Severance Pay in India: Rules, Calculation, and Tax

What Is Severance Pay in India and Which Laws Govern It?

Severance pay in India is the compensation a departing employee receives on involuntary exit. As of November 2025, it is governed by three of the four Labour Codes: the Industrial Relations Code, 2020 (retrenchment), the Code on Social Security, 2020 (gratuity), and the Code on Wages, 2019 (final wage settlement).

"Severance pay" is not a single line item under Indian law. It is a bundle of statutory entitlements that trigger together when employment ends, and each has its own governing Code, formula, and deadline. Having run exits for global companies hiring in India through our Employer of Record service, we treat every separation as a package, not one payment.

The four Labour Codes replaced dozens of older Acts and came into force on November 21, 2025. When you read older guidance that still cites the Industrial Disputes Act or the Payment of Gratuity Act, map it to the new Codes below. The old Act names still help with recognition, so we keep them in parentheses.

For context on how these dues sit alongside statutory contributions, our guide to payroll compliance in India covers the wider filing calendar, and the employee benefits in India guide explains gratuity as a benefit.

How Do State Rules and Shops & Establishments Acts Change This?

Retrenchment and gratuity are central law, but termination notice and some exit formalities live in each state's Shops & Establishments Act. That means the same exit can carry different notice obligations depending on where the employee is based, which is why we confirm the state rule before serving notice.

Because these provisions vary and change as states notify rules under the new Codes, we verify the current text for the employee's state on every exit rather than working from memory.

Who Is Eligible for Severance Pay in India and Under What Circumstances?

Involuntarily separated employees are eligible for severance in India. Retrenchment compensation covers a "workman" (roughly a non-managerial employee) with at least one year of continuous service. Gratuity covers permanent employees after five years, while fixed-term employees earn gratuity on a pro-rata basis after just one year.

For a US reader, "workman" is a legal category, not a job title. It broadly means employees doing manual, skilled, technical, operational, or clerical work, and it excludes those in mainly managerial or supervisory roles above a wage threshold. Retrenchment compensation under the Industrial Relations Code applies to this workman category with at least one year of continuous service.

The circumstance matters as much as the tenure. The main exit types are:

• Retrenchment: termination for business reasons such as redundancy or restructuring, which triggers retrenchment compensation plus the Re-Skilling Fund.
• Resignation: voluntary exit, which pays out gratuity (if eligible) and final wages but no retrenchment compensation.
• Termination for misconduct: dismissal after due process, which can forfeit gratuity in defined cases but still requires final wage settlement.
• End of a fixed term: completion of a fixed-term contract, which pays pro-rata gratuity and final dues.

Gratuity eligibility has one important carve-out. Permanent and regular employees qualify after five years of continuous service (waived on death or disablement), but fixed-term employees qualify on a pro-rata basis after just one year under Section 53 of the Code on Social Security. This one-year rule applies to fixed-term staff only; it does not extend to ordinary contract or gig workers. You can estimate gratuity fast with our gratuity calculator.

How Is Severance Pay Calculated and What Does a Typical Package Include?

Severance in India is calculated component by component. Retrenchment compensation is 15 days' average pay for every completed year of continuous service, using a 26-day month. Gratuity is 15 days' pay per completed year, capped at ₹20,00,000 (about $23,500). A full package also adds notice pay and unpaid wages.

Both statutory formulas run off a daily wage derived from monthly Basic plus Dearness Allowance (DA), divided by 26. Understanding how Basic and DA sit inside total pay matters here, which is why we point clients to our breakdown of salary structure in India and payroll components.

Here is a retrenchment worked example. For an employee earning ₹50,000 per month (Basic plus DA) with 5 completed years:

• Daily wage: ₹50,000 / 26 = ₹1,923.08
• Per year: ₹1,923.08 x 15 = ₹28,846.20
• Total: ₹28,846.20 x 5 = ₹1,44,231 (about $1,700)

Here is a gratuity worked example. For an employee earning ₹80,000 per month (Basic plus DA) with 20 completed years:

• Daily wage: ₹80,000 / 26 = ₹3,076.92
• Per year: ₹3,076.92 x 15 = ₹46,153.80
• Total: ₹46,153.80 x 20 = ₹9,23,076 (about $10,900), within the ₹20 lakh cap

One change catches many foreign employers off guard: the "wages" 50% rule now common across the Codes. If excluded allowances exceed 50% of total remuneration, the excess is added back into "wages" for statutory dues. So allowance-heavy, low-Basic structures now compute severance, gratuity, and PF on a higher base, at least about 50% of total pay. Our salary calculator and employee cost calculator help model the true exit cost before you hire.

What Is the Worker Re-Skilling Fund and How Much Must Employers Pay?

The Worker Re-Skilling Fund is an additional employer contribution under Section 83 of the Industrial Relations Code, 2020. On top of retrenchment compensation, the employer pays 15 days' last-drawn wages of each retrenched worker into a government fund that helps the worker retrain and find new work.

This is the part of severance most global companies miss, because it is new and does not appear in older guidance built on the Industrial Disputes Act. It is not a substitute for retrenchment compensation; it is a second 15-day payment stacked on top, so a retrenchment now carries roughly 30 days' worth of pay per year of service plus the fund contribution.

The timing is tight and separate from other exit payments. Under the Industrial Relations (Central) Rules, 2026, the employer must transfer the contribution within 10 days of retrenchment to the prescribed labour commissioner's account, and it is then credited to the worker within 45 days of separation. The fund applies to retrenched employees in the workman category.

The exact establishment and worker-size scope of the Re-Skilling Fund varies by state notification, so confirm the applicable threshold for the employee's state. We check that threshold before processing a retrenchment, since getting the trigger wrong exposes the employer to penalties. For how these payments flow through a compliant payroll run, see our guide to managed payroll and how to pay employees in India.

Is Severance Pay Mandatory in India, and Can It Be Negotiated?

Yes, statutory severance in India is mandatory. Retrenchment compensation, gratuity, and final wage settlement are legal entitlements you cannot contract out of. What is negotiable sits on top: enhanced ex-gratia, extended notice, longer benefits continuation, and mutual-separation terms that many employers use to close exits cleanly and reduce dispute risk.

The statutory floor is fixed by law. You cannot ask an employee to waive gratuity they have earned, and you cannot pay less than the retrenchment formula for an eligible workman. Attempting to do so is a common source of labor disputes and back-pay claims.

Above that floor, negotiation is normal and often smart. In practice we see employers offer:

• Ex-gratia top-ups: an additional lump sum beyond the statutory amount to secure a clean, dispute-free release.
• Extended notice or garden leave: paid time that eases the transition for both sides.
• Benefits continuation: keeping insurance or other employee benefits active for a defined period.
• Mutual separation agreements: a documented settlement where both parties agree terms and release claims.

Because Indian labor law leans protective of the employee, a well-structured, slightly generous package almost always costs less than a contested exit. Structuring these while staying compliant is a core part of our EOR and PEO in India work.

What Are the Tax Implications of Severance Pay in India?

Severance in India is taxable as salary, but key exemptions apply. Retrenchment compensation is exempt up to the lower of the statutory amount or ₹5,00,000 (about $5,900); gratuity up to ₹20,00,000 (about $23,500); and VRS up to ₹5,00,000. Section 89 relief can further reduce the tax on a lump sum spread across years.

The default position is that every severance component is salary income and taxed at the employee's slab rate, with a 4% Health and Education Cess on the income tax. The exemptions then carve out specific slices, so the employee is usually taxed only on the portion above each cap.

Section 89 relief matters when a large lump sum lands in one year and pushes the employee into a higher slab. Filing the relief form lets them spread the notional tax across the years the money relates to. It stays valid for AY 2026-27 via Form 10E; under the Income Tax Act, 2025 (effective April 1, 2026), Form 10E is replaced by Form 39 from tax year 2026-27 (the exact renumbered section for the relief is still being confirmed). To see how exit pay affects the employee's actual receipt, our take-home pay in India guide is a useful companion.

What Are an Employer's Key Compliance Obligations Regarding Severance Pay?

Your core obligations are timing and documentation. Settle final wages within two working days of exit, pay gratuity within 30 days of it becoming due, and transfer the Worker Re-Skilling Fund within 10 days of retrenchment. Keep clean records of every calculation, notice, and payment to defend against disputes.

Each deadline runs on its own clock, and missing any one creates exposure. The two-working-day wage rule under Section 17(2) of the Code on Wages is separate from the 30-day gratuity timeline, so do not fold them together.

Beyond timing, keep the paper trail: signed notice or notice-pay records, the calculation sheet for each component, proof of statutory transfers, and a release document where a settlement is agreed. Our payroll process in 8 steps and the payroll in India pillar show where exit processing fits in the wider cycle, and employee bonuses in India covers dues that sometimes settle at exit.

Why Handle Severance in India With Wisemonk EOR?

Wisemonk is an India-native Employer of Record. We help global companies hire, pay, and manage talent in India without setting up a local entity, and we own the compliance detail that severance turns on: retrenchment math, gratuity, the new Re-Skilling Fund, and the exit timeline. Through our Employer of Record service and managed payroll, every calculation, transfer, and record is handled on your behalf.

We support 300+ global clients and 2,000+ employees across India, process $20M+ in annual payroll, and hold a 4.8/5 rating on G2, with pricing from $99 per employee per month. You can see our data-backed reporting on the Wisemonk research hub.