of the IT Act.

Relief Under Section 89(1)

Regarding Section 89(1) – Relief of Salary, tax is calculated on the taxpayer's total income earned or received/payable during the financial year. If the assessee has received any portion of salary 'in arrears or in advance' (such as a retrenchment package), or received a family pension in arrears, it is allowed to be claimed as tax relief under section 89(1) of the IT Act.

How to Get Relief Under Section 89(1)?

Here are the steps to calculate relief under section 89(1) of the Income Tax Act, 1961:

- Calculate tax payable on total income including arrears in the year in which it is received.
- Calculate tax payable on total income excluding arrears in the year in which it is received.
- Calculate the difference between (1) and (2).

For a detailed illustration, please read the attachment. For any assistance, one should seek the help of a Chartered Accountant who can handle the rest. This is an exercise worth the effort as individuals involved are likely to benefit from 'tax planning.'