This article is written by Upasana Sarkar. This article aims to provide an understanding of the concept of retrenchment. It provides an extensive analysis of the meaning, definition, objective, procedure, and various conditions that are required to be fulfilled during the retrenchment period. It has been published by Rachit Garg.

Introduction

The Industrial Dispute Act, 1947, was enacted to solve industrial conflicts and maintain peace between employers and employees. Retrenchment is one of the important factors relating to industrial disputes. This Act helps in negotiating and resolving conflicts in the workplace. It was formulated to protect employees from exploitation by employers. It was implemented for retrenching the workers and the employees due to financial and business factors. Retrenchment is the process of letting go of employees by employers, not due to conflicts taking place but for economic reasons. The employers are retrenched only after prior permission from the government.

Meaning of retrenchment

The meaning of retrenchment is to terminate employees or workmen by the employer for economic reasons. This termination of their services is not done as a punishment or disciplinary action but on the ground of surplus labour or the financial position of the business or company. This removal or discharge of a worker from work by the employer is known as retrenchment. It denotes the end of the employer-employee relationship.

Definition of retrenchment

Retrenchment is defined in Section 2(oo) of the Industrial Dispute Act, 1947. According to the definition, retrenchment means the termination of the service of a workman by an employer for any reason whatsoever, other than as a punishment inflicted by way of disciplinary action’. There are certain factors that do not fall under the definition of retrenchment, which are as follows:
  • If the workman or employee voluntarily retires.
  • If the workman or employee retires after reaching the age of superannuation because of a provision of an agreement relating to superannuation that was made between the employer and the employee at the time of his employment.
  • If the termination of employment of the workman or employee took place due to the non-renewal of the employment agreement.
  • If the termination of employment occurs due to the continuous ill-health of the workman or employee.
Therefore, retrenchment is considered an employee’s end of service due to financial or business constraints, restructuring of the company, advancements of technologies, downsizing, discontinuation of a specific unit, and so on. 

Object of retrenchment in Labour Law

The main object of retrenchment is to terminate employees when an establishment faces financial constraints and is forced to downsize its number of employees. The companies retrench the employees due to the surplus labour and to cut down on the expenditure on human resources. The purpose of retrenchment is to:
  • reduce the outgoing money, or
  • cutting down the expenditure, or
  • attempting to become more financially solvent. 
Retrenchment also takes place when an industry faces difficulties paying the wages of its employees. During that time, they decide to remove the employees from their services.

Requirements for a valid retrenchment in Labour Law

The requirements of valid retrenchment in labour law are mentioned in Section 25F of the Industrial Dispute Act, 1947. These conditions are applicable only when the employee has completed one year of his service on the job. The prerequisites for valid retrenchment in labour law are as follows:
  • Notice to the employees: Before retrenching the employees from their services, it is necessary to issue a written notice at least one month before the retrenchment comes into force. The notice must contain the reason for retrenchment. The employees can be removed only after notice has been provided to them and not before that.
  • No requirement of notice if an agreement already specifies the date of termination: In case, there exists an agreement that already mentions the date of termination of employment for the employees, it is not required to give notice to them before retrenchment from their services.
  • Compensation for retrenchment: In case, the employer fails to send the retrenchment notice to the employees, he will be liable to pay compensation to the employees for this failure. The compensation should be given on the basis that it is equal to fifteen days’ earnings for each year of continuous employment, or any portion of it longer than six months. 
  • Notice to be served on the appropriate authority: Before retrenching the employees from their jobs, it is necessary to notify the appropriate government or authority. The notification must be served in the prescribed manner, as stated in the official gazette.
  • Adherence to notice regulations: The notice that has been provided to the employees must be in accordance with the provisions of Rule 76 of the Industrial Disputes (Central) Rules, 1957, as it governs the notice of retrenchment in Labour Law.
While retrenching the employees from their services, the employer must act within the limitations imposed by the law, which are as follows:
  • The intention should be bona fide.
  • The employees must not be victimised.
  • The law in force should not be violated by the employer.

Exceptions to retrenchment in Labour Law

Section 2(oo) of the Industrial Dispute Act, 1947, states the exceptions to the definition of retrenchment, which are as follows-
  • Voluntary retirement: In case a workman or employee retires from his service voluntarily without any other reason, it is not considered retrenchment under labour law. This is because the employer has not removed him from his job, but the employee quit voluntarily by taking voluntary retirement.
  • Retirement after superannuation: In case a workman or an employee retires after reaching the age of superannuation due to the presence of the superannuation clause in the employment agreement that was made between the employer and employee at the time of his employment. 
  • Non-renewal of the employment agreement: In case the agreement of employment of the workman or employee has not been renewed by the employer and, as a result, he cannot continue his work further, it is not considered retrenchment.
  • Termination of employment due to an employee’s ill-health: In case a workman or employee is terminated from his job due to his continuous ill-health, it is not considered retrenchment under labour law. Illness of the body or mind is considered symptoms of an employee’s poor health. To determine whether the employee is suffering for a continuous period of time or not, the parties to the contract have to prove that in court.

Procedure for retrenching employees

The procedure for retrenching employees from their services is based on the concepts of ‘first come, last go’ and ‘last come, first go’. This principle is mentioned in Section 25G of the Industrial Disputes Act, 1947. There are certain factors based on which the employee can seek procedural protection, which are as follows:
  • Prescribed qualification: An employee who wants to seek protection must have the appropriate qualification as prescribed in Section 2(s) of the Act. 
  • Citizenship: The employee needs to be a citizen of India. Indian citizenship is an important factor.
  • Employment of the employees in an industry: The employee must be an employee of an industry. In other words, he must be employed in an establishment in accordance with the provisions of Section 2(j) of the Act.
  • Specific category of workforce: The employee needs to be a member of a particular workforce in an establishment.
  • Non-existence of a retrenchment contract: The employee who wants to seek protection under Section 25G must not have a prior retrenchment agreement with the employer of that industry.
If the above conditions are satisfied, the employee will get procedural protection under this section of the Act.

Ethical standards for retrenchment in Labour Law

It is the responsibility of the employers to handle the retrenchment ethically. So the employer does that in the following ways:
  • By fairly retrenching the employees: It is the ethical responsibility of the employer to ensure that the retrenchment of employees is done in a fair way without any biases. The employees should be retrenched from their services in accordance with operational necessities or performance metrics, not personal prejudices.
  • By keeping it transparent: It is the ethical responsibility of employers to communicate the reasons for retrenchment to employees. They should do that in such a way that the employees understand the rationale behind the decisions made. It is their duty to follow the principles of ‘first come, last go’ and ‘last come, first go’.
  • By sending advance notice: It is the ethical responsibility of employers to send advance notice so that employees get appropriate time to prepare themselves both physically and mentally. The employer must support them by giving them a heads up, softening the blow of a sudden loss of their job.
  • By offering severance and support: It is the ethical responsibility of employers to offer employees support and severance packages. They must be provided with counselling or outplacement services that will help them in their transition. The employers must support them by looking after their well-being.
  • By offering opportunities for retraining: It is the moral responsibility of employers to help retrenched employees by giving them various opportunities to retrain or re-skill themselves. They can equip them for a particular role and invest in the betterment of the employees’ future.

Retrenchment differs from termination

As mentioned above, retrenchment means the termination of employment for the employees. So it might seem that both retrenchment and termination are the same thing. But in reality, they are distinct from one another. Retrenchment means the discharging of employees from their jobs due to economic conditions or financial constraints like restructuring or merging of companies, cost-cutting measures, failure of machinery, advancement of technologies, and others. Therefore, it is not done on the basis of the performances of the employees but for social problems that the company faces. Termination, on the other hand, means the end of the employer-employee relationship on various grounds, such as poor performance, misconduct, or violation of company policies. Thus, in short, it can be said that retrenchment occurs due to the financial position of the company, whereas termination takes place on the basis of the performance or misconduct of the employees at the time of their employment.

Rights of employees at the time of retrenchment

The employees are equipped with various rights during the retrenchment process to protect them from exploitation by their employers. They are protected against the arbitrary actions of their employers. To ensure fairness, the following rights are given to the employees:
  • To get prior notice: It is the right of employees to get  prior notice  and compensation in lieu of notice, which depends on the employment agreement made between employers and employees.
  • To receive counselling and support: In case of the retrenchment of a large number of employees from a company, they should be given support services like counselling or assistance for job placement. 
  • To get severance pay: In case there is an employment agreement where the terms of the contract say that the retrenched employees will get severance pay, the employees are entitled to get retrenchment compensation or severance packages. 
  • Representation and consultation: In many regions or localities, the employees or their representatives have the right to consultation regarding the process of retrenchment. 
  • To know the reason for retrenchment: The employees have the right to know the reason for their retrenchment. They must be given the justification and rationale for the retrenchment decision.
  • To get access to grievance mechanisms: The employees must be given the right to challenge the retrenchment decision if they think that they are being retrenched in an unfair way. They are removed in an arbitrary manner, and their rights have been violated. 
  • Retrenchment without personal biases: The employees must be retrenched based on fair and justified grounds. No kind of personal bias or discrimination will be involved while retrenching the employees by the employers. 
  • To get re-employment opportunities: If employers think of employing individuals for a post, they should give priority to the retrenched employees. They should be provided with re-employment opportunities or retraining opportunities within the company.

Conditions for retrenchment in Labour Law

A workman or employee can be terminated from his service by the employer under various conditions, which are as follows:
  • Economic difficulties: A company or a business may, sometimes, face financial constraints or a loss in business income. Due to such situations, there is no other option but to discharge the employees from their work. Therefore, economic difficulties may lead to the retrenchment of the employees.
  • Restructuring of the company: A company needs to restructure many times to improve its efficiency. The restructuring may include structural or operational changes in a particular department of the company. This can lead to the retrenchment of employees from their services.
  • Advancements in technologies: A company can adopt new and advanced technologies to improve the efficiency of their work. The introduction of new and modern technologies reduces the need for employees. Therefore, it can lead to the retrenchment of employees from their jobs as their techniques become old and obsolete. 
  • Discontinuation of a specific unit: In a company, the employees may be retrenched from their services by the employer due to the removal of a specific unit. This may be because that specific unit is no longer required by the company or due to the installation of new technologies.
  • Failure of machinery: The employees of a company can also be removed from their jobs in case of machine failure. In case, the machinery of a company fails or breaks down, it may lead to the retrenchment of the employees.
These are the various reasons that are responsible for the retrenchment of employees by employers. Thus, a retrenchment takes place due to social factors, not to penalise the employees of the company.

Average pay of retrenched employees

The average pay or the amount of compensation to be paid to the retrenched employees depends on the nature of the retrenchment and the terms of the employment agreement. It is basically of two kinds, which are as follows:
  • Retrenchment of the employees due to the closure of the establishment.
  • Retrenchment of the employees due to the non-closure of the establishment.
In both the above two situations, the compensation to be paid to the retrenched employees by the employer will be decided on the basis of each year of continuous employment, or any portion thereof, that exceeds six months and will be paid at a rate of fifteen days’ average wage. The average pay is calculated by taking into consideration the employee’s wages earned in the last twelve months of his job in that industry. The employer can pay more if he thinks it is reasonable to do so, but he cannot pay less than the minimum amount of compensation as stated in the Act. 

Essential requirements of retrenchment compensation

As mentioned above, it is necessary to pay compensation to the retrenched employees who have completed one year of continuous work. While paying the retrenchment compensation, the employer should keep the following essential requirements in mind:
  • The retrenched employee should be given half of their average monthly salary for each completed year of his continuous service in the establishment, or any portion thereof that exceeds six months.
  • If the employer wishes, he can also pay additional compensation to the retrenched employees. The additional compensation will depend on the company’s nature, size, financial status, as well as the number of retrenched employees. This amount should be greater than the basic compensation that is to be paid to them.
  • If the employer wants, he can give the employees extra benefits by paying them bonuses, gratuities, and any other unpaid wages or dues.

Re-employment of retrenched workers

Section 25H of the Industrial Dispute Act, 1947, says that if an employer is retrenched from the service on the ground of surplus labour, that employee must be given the first opportunity to return to work in case the employer decides to employ additional employees in the establishment. This section imposes a duty on the employer, which is to give a chance to the retrenched employees to apply for re-employment in case of any employment opportunities that arise in the industry. To apply for re-employment, the employees must fulfil the following conditions:
  • Re-employment opportunity: If the employees of a company are retrenched due to the financial position of the company or surplus labour, the retrenched employees must be provided with the opportunity to return to their services if employment of additional employees is required.
  • Notice to be given to the retrenched employees: If the employer finds a post empty and thinks of appointing someone, it is their duty to give that notice to the retrenched employees who have the potential to do the work. 
  • Citizenship: The employee needs to be a citizen of India.
  • Re-employment in the same establishment: In the case of re-employment of the retrenched employees, the place of work in the industry must be the same as it was before their retrenchment. 
  • Preferences must be given to the retrenched employees: When the employer of an establishment decides to employ new workers in the service, the retrenched employees must be given preference over the other individuals.
The above mentioned re-employment opportunities are available to only those employees who were retrenched from their services. The employees who were discharged, dismissed from their jobs, or retired due to superannuation have no right to claim the benefits under Section 25H of the Act. In case a retrenched employee is given the opportunity to return to their work but he denies taking the opportunity for a valid reason, he may lose the benefits of Section 25H. When the employer wants to appoint new employees, he must provide that opportunity to the retrenched employees to rejoin the workforce before the others. This is one of the important fundamental principles mentioned in the Act and is used in industrial adjudication. This section portrays the principles of natural justice, fairness, justice and equity, with an emphasis on equal treatment and protection of the rights of employees.

Conditions to be fulfilled for the retrenchment of workers

Section 25N of the Industrial Dispute Act, 1947, states the conditions that need to be followed before retrenching an employee from the service. The conditions are as follows:
  • Notice needs to be given to the employee: An employee who has worked for a continuous period of at least one year can only be retrenched by the employer for his service. Before retrenching the employee, the employer must send notice of retrenchment at least three months before the date of his retrenchment. It is also the responsibility of the employer to ensure that the employee receives his annual wages before the notice period.
  • Approval of the government is needed: When the employer of a company decides to retrench an employee, he should obtain prior permission from the appropriate government or authority before issuing the notice of retrenchment.
  • Application for the approval is needed to be submitted: An application requiring approval for retrenchment needs to be submitted to the appropriate government or authority, which must be done in the prescribed format. A copy of approval or refusal as decided by the appropriate authority is to be given to the employee in accordance with the specifications of the official gazette.
  • Proper investigation by the government: When the employer submits an application for retrenchment approval, the appropriate authority looks into the matter. They conduct a proper investigation regarding it. Then the reason for such a retrenchment decision by the employer is taken into consideration, and he is permitted to present his case. After hearing from him, the government will either approve or refuse the application based on their satisfaction. 
  • Decisions need to be communicated to the employee: Whatever the decision of the government, it needs to be communicated to the employer as well as the employee. It is the responsibility of the government to do a thorough investigation and pass the order following the principles of natural justice, fairness, and equity. 
  • A specific time period for the issuance of the decision: The government must pass the order within sixty days after receiving the application from the employer for authorisation. In case the government fails to do so, it is assumed to be authorised by the government.
  • The finality of the decision: The decision given by the appropriate authority for approval or refusal is binding on both parties for a period of one year from the date it was communicated to them.
  • Tribunal for adjudication: If the employer is not satisfied with the decision of the appropriate authority, he can go to the tribunal with the matter for adjudication. The tribunal has to pass the judgement within a period of thirty days.
  • Application can be refused by the government: In case the government disapproves or refuses the application for retrenchment, then it would be considered unlawful.

Penalty for infringement

The employer should not violate any provisions of the Industrial Dispute Act, 1947, while retrenching the employees from their services. If he does not follow the provisions and does something contrary, then he will be punished in accordance with the provisions of Section 25Q of the Act. He would be imprisoned for a period of one month, or a fine with a maximum amount of one thousand rupees, or both.

Differences between lay-off and retrenchments in Labour Law

Both the terms ‘lay-off’ and ‘retrenchment’ are defined in the Act. Lay-off means temporarily suspending an employee from his service. It is when the employer temporarily keeps an employee away from work, but their employer-employee relationship does not come to an end. Unlike retrenchment, lay-off does not mean termination of employment of the employees. A few points of difference between lay-off and retrenchments are represented in tabular form:
Sl no. Lay-off  Retrenchment 
1. Lay-off is defined in Section 2(kkk) of the Industrial Dispute Act, 1947. Retrenchment is defined in Section 2(oo) of the Industrial Dispute Act, 1947.
2. Temporary cessation of work for a particular period of time. Permanent termination of employment of the employees.
3. It takes place due to a lack of work in a specific unit of the company or the occurrence of a downturn in business. It takes place due to financial constraints or the restructuring of the company.
4. During the lay-off period, the employees are not terminated from their services. During retrenchment, employees are terminated from their services.
5. Employees are usually re-hired after the condition of the business improves or new work comes in. Employees are not re-hired as they are permanently dismissed from their jobs.
6. When the employees are laid-off, they may be given unemployment benefits. When the employees are retrenched, they are given severance pay and other compensation.
7. It usually affects the employees of a particular unit or location of the industry. It may affect the employees of the industry as a whole, not just a particular division.
8. Lay-off occurs when the employer fails to provide employment to the employees due to the shortage of coal, raw materials, power, or natural calamity, or accumulation of stocks or breakdown of machinery, or any such reasons whatsoever. Retrenchment occurs when the employer terminates an employee from the service due to financial position, technological advancements, economic difficulties, restructuring of the company, discontinuation of a specific unit, and any such reasons whatsoever. 
9. The employer-employee relationship does come to an end but remains suspended for a while. The employer-employee relationship is terminated permanently.
10. The status of employees in lay-offs is employed. The status of employees in retrenchment is unemployed.
11. The notice period is not essential for lay-offs. The notice period is an essential requirement for retrenchment.
12. The operation or working of the establishment may temporarily stop during the lay-off period. The operation or working of the establishment continues after the declaration of retrenchment.

Differences between retrenchment and closure

The term ‘closure’ is defined in Section 2(oo) of the Industrial Dispute Act, 1947, which refers to the permanent closing down of an establishment. It signifies the end of the employer-employee relationship. A few points of difference between retrenchment and closure are represented in tabular form:
Sl no. Retrenchment  Closure 
1. It means termination of employment of the employees by the employers. It means closing down of an establishment, which leads to the termination of employment.
2. In retrenchment, only those employees are affected who are retrenched from their jobs. In closure, all the employees working in an establishment are affected since it means total closure of work.
3. The employees are terminated mainly on account of surplus labour. The employees lose their jobs due to the closing of the business for trade reasons.
4. Retrenchment affects only the employees and not the employers. Closure affects both employers and employees as it leads to the permanent closing of a place of employment.
5. Retrenchment means the removal of employees from an establishment. The business operation does not terminate.  Closure means the final and irrevocable termination of business operations due to trade reasons.
6. When the process of retrenchment is going on, the establishment does not stop functioning. It continues its work, irrespective of the retrenchment process.  When closure takes place in an establishment, it means the functioning of that industry automatically comes to an end. No further work will happen.
7. The retrenched employees can be re-employed if the establishment decides to hire new employees.  No re-employment can take place as the establishment has already been permanently closed.
8. In retrenchment, the retrenched employees are paid retrenchment compensation if they have completed one year of continuous work in that establishment. In closure, such a situation does not take place as the establishment has been closed due to bad trade conditions. So the employer does not have money to pay compensation to the employees.

Landmark cases on retrenchment in Labour Law

  • In the case of Laxmi Devi Sugar Mills Ltd. v. Ram Sagar Pandey (1957), the Supreme Court of India states certain conditions that need to be followed while retrenching the employees. The following conditions will be considered valid for retrenchment:
    1. It is the employer’s responsibility to prove that the retrenchment is taking place due to financial issues like a decline in business due to trade reasons or on account of surplus labour. No other reason would be considered valid.
    2. Before retrenchment, the employer must send a notice to the employees who will be retrenched, and retrenchment compensation must be paid to them as stated in Section 25F of the Industrial Dispute Act, 1947.
    3. While retrenching the employees, the employer must follow the principle ‘last come, first go’. It means that those who were employed last among all the other employees will be the first to be retrenched.
    4. Another condition stated by the Court was that the employers need to prove that there are no other alternatives to retrenchment, like transferring or redeploying the employees to other places, or the presence of any other options.
These are the grounds that the employers of an establishment have to follow before retrenching the employees from their services.
  • In the case of Workmen of Meenakshi Mills Ltd. v. Meenakshi Mills Ltd. and Anr. (1992), the plaintiff filed a suit challenging the constitutional validity of Section 25N. He argued that Section 25N of this Act was violating the employees’ fundamental rights to equality and freedom under Article 14, Article 19(1)(g), and Article 19(6) of the Constitution of India. It was contended by the plaintiff that the employers cannot retrench them from the establishment as they do not have the right to do so. The Supreme Court rejected the contention, stating that Section 25N is not unconstitutional. Employers can retrench employees, but only under certain conditions that are placed on them. The employers’ failure to retrench the employees in accordance with the provisions of Section 25N can lead to industrial disputes. So the court gave the power to raise industrial disputes with both the management and employees. Both of them were given the right to move the court for approval or refusal of retrenchment. 
  • In the case of Managing Director of Karnataka Handloom Development Corporation Limited v. Sri Mahadeva Laxman Raval (2006), the respondent filed the suit under Section 2(oo) of the Industrial Dispute Act, 1947, in the Supreme Court. He was hired on a contractual basis for some specific hours and intervals. So he was terminated from his job as soon as that period was over. This was the reason the respondent raised an industrial dispute. The Apex Court observed that his termination of employment cannot be considered retrenchment, as it was already mentioned in the contract that he was employed in the establishment only for a specific time interval. After that, his service will automatically be terminated. Since he wasn’t a regular employee of that establishment, his removal was not retrenchment.

Recent judicial pronouncements on retrenchment in Labour Law

  • In the case of Management of the Barara Cooperative Marketing and Processing Society Ltd. v. Workman Pratap Singh (2019), an employee was unlawfully retrenched from his job. The respondent had accepted the compensation that was paid to him because of his illegal termination of employment. When the respondent saw that the appellant’s company regularised the employment of two peons, he argued that he was also eligible for re-employment as per Section 25(H) of the Industrial Disputes Act, 1947. The Supreme Court dismissed the claim and observed that he was not entitled to re-employment in accordance with the provisions of Section 25(H). It was stated that he had already taken the compensation given to him because of his illegal termination of employment. He is now not permitted to cite the case of other employees who are already employed and whose service the appellant had only regularised based on their services to claim re-employment. So the Apex Court rejected his petition.
  • In the case of Ashok Gupta v. Modi Rubber Limited (2021), the plaintiff filed the suit against the person who had appointed him as the law officer in his company. Though his services were verified by the defendant, he was not permitted to enter the company premises. He was notified that his employment was terminated with immediate effect. The reason stated for his termination of employment was due to business emergencies and administrative reasons, not as a punishment. The Trial Court of New Delhi stated that termination of employment by way of retrenchment could occur for any reason whatsoever. But in this case, it cannot be considered retrenchment as the notice of retrenchment was not served upon the plaintiff. So it was not valid as per Section 25(F) of the Industrial Dispute Act, 1947. So the case does not fall under the Industrial Dispute Act, though he will get compensation as per Section 73 and Section 74 of the Indian Contract Act, 1872.

Conclusion

The Industrial Dispute Act, 1947, was enacted to solve all the problems that arise between employers and employees. Retrenchment is an important provision of this Act that helps in discharging the employees without any chaos or riots, as it is legal. The process of retrenchment can also be termed a reduction or curtailment process. This helps a company properly organise its resources and structures by cutting down on extra expenditures. Companies or businesses can reduce their surplus employees whenever they face financial difficulties. But before retrenching the employees, they have to follow a procedure, which is stated in the Act. It also helps the employees to challenge the decision of the employer if any employee thinks that he is being removed unjustly. Then he can go to the tribunal and challenge the decision. Thus, it is helpful for both employers and employees, as it ensures peace and harmony within the industrial establishment. 

Frequently asked questions (FAQs) 

What are the things that are not considered retrenchment compensation under the Industrial Disputes Act?

There are certain payments that do not come under retrenchment compensation. Compensation is provided to the employee depending on the years of his work in the establishment and the wages he used to get. Section 25F of the Industrial Dispute Act, 1947, excludes the following amounts from the computation of retrenchment compensation:
  • An amount that is paid to the employee as a gratuity that is payable to him for the termination of his service in accordance with the provisions of the Payment of Gratuity Act, 1972.
  • An amount that is paid by the employer to the employee for reducing the incidence of unemployment when he is terminated from his service.
  • An amount that needs to be paid to the employee as it is prescribed by the appropriate government or authority.
These are the amounts that are not considered retrenchment compensation. 

What are the exemptions permitted under this Act regarding retrenchment compensation?

Retrenchment compensation is considered a taxable income under the Income Tax Act, 1961. It is included in one of the five heads of income and falls under the head ‘Income from salaries’. However, this Act exempts certain retrenchment compensation. The retrenchment compensation given to the employees by the employers is exempted from tax under Section 10(10B) of the Income Tax Act to the following extent:
  • An amount that is calculated for payment of retrenchment compensation as per the provisions of the Industrial Dispute Act, 1947.
  • An amount of rupees five lakhs is given to the employee, as that is his average pay. 
  • The actual amount paid to the employee as retrenchment compensation.
  • Under this section, the tax-free amount  is limited to the amount of compensation the employee is paid as a result of retrenchment from his service.
An important point to be noted under this section is that this exemption is applicable only in cases of retrenchment compensation and not for voluntary retirement or resignation. Section 10(10B) of the Income Tax Act states that this exemption can be used by employees only and not by the shareholders of a company or partners of a firm.

What constitutes a reasonable retrenchment procedure?

There are a few methods that can be followed by the employer to ensure fair retrenchment, which are as follows:
  • Before retrenching the employees, the employer needs to consult with those who will be affected by the retrenchment. He should consult with registered or elected representatives of the employees, their workplace forum, or any other persons who are appointed by the employees. They are known as ‘consulting employees’.
  • The notice of retrenchment should be issued by the employer only after prior consultation with the consulting employees. He must be made aware of the situation and the reasons for such retrenchment.
  • It is necessary to have the consensus of both the employer and consulting employees regarding the matter of retrenchment and the matters stated in the notice.
  • The representations of the consulting employees must be taken into consideration by the employer regarding the notice as well as the proposed retrenchment of employees.
  • It is the responsibility of the employer to respond to suggestions given by the consulting employees. He must say whether he agrees or disagrees with the suggestions of the consulting employees. If he disagrees on any matter relating to retrenchment, he must state the reason for disagreeing with them.
  • It is the responsibility of the employer to decide the criteria that will be followed while retrenching the employees. He should consult with the consulting employees and retrench the employees in a fair and just way.
  • After consulting with the consulting employees, the employer must make a decision regarding retrenchment, and a notice must be given to those employees who would be retrenched from their jobs.
This procedure of retrenchment is not required to be followed by every employer. It must be followed by those employees under whom more than fifty employees are employed in an establishment. It is considered to be a fair procedure for retrenchment.

References

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