Is It Legal for Companies to Forfeit Your Contributions If You Leave Before 10 Years?

Company Scheme: Deduction and Contribution

I am working in a company where there is a rule (they term it as a scheme). As per the rule, the company will deduct 5% of your basic salary every month and will contribute an equal amount. This amount (both your and the company's contribution) will be returned by the company after 10 years of service, along with simple interest. However, if you leave the company before completing 10 years, the amount will be forfeited, and you will not receive anything. The company informs you about this rule during the interview, and if you agree, you are required to sign a stamp paper where all this is mentioned. After completing 10 years, a new stamp paper is signed for the next 10 years.

Legal Validity of the Scheme

My question is: is it legally correct to do so? Can it be challenged in the Industrial Court or Court of Law?

Dear member,

If your company is clarifying the terms and conditions of employment right at the stage of recruitment and if the recruitment has been taking place with complete acceptance, then where is the problem?

Appointment Letter as a Contract

An appointment letter is a contract between an employer and employee under the provisions of the Indian Contract Act, 1872. But while executing this scheme, your company is not just relying on the appointment letter but going beyond and signing a legal agreement. Therefore, in the eyes of the law, there is no flaw as such.

Hopefully, the company is executing the scheme for everybody and the deductions are shown in the salary slip. In that case, there is nothing wrong per se.

Labour Law Considerations

As far as labour laws are concerned, the legal requirement is to pay the minimum wages. The labour laws do not look into the wages paid on and above the minimum wages. Nevertheless, experts in labour law are better persons to comment on this scheme.

From the Finance Point of View

For the sake of convenience, suppose your company deducts Rs 1,000/- per month for 120 months (10 years). So on completion of the scheme, the company is liable to pay Rs 1,20,000 + Rs 1,20,000 = Rs 2,40,000/-. For this amount, the simple interest is 10% and the compound interest is 7.17%.

Your company could continue with this scheme because it had two advantages. The first one was the higher bank interests. After deducting the amount, if the company had opened a Recurring Deposit (RD) account, they would have got the interest from the bank more than 7.17%. So anyway the company was not at a loss. The second benefit was from the employees who were not completing a tenure of 10 years. They were ready to forego the deducted amount. This also helped the company to continue with the scheme.

Nevertheless, bank interests have come down drastically. 7% interest is a distant dream. Therefore, in the future, economically it may not be viable to continue with the scheme.

Thanks,

Dinesh Divekar

Legality of Wage Deductions and Company Schemes

This practice is absolutely illegal. If you are in the "workman" category and are covered under the Payment of Wages Act, 1936, then it could be challenged as an unauthorized deduction from wages before the Prescribed Authority under the Payment of Wages Act, 1936. Otherwise, it can also be claimed under the Industrial Disputes Act before the Labour Court.

- S. K. Mittal
[Phone Number Removed For Privacy-Reasons]

Dear Mr. SK Mittalji, would you mind explaining specifically which clause of the Payment of Wages Act, 1936, or the Industrial Disputes Act, 1947, prohibits the said scheme? Please note that the query is for learning purposes and not to challenge you as such.

Regards,

Dinesh Divekar

Illegal Deductions Under the Payment of Wages Act

The deduction is illegal because it is not an allowed deduction under Sections 6 and 7 of the Payment of Wages Act. A similar provision exists in the new Code on Wages.

If they were giving him lower gross wages and offering the total amount as a bonus for working for 10 years, it would be different. This deduction, which may not come to him if he leaves for any reason, is definitely illegal.

The interesting thing is that it also has serious tax implications and a dangerous GST implication for the employer.

Payment of Wages Act, 1936

Deductions which may be made from wages

(1) Notwithstanding the provisions of sub-section (2) of section 47 of the Indian Railways Act, 1890 (9 of 1890), the wages of an employed person shall be paid to him without deductions of any kind except those authorized by or under this Act.

Explanation I: Every payment made by the employed person to the employer or his agent shall, for the purposes of this Act, be deemed to be a deduction from wages.

Explanation II: Any loss of wages resulting from the imposition, for good and sufficient cause upon a person employed, of any of the following penalties, namely:

(i) the withholding of increment or promotion (including the stoppage of increment at an efficiency bar);

(ii) the reduction to a lower post or time scale or to a lower stage in a time scale; or

(iii) suspension;

shall not be deemed to be a deduction from wages in any case where the rules framed by the employer for the imposition of any such penalty are in conformity with the requirements, if any, which may be specified in this behalf by the State Government by notification in the Official Gazette.

(2) Deductions from the wages of an employed person shall be made only in accordance with the provisions of this Act and may be of the following kinds only, namely:

(a) fines;

(b) deductions for absence from duty;

(c) deductions for damage to or loss of goods expressly entrusted to the employed person for custody or for loss of money for which he is required to account where such damage or loss is directly attributable to his neglect or default;

(d) deductions for house-accommodation supplied by the employer or by the government or any housing board set up under any law for the time being in force (whether the government or the board is the employer or not) or any other authority engaged in the business of subsidizing house-accommodation which may be specified in this behalf by the State Government by notification in the Official Gazette;

(e) deductions for such amenities services supplied by the employer as the State Government or any officer specified by it in this behalf may by general or special order authorize.

Explanation: The word "services" in this clause does not include the supply of tools and raw materials required for the purposes of employment;

(f) deductions for recovery of advances of whatever nature (including advances for traveling allowance or conveyance allowance) and the interest due in respect thereof or for the adjustment of overpayments of wages;

(ff) deductions for recovery of loans made from any fund constituted for the welfare of labor in accordance with the rules approved by the State Government and the interest due in respect thereof;

(fff) deductions for recovery of loans granted for house-building or other purposes approved by the State Government and the interest due in respect thereof;

(g) deductions of income tax payable by the employed person;

(h) deductions required to be made by order of a court or other authority competent to make such order;

(i) deductions for subscriptions to and for the repayment of advances from any provident fund to which the Provident Funds Act, 1952 (19 of 1952) applies or any recognized provident funds as defined in section 58A of the Indian Income Tax Act, 1922 (11 of 1922) or any provident fund approved in this behalf by the State Government during the continuance of such approval;

(j) deductions for payments to cooperative societies approved by the State Government or any officer specified by it in this behalf or to a scheme of insurance maintained by the Indian Post Office and

(k) deductions made with the written authorization of the person employed for payment of any premium on his life insurance policy to the Life Insurance Corporation Act of India established under the Life Insurance Corporation, 1956 (31 of 1956), or for the purchase of securities of the Government of India or of any State Government or for being deposited in any Post Office Saving Bank in furtherance of any savings scheme of any such government.

(kk) deductions made with the written authorization of the employed person for the payment of his contribution to any fund constituted by the employer or a trade union registered under the Trade Union Act, 1926 (16 of 1926), for the welfare of the employed persons or the members of their families or both and approved by the State Government or any officer specified by it in this behalf during the continuance of such approval;

(kkk) deductions made with the written authorization of the employed person for payment of the fees payable by him for the membership of any trade union registered under the Trade Union Act, 1926 (16 of 1926);

(l) deductions for payment of insurance premiums on Fidelity Guarantee Bonds;

(m) deductions for recovery of losses sustained by a railway administration on account of the acceptance by the employed person of counterfeit or base coins or mutilated or forged currency notes;

(n) deductions for recovery of losses sustained by a railway administration on account of the failure of the employed person to invoice, bill, collect, or account for the appropriate charges due to that administration whether in respect of fares, freight, demurrage, wharfage, and carnage or in respect of the sale of food in catering establishments or in respect of the sale of commodities in grain shops or otherwise;

(o) deductions for recovery of losses sustained by a railway administration on account of any rebates or refunds incorrectly granted by the employed person where such loss is directly attributable to his neglect or default;

(p) deductions made with the written authorization of the employed person for contribution to the Prime Minister's National Relief Fund or to such other Fund as the Central Government may by notification in the Official Gazette specify;

(q) deductions for contributions to any insurance scheme framed by the Central Government for the benefit of its employees.

(3) Notwithstanding anything contained in this Act, the total amount of deductions which may be made under sub-section (2) in any wage-period from the wages of any employed person shall not exceed:

(i) in cases where such deductions are wholly or partly made for payments to cooperative societies under clause (j) of sub-section (2) seventy-five per cent of such wages and

(ii) in any other case fifty per cent of such wages:

Provided that where the total deductions authorized under sub-section (2) exceed seventy-five per cent or as the case may be, fifty per cent of the wages, the excess may be recovered in such manner as may be prescribed.

(4) Nothing contained in this section shall be construed as precluding the employer from recovering from the wages of the employed person or otherwise any amount payable by such person under any law for the time being in force other than the Indian Railways Act, 1890 (9 of 1890).

Comment: The list given in this section is exhaustive, and no other deduction from the wages is permissible. AIR 1956 Madras 79

A 5% deduction is not in order and is indirectly keeping the employee bonded for 10 years by not refunding his 5% deduction. This has many aspects, and the company should avoid adopting such schemes to retain employees.

Though correct as per the Contract Act, this deduction is unauthorized under the Payment of Wages Act, 1936 for wages up to Rs 24,000 per month and under the Code of Wages without a wage limit.

Varghese Mathew

Scheme Overview

The scheme to deduct 5% of the basic salary per month, with an equal contribution by the employer, is appropriate. The return of the contributed and deducted amount with simple interest after 10 years is also suitable. However, the forfeiture of the deducted/contributed amount if one leaves the job before completing 10 years is both unfair and illegal.

Legal Concerns

It is legal and correct up to the contribution part, but the forfeiture of the entire amount is illegal and unjust. This can be challenged in a court of law on legitimate grounds. The service can end due to death, termination by the management, or permanent disablement of the employee. It is unreasonable to demand forfeiture of the hard-earned living substance, which should be treated as a legal right. Therefore, it cannot be considered a scheme of labor welfare nature.

This is not an authorized deduction once the Code of Wages is enforced.

Thank you all for your helpful insights and contributions. I would like to add and clarify:

1. The scheme is only for the Staff category, and workers are excluded.
2. The deduction is shown in the salary slip under "Other deductions."
3. The deducted amount is not deposited in any fund.
4. The 5% deduction is only for retaining the employee and deterring them from leaving. It is renewed even after the completion of 10 years, meaning as long as they are working for the company, this deduction will continue. I think this is nothing but a scheme for the company to earn easy money.
5. Even if the company management asks the employee to leave for some reason, the amount is not refunded.

Please note that the 5% deduction mentioned is not stated anywhere in the appointment letter.

Financial pressure in employee retention

Financial pressure is being exerted to retain employees. There is no point in trying to disguise it as a welfare scheme. If challenged in a court of law, the employer will find it difficult to justify. One must find better ways of retaining employees. This includes creating a better work atmosphere, implementing friendlier policies, and fostering a sense of camaraderie so that employees are motivated to stay, grow, learn, and progress along with the company. HR can play a proactive role in suggesting schemes that meet legal requirements and help retain good employees.

Dear colleague,

The scheme, under the lure of equal contribution by the employer and payment of simple interest after ten years' compulsory service, is nothing but creating bonded labor of sorts. In the end, you only live with unwilling and barely contributing employees.

The forfeiture clause is unjust, one-sided, and illegal. The scheme violates the basic right of an Indian citizen to choose their work and can't bind them under such dubious agreements, although they may somehow agree to sign at the time of joining in full awareness.

Such lopsided schemes, protecting only the employers' interests at the cost of employees', should not only be condemned as bad employment practices but should also be put to the test in the court of law.

Instead of chaining employees with such negative initiatives, create a positive work culture where the employee not only does not think of leaving the organization but also feels committed to working at their best for the company's interest.

Regards,
Vinayak Nagarkar
HR and Employee Relations Consultant

Illegal Deduction and Employee Training

Oh, sir, it is undoubtedly an illegal deduction. If the company wants to train employees for saving, this is not the way. It should not be compulsory for everyone. This falls under illegal chit fund operations and violations of RBI rules. It can be challenged in the public court by employees, either in a group or individually.

Issues with Employment Conditioning

Moreover, conditioning before employment is also the wrong method of recruitment. It can be challenged at the time of joining at any local labor department district office or any public court. This practice is totally beyond ethics and a violation of prescribed deductions under labor laws, the Minimum Wages Act, etc.

Legality of Salary Deduction and Forfeiture Clause

A deduction from salary as per mutual agreement is legal. The only issue is the forfeiture clause. If the employee's share is paid without service conditions (minimum service of ten years) with interest, there is no illegality in this scheme. You can place a ten-year service condition for eligibility for the employer's share, as long as the same is not reflected in the CTC. You can make it a component of CTC with a condition that it is subject to continuous service of ten years.

I will disagree with you on this. Any deduction not covered under Sections 6 and 7 of the Payment of Wages Act is illegal, irrespective of the agreement. Contracting out of a statutory provision is not allowed in Indian jurisprudence. If this was not a part of the salary but an additional loyalty scheme, meaning that the employer will give 10% of the annual salary for 10 years and interest for anyone who works for 10 years, it would be different because in such a scenario, there is no deduction but an additional payment promised.

Legality of Thrift Fund Schemes

But what is wrong with this kind of arrangement? As already pointed out, if there is no clause stating that an employee leaving the organization before ten years will lose both their share and the employer's share, the scheme is not illegal. This is a thrift fund that will accrue interest as well. Obviously, if you complete ten years, you will receive the employer's share as well. A similar thrift fund scheme was practiced in the Kerala Dinesh Beedi Workers' Cooperative Society, where the beedi workers contributed a very small amount that they withdrew upon retirement.

It is true that if the employer is to forfeit the employees' share if they do not serve for ten years, then it would attract penal provisions. As long as the system is such that upon termination of employment, the employee's share is paid with interest at prescribed rates, I don't think there is any issue.

The money is not being put into a fund. There is no guarantee the money will ever come to the employee.

Legal Concerns Under the Payment of Wages Act

Coming back to the basic and first point I made, it's not allowed under sections 6 and 7 of the Payment of Wages Act.

Understanding Section 7 and Employee Deductions

True, but you need not take section 7 as discrete; it shall include all such deductions mandated by an agreement between the employee and employer. Clause (kk) permits contributions to a fund constituted by the employer, in addition to the welfare fund of trade unions, as long as it is for the benefit and welfare of the employees and their families.

Gratuity Fund and Employee Trust

In this arrangement, there is a fund, and the amounts deducted from the employee will go to that fund only. The guarantee of whether this amount will be paid back to the employees is a question of trust. Even in states where section 4A of the Payment of Gratuity Act, which provides for compulsory insurance of the gratuity fund, is not enforced or notified as effective, you cannot expect to be paid statutory gratuity upon leaving the company.

Investment of Gratuity Fund

Section 4A states that a gratuity fund should be invested in LIC to guarantee the payment of employees' gratuity. However, this section applies only to states that notify its applicability, and many states are yet to notify the effective date of section 4A for establishments in their respective states. If your state has not specified that the gratuity fund should be invested in LIC, then you need only to "provide" for gratuity in the statements of accounts. In such a provision, no cash flow occurs, and if the employer is in a bad financial situation, it will be the employees who suffer the loss.

Illegal Deductions Under the Payment of Wages Act

Any deduction that is not authorized under Section 7 of the Payment of Wages Act is considered an illegal deduction. In this case, as employees are forfeiting the amount, it is totally illegal.