Gratuity for Contract Staff as per New Labour Codes

The implementation of the New Labour Codes in India marks a significant shift in how social security benefits are administered. One of the most critical changes involves the eligibility and payment of gratuity for contract staff and fixed-term employees. Historically, the five-year continuous service rule acted as a barrier for many temporary workers. However, the Code on Social Security, 2020, effectively removes this hurdle for specific categories of contractual workers, ensuring they receive equitable treatment compared to permanent staff.

Under the Code on Social Security, 2020, contract staff hired on a fixed-term basis are entitled to gratuity payments regardless of the traditional five-year service requirement. These employees receive pro-rata gratuity based on their actual tenure, provided they complete at least one year of service. This change ensures that the duration of a contract does not deprive a worker of statutory terminal benefits, aligning their compensation with their period of contribution.

The Shift from the Payment of Gratuity Act, 1972

For decades, the Payment of Gratuity Act, 1972, governed the terminal benefits of employees in India. The primary condition for gratuity eligibility was the completion of five years of continuous service with a single employer. While this protected long-term employees, it left contract workers—who often move between projects or employers every two to three years—without any gratuity benefits.

The new legal framework recognizes the growing “gig” and “contractual” nature of the modern workforce. By introducing the concept of Fixed-Term Employment (FTE), the government has mandated that these workers receive the same statutory benefits as permanent employees. This includes hours of work, wages, and social security benefits, including gratuity.

Eligibility Criteria for Contractual and Fixed-Term Staff

The eligibility for gratuity under the new codes depends largely on the nature of the contract. It is essential to distinguish between a worker hired through a third-party contractor and a worker hired directly by a company on a fixed-term contract.

• Fixed-Term Employees (FTE): These are individuals hired directly by an organization for a specific duration. Under the new codes, the five-year eligibility period is waived. If an FTE completes one year of service, they are entitled to gratuity on a pro-rata basis.
• Regular Contract Labour: For workers supplied by contractors, the responsibility for gratuity usually rests with the contractor. However, if the contractor fails to provide these benefits, the principal employer may be held liable under the overarching social security guidelines.
• Seasonal Establishments: In industries that do not operate year-round, the codes maintain that gratuity should be paid at the rate of seven days’ wages for each season.

Understanding the impact of the new wage code on salary structures is vital for HR professionals, as the definition of “wages” has been expanded, directly affecting the quantum of gratuity payable.

Calculating Gratuity for Fixed-Term Staff

The calculation formula for gratuity remains largely consistent with the previous regime, but the “wage” component used in the calculation has been redefined. Gratuity is calculated as 15 days of wages for every completed year of service or part thereof exceeding six months.

The Formula:
(Last Drawn Basic Salary + DA) × (15/26) × Number of Years of Service

For fixed-term staff, the “Number of Years of Service” can now be a fraction. For instance, if a contract worker completes two years of service, the employer must calculate the gratuity for those two years rather than waiting for the five-year milestone. This shift ensures that statutory retirement benefits in India are accessible to a broader segment of the working population.

Comparison of Gratuity Rules: Old vs. New

Impact on Employer Liability and CTC Design

The inclusion of contract staff in gratuity benefits significantly impacts the Cost to Company (CTC) modeling. Employers can no longer exclude gratuity provisions for short-term hires. From a financial planning perspective, companies must now create an actuarial provision for gratuity from the first year of a contract worker’s tenure.

Furthermore, the new definition of “wages” ensures that allowances cannot exceed 50% of the total remuneration. If allowances exceed this threshold, the excess amount is added back to the “wages” for the purpose of calculating gratuity. This prevents employers from artificially lowering gratuity liability by inflating non-wage allowances.

Compliance Checklist for Employers

To remain compliant with the new labour codes regarding contractual gratuity, organizations should review their current employment frameworks. Failure to adhere to these provisions can lead to significant penalties and legal disputes.

• Review Employment Contracts: Ensure that fixed-term contracts explicitly mention the eligibility for pro-rata gratuity after one year.
• Update Payroll Systems: Adjust payroll software to calculate “wages” based on the new 50% threshold rule to ensure accurate gratuity provisioning.
• Accrual Accounting: Update financial statements to reflect the gratuity liability for all employees, including those on fixed-term contracts who have surpassed the one-year mark.
• Communication: Clearly communicate the change in benefits to contract staff to foster transparency and reduce industrial relations risks.

Common Misconceptions

There is a common misconception that the five-year rule has been abolished for all employees. It is important to clarify that for regular, permanent employees, the five-year continuous service requirement remains in place. The relaxation to one year applies specifically to fixed-term employees to prevent the exploitation of “rolling contracts” where workers are terminated and rehired just to avoid gratuity payouts.

Another point of confusion is the status of working journalists. Under the new codes, the eligibility period for gratuity for working journalists has been reduced to three years, further demonstrating the legislative intent to make social security more inclusive across different professional sectors.

As the transition to the New Labour Codes nears full implementation across all Indian states, businesses must proactively align their HR policies. The inclusion of contract staff in the gratuity net is not just a legal mandate but a step toward a more equitable and secure industrial environment.