Severance Pay is an additional compensation benefit provided by the organization to its employees upon the termination of their employment. It is given as financial assistance during a transition period, helping employees to plan their expenses until they stabilize their source of income or manage to get another job. Sometimes, Severance Pay becomes a legal necessity depending on the employment terms.
This component does not have a fixed structure, it may include various financial benefits and may vary from one country to another. In this blog, we will understand the meaning of Severance Pay, the benefits you get in India, what are its components, and how it can be calculated.
What is the Meaning of Severance Pay?
The term Severance comes from the word ‘Sever’, which means – ‘To Cut’ or ‘To Separate’.
Severance Pay is the money or financial benefit that the company will pay to the employee whose job had to be cut or terminated for any reason. This payment acts as a cushion which smoothens the transition process and helps in managing the expense till one attains another job / source of income.
Severance and Unemployment Benefits in India
Severance pay and unemployment benefits are two separate financial assistance programs for employees who part from their jobs. The employer offers severance as a component of the agreement or as a matter of law in case of discharge. On the other hand, unemployment benefits are granted by the authorities as part of schemes. In India, unemployment benefits are marginal compared to other developed countries, so severance pay is a greater financial cushion for retrenched employees.
When Does an Employee Become Eligible to Receive Severance Pay in India?
Severance pay eligibility in India depends on the following:
- Nature of Employment Contract: In case the employment contract provides for severance pay amongst the termination benefits, the employee is entitled to it.
- Retrenchment: According to the Industrial Disputes Act of 1947, retrenched employees are eligible for compensation after more than one year of continuous service.
- Voluntary Retirement Schemes: Employees who enroll in a voluntary retirement scheme may receive termination benefits in addition to those offered under the scheme.
- Redundancy: Termination benefits become applicable when an employee is terminated for redundancy, downsizing, or restructuring.
- Company Policies: Companies would award termination benefits of their free will as a human resources policy, though not obligatory by law.
How is Severance Pay Calculated in India?
The severance pay in India is calculated mainly under the Industrial Disputes Act of 1947. The standard formula is:
Severance Pay = (15 days’ average pay) × (Number of completed years of service)
Important elements are:
- Average Pay: It is typically the basic pay and dearness allowance (if any).
- Years of Service: Partial years longer than 6 months are typically treated as a full year.
- Notice Pay: By pay, there may also be compensation for the notice period when the employer does not wish to provide notice.
How Do Employees Negotiate Their Severance Pay Package?
Negotiating a severance package requires intellectual work (i.e., strategy) and knowledge of what is owed to the employee. Here are the most important tips:
- Review Employment Contracts: Please take time to review the employment agreement, particularly clauses regarding severance, carefully. Know about statutory benefits under labor laws to strengthen your hand in negotiating.
- Focus on contributions: A valuable package is justified by work record and length of employment.
- Expert advice: Seek guidance from labor law attorneys or HR consultants on your rights and how to negotiate effectively.
- Negotiate for non-monetary rewards: Once any financial demands are not feasible, claim additional health coverage benefits, career counseling, and job placement benefits.
Components of a Severance Package in India
A well-rounded severance package would comprise the following:
- Severance pays: Amount received based on years of service and salary.
- Gratuity: A statutory benefit for employees who have completed at least five years of service.
- Compensation for unused leaves: Compensation for accrued but untaken leave.
- Extended health benefits: Health insurance coverage for a certain period after termination.
- Career transition services: Resume writing, career coaching, and job search support.
Is Severance Pay Compulsory in India?
Severance pay is not generally compulsory in India, though it is applicable in some situations, like retrenchment under the Industrial Disputes Act of 1947. Small-scale enterprises with less than 100 employees have lesser liability than larger corporate houses. Many organizations voluntarily offer severance packages to ensure no case is dragged into litigation and the relationship remains good.
Is Severance Pay Taxable in India?
Severance pay is taxed in India under the Income Tax Act of 1961. It is treated as “income from salary,” taxed on that account. There might also be exemptions and deductions.
How is tax on severance pay calculated in India?
The tax on severance pay is calculated based on the employee’s income slab. The severance amount is added to the total income for the financial year and taxed as per the applicable slab rate. The employer may also apply TDS (Tax Deducted at Source) at the time of payment.
What are the Tax Exemptions Available on Severance Pay?
The following exemptions may apply to severance pay:
- Gratuity Exemption: Gratuity payments are exempt up to a specific limit under Section 10(10) of the Income Tax Act.
- Leave Encashment: Leave encashment is exempt for government employees up to certain limits and partially exempt for private sector employees.
- VRS Benefits: Compensation received under Voluntary Retirement Schemes is exempt up to ₹5 lakhs under Section 10(10C).
- Section 89: Employees can claim tax relief on any amount received in advance or salary and severance pay arrears.
Compliance by the Employer Relating to Severance Pay in India
The following compliance steps are required to be undertaken by employers:
- Statutory Requirements: Compliance with statutory requirements under labor laws like the Industrial Disputes Act of 1947.
- Paperwork: Breakup of severance package clearly, specifying notice pay, gratuity, and other constituents.
- TDS Deductions: Deduct TDS from severance pay and provide Form 16 to the employee.
- Policy Transparency: To avoid disputes, maintain clear and transparent policies regarding severance pay.
- Timely Payment: Ensure prompt disbursal of severance pay to avoid legal repercussions.
Conclusion
Severance pay is a crucial component of employee compensation in India, providing financial security to employees during uncertain times and building goodwill for employers. It is not always mandatory but essential to ensure a smooth transition and maintain labor standards. It is critical to understand how it is calculated, taxed, and legal nuances so that both employees and employers can handle the termination scenario properly. The need for fair and transparent severance policies in the Indian workforce will keep growing, and all the stakeholders need to stay abreast and compliant with such policies. With a comprehensive approach, employers and employees can confidently navigate the complexities of severance pay.
