Losing a job is never easy. Whether it’s due to company restructuring, downsizing, or other unforeseen circumstances, employees face not just the emotional stress of job loss but also financial uncertainty. One of the key financial protections in such situations is severance pay. Understanding your rights, the legal framework, eligibility, and tax implications of severance can help you navigate this transition more confidently.
This guide provides a detailed overview of severance pay in India, covering the rules, eligibility, statutory requirements, corporate practices, and taxation.
What is Severance Pay?
Severance pay, also referred to as retrenchment compensation, is a financial package provided by an employer to an employee when their employment is terminated. It is generally offered in cases of layoffs, organizational restructuring, or voluntary resignation under certain conditions.
The primary purpose of severance pay is to provide a financial cushion to employees during the period they are transitioning out of their current job and seeking new employment. It is also seen as a recognition of service and loyalty, especially for long-serving employees.
Severance pay may include:
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Payment in lieu of notice period
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Compensation based on years of service
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Additional benefits like career transition assistance, health insurance continuation, or stock options
Legal Framework Governing Severance Pay in India
In India, severance pay is governed by both statutory laws and contractual agreements with the employer. The Industrial Disputes Act, 1947 (ID Act) plays a significant role in determining retrenchment compensation for certain categories of employees.
1. Workmen under the Industrial Disputes Act
Employees who qualify as “workmen” are entitled to statutory severance pay under the ID Act. According to Pooja Ramchandani, Partner at Shardul Amarchand Mangaldas & Co.,
"Workmen category employees are essentially those who are involved in technical, operational, unskilled, skilled, clerical, and manual work. It excludes those in supervisory and managerial functions drawing a monthly salary in excess of ₹10,000."
For such employees, retrenchment compensation is calculated as:
15 days’ average pay per completed year of service (or part thereof exceeding six months).
This compensation is in addition to other statutory dues, such as:
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Notice period pay
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Unpaid wages
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Gratuity (if applicable)
2. Non-Workmen Employees
For employees who do not fall under the “workmen” category—typically managers, executives, and professionals—the severance pay is governed by employment contracts or company policies.
Corporate practices often exceed statutory requirements, with some organisations offering:
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30 days’ pay per year of service
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A minimum and maximum severance payout
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Calculation based on years remaining until retirement
In many companies, long-serving employees or employees affected by large-scale layoffs receive more generous packages than the statutory minimum.
Examples of Severance Packages in India
Several companies in India have recently offered substantial severance packages during layoffs or restructuring:
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Tata Consultancy Services (TCS): TCS has offered tiered severance packages for long-serving employees affected by layoffs. According to Moneycontrol, packages vary depending on the number of years of service and employee grade.
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Amazon India: In January 2023, Amazon India reportedly offered a minimum of five months’ salary as severance, along with career transition support for affected employees.
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Ford India: Upon closing its Chennai manufacturing plant in January 2022, Ford India provided severance packages ranging from ₹33 lakh to ₹85 lakh, with an average payout of ₹41 lakh per employee (Times of India).
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Accenture India: In 2020, Accenture offered impacted employees a payout of seven months’ salary, which included three months’ pay in lieu of notice and an additional four months for voluntary resignation.
These examples demonstrate that corporate severance packages in India can be significantly higher than statutory minimums, particularly for senior or long-tenured employees.
Eligibility for Severance Pay
Eligibility for severance pay depends on the type of employee and the reason for termination.
1. Workmen
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Must have completed at least one year of continuous service
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Payment calculated based on the Industrial Disputes Act formula: 15 days’ pay for every completed year of service (or part thereof exceeding six months)
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Retrenchment must be initiated by the employer for reasons other than misconduct
2. Non-Workmen
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Eligibility and calculation are based on employment contract and company policy
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Companies may offer additional benefits depending on the employee’s grade, years of service, and contractual agreements
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May include career counseling, relocation support, or extended medical benefits
Taxation of Severance Pay in India
Understanding the tax implications of severance pay is crucial because it can significantly impact the net amount received.
1. Taxable Nature
Under Section 17(3) of the Income Tax Act, 1961, severance pay is treated as “profits in lieu of salary.” This includes compensation received from an employer at the time of termination or due to changes in employment terms.
2. How Severance Pay is Taxed
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Severance pay is added to your total income for the financial year
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Tax is applied according to the income tax slab applicable to the individual
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There may be certain exemptions or deductions under Sections 10(10C) and 89 of the Income Tax Act for compensation received in specific situations (such as retrenchment under ID Act)
3. Practical Example
Suppose an employee with a monthly salary of ₹1,00,000 is laid off after 10 years of service, receiving 15 days’ average pay per year:
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Average pay per month: ₹1,00,000 ÷ 30 × 15 = ₹50,000
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Total severance (10 years): ₹50,000 × 10 = ₹5,00,000
This ₹5 lakh is added to taxable income and taxed as per the applicable slab rate.
4. Tax Planning
Employees can plan taxation on severance pay by:
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Requesting split payments over multiple financial years if permitted
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Investing in tax-saving instruments like PPF, NSC, or ELSS
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Consulting a tax advisor to explore exemptions for retrenchment compensation under Section 10(10C)
Calculating Severance Pay
While the exact calculation depends on the employee type and company policy, the following methods are commonly used:
1. Workmen
Formula under ID Act:
Severance Pay = (Average monthly salary ÷ 30) × 15 × Number of completed years of service
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“Average salary” includes basic pay plus dearness allowance
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Fractional years exceeding six months are rounded to one year
2. Non-Workmen
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May follow a formula based on months’ pay per year of service
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Some companies offer higher compensation for senior employees or those nearing retirement
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Policies may include minimum and maximum caps
Notice Pay and Other Statutory Dues
Severance pay is in addition to other benefits such as:
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Notice period pay: Payment in lieu of notice if the employee is not required to serve it
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Gratuity: Applicable if the employee has completed at least five years of continuous service
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Unused leave encashment: Some companies pay for accumulated annual leave
It’s important for employees to review their full separation package to ensure all entitlements are included.
Key Takeaways for Employees
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Know your eligibility: Determine whether you are a workman or non-workman and understand the applicable law or company policy.
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Check your contract: Non-workmen employees should carefully review employment agreements and company severance policies.
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Understand taxation: Severance pay is taxable as profits in lieu of salary; consult a tax advisor for planning.
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Negotiate if possible: Some companies allow negotiation on severance, especially for senior employees or long-serving staff.
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Verify other dues: Ensure that notice pay, gratuity, and leave encashment are included in your final settlement.
Conclusion
Severance pay is an essential financial safety net for employees facing layoffs or termination. While the Industrial Disputes Act provides a legal baseline, many companies offer higher severance packages based on tenure, role, and industry norms.
Understanding your eligibility, calculation methods, and tax implications is crucial for ensuring that you receive the full benefits of your severance package. With proper knowledge and planning, severance pay can help cushion the financial impact of job loss and provide a bridge to your next career opportunity.
Whether you are a workman or a non-workman, a careful review of your severance agreement, combined with informed tax planning, can ensure a smoother transition and financial stability during a challenging period.
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