The Gratuity Conundrum for Fixed-Term Employees

Introduction

The landscape of employment in India has undergone a fundamental transformation with the recent notification of the four Labour Codes on November 21, 2025. Among the various reforms introduced, the provisions relating to gratuity for fixed-term employees represent one of the most significant departures from traditional employment law. While the Payment of Gratuity Act, 1972 has governed retirement benefits for over five decades, the newly implemented Code on Social Security, 2020 and the Industrial Relations Code, 2020 have introduced provisions that fundamentally alter gratuity entitlements for workers engaged on fixed-term contracts. This change reflects the evolving nature of work in modern India, where temporary and contractual employment has become increasingly prevalent across sectors. The tension between providing adequate social security to temporary workers and maintaining flexibility for employers has created what can only be described as a gratuity conundrum, one that requires careful examination of both legislative frameworks and their practical implications for India’s workforce.

The Traditional Gratuity Framework Under the Payment of Gratuity Act, 1972

The Payment of Gratuity Act, 1972 was enacted by Parliament on August 21, 1972 and came into force on September 16, 1972[1]. The Act established a mandatory framework requiring employers to provide a lump-sum gratuity payment to employees as a reward for long-term service upon termination of employment. Under Section 4 of the Act, gratuity becomes payable to an employee on the termination of employment after rendering continuous service for not less than five years. The termination can occur due to superannuation, retirement or resignation, death or disablement due to accident or disease. However, the completion of continuous service of five years is not required where termination results from death or disablement. The Supreme Court of India in Indian Hume Pipe Co Ltd v Its Workmen held that the general principle underlying a gratuity scheme is that by service over a long period, the employee is entitled to claim a certain amount as a retirement benefit[2]. This landmark judgment established gratuity as distinct from retrenchment compensation, recognizing it as a legitimate claim arising from sustained employment rather than a discretionary payment.

The Payment of Gratuity Act applies to every factory, mine, oilfield, plantation, port, and railway company. For shops and establishments, the Act applies to those organizations employing ten or more persons on any day during the preceding twelve months. Once an establishment becomes covered under the Act, it continues to be governed even if the number of employees subsequently falls below ten. Gratuity is calculated at the rate of fifteen days’ wages for every completed year of service or part thereof in excess of six months, based on the wages last drawn by the employee. The formula for calculation is derived by dividing the last drawn wages by twenty-six and multiplying the result by fifteen. Under Section 4(3) of the Act, the maximum gratuity payable was originally capped, and this ceiling was revised to twenty lakh rupees through the Payment of Gratuity (Amendment) Act, 2018. This calculation methodology has remained consistent since the Act’s inception, providing a clear and predictable framework for both employers and employees to determine retirement benefits.

Fixed-Term Employment and the Changing Nature of Work

The concept of fixed-term employment represents a significant evolution in Indian labour law. Fixed-term employment was first introduced through a Central Government Notification in February 2017, initially applicable only to employees working in Apparel Manufacturing Units. The provision was subsequently extended to leather industries and other sectors in January 2018, and eventually to all sectors through the Industrial Employment (Standing Orders) Central Amendment Rules, 2018. The Industrial Relations Code, 2020 formally codifies fixed-term employment and defines it as “the engagement of a worker on the basis of a written contract of employment for a fixed period,” with the proviso that the worker’s hours of work, wages, allowances and other benefits shall not be less than that of a permanent employee doing the same work or work of a similar nature[3]. This definition marked a deliberate policy shift towards formalizing temporary employment relationships that had previously operated in grey zones, where employers frequently used short-term contracts to avoid extending statutory benefits to workers.

The rationale for introducing fixed-term employment stems from economic realities facing Indian businesses, particularly in sectors characterized by seasonal demand, project-based work, or fluctuating market conditions. Before the formal recognition of fixed-term employment, employers often relied on contract labour supplied through intermediaries to maintain workforce flexibility. However, this arrangement frequently resulted in exploitation of workers who were denied basic statutory benefits despite performing work identical to permanent employees. The formalization of fixed-term employment under the Industrial Relations Code, 2020 aims to eliminate this disparity by mandating that fixed-term employees receive statutory benefits including provident fund, employee state insurance, bonus, and wages on par with permanent workers. The Code specifically provides that fixed-term employees will be eligible for gratuity if they render service under the contract for a period of one year. Importantly, the termination of service resulting from completion of the tenure of fixed-term employment is explicitly excluded from the definition of retrenchment, meaning such employees do not receive retrenchment compensation when their contracts naturally expire.

The Code on Social Security, 2020 and Gratuity Provisions for Fixed-Term Employees

The Code on Social Security, 2020 consolidates nine existing labour laws related to social security, including the Payment of Gratuity Act, 1972. Section 53 of the Code on Social Security, 2020 sets forth the conditions for payment of gratuity, largely replicating the framework of the 1972 Act but with crucial modifications for fixed-term employees. Under Section 53(1), gratuity shall be payable to an employee on the termination of employment after rendering continuous service for not less than five years, upon superannuation, retirement or resignation, death or disablement due to accident or disease, or termination of contract period under fixed-term employment, or upon happening of any event as may be notified by the Central Government[4]. The second proviso to this subsection explicitly states that the completion of continuous service of five years shall not be necessary where the termination of employment of any employee is due to death, disablement, or expiration of fixed-term employment.

Section 53(2) of the Code on Social Security, 2020 provides that for an employee employed on fixed-term employment or a deceased employee, the employer shall pay gratuity on a pro-rata basis. This pro-rata calculation represents a fundamental departure from the traditional gratuity framework, which required completion of five years of service except in cases of death or disability. The practical effect of this provision is that a fixed-term employee who completes even one year of service becomes entitled to receive gratuity proportionate to the period worked. For instance, a fixed-term employee who works for two years would receive gratuity calculated as fifteen days’ wages multiplied by two years divided by twenty-six, without needing to complete the traditional five-year threshold. This change significantly expands the pool of employees eligible for gratuity and imposes additional financial obligations on employers who engage workers on fixed-term contracts. The Code further stipulates that the amount of gratuity payable to an employee shall not exceed such amount as may be notified by the Central Government, though the specific ceiling under the Code remains to be clarified through subordinate legislation.

The Intersection of Two Codes and Regulatory Ambiguity

A significant source of confusion arises from the interaction between the Code on Social Security, 2020 and the Industrial Relations Code, 2020, both of which contain provisions relating to gratuity for fixed-term employees. The Industrial Relations Code, 2020 defines fixed-term employment and explicitly states that such workers will be eligible for gratuity if they complete a one-year contract. Meanwhile, the Code on Social Security, 2020 provides that gratuity is payable on expiration of fixed-term employment on a pro-rata basis, without specifically mentioning a one-year threshold. This apparent discrepancy has led to interpretative challenges regarding whether a fixed-term employee with a contract of less than one year would be entitled to gratuity under the Code on Social Security, 2020[5]. The PRS Legislative Research analysis of the Code on Social Security, 2020 highlighted this inconsistency, noting that the two Bills contain different provisions on gratuity for fixed-term workers and it is unclear whether a fixed-term employee with a contract of less than one year will be entitled to gratuity.

The resolution of this ambiguity likely requires harmonious construction of both Codes, reading them together to give effect to the legislative intent. A reasonable interpretation would suggest that the one-year threshold mentioned in the Industrial Relations Code, 2020 should apply as a minimum qualifying period for fixed-term employees to claim gratuity, while the pro-rata calculation methodology prescribed in the Code on Social Security, 2020 would determine the quantum of payment for those who satisfy the one-year requirement. This interpretation aligns with the overall policy objective of providing social security to fixed-term employees while maintaining some threshold to prevent administrative complexity and excessive compliance burden for very short-term contracts. However, until the Central Government issues clarificatory rules or judicial precedents emerge from disputes arising under these provisions, employers and employees navigate this uncertainty with limited guidance. The Draft Industrial Relations (Central) Rules, 2020 and related subordinate legislation will play a crucial role in resolving these interpretative questions when they are finalized and notified.

Judicial Precedents on Gratuity and Their Relevance to Fixed-Term Employment

While specific judicial pronouncements on gratuity for fixed-term employees under the new Codes are yet to emerge, given their recent implementation, the extensive jurisprudence developed under the Payment of Gratuity Act, 1972 provides valuable guidance for interpreting the new provisions. The Supreme Court’s decision in Indian Hume Pipe Co Ltd v Their Workmen established foundational principles distinguishing gratuity from other forms of compensation. The Court held that gratuity is a kind of retirement benefit akin to provident fund or pension, intended to help employees after retirement whether due to superannuation or physical disability. The judgment emphasized that by length of service, workmen are entitled to claim a certain amount as a retirement benefit, establishing gratuity as a legitimate right rather than an ex gratia payment subject to employer discretion. This precedent remains relevant to understanding gratuity for fixed-term employees, as it establishes that even temporary workers who render service over a period should be entitled to retirement benefits proportionate to their tenure.

The Karnataka High Court’s judgment in Bharat Gold Mines Ltd v Regional Labour Commissioner (1986) addressed the circumstances under which gratuity can be forfeited[6]. The Court examined whether theft, being an offence involving moral turpitude, justified complete forfeiture of gratuity under Section 4(6)(b)(ii) of the Payment of Gratuity Act, 1972. The Court held that when an employee is found guilty of theft, which involves dishonest conduct, it constitutes an offence involving moral turpitude, and the gratuity payable stands wholly forfeited. However, subsequent judicial developments have clarified that forfeiture of gratuity requires adherence to principles of natural justice. Courts have consistently held that before passing an order forfeiting gratuity, whether wholly or partially, the employee must be given notice and an opportunity to be heard. This procedural safeguard ensures that the statutory right to gratuity, once vested, cannot be arbitrarily denied without due process. These principles apply equally to fixed-term employees, protecting them from unjust forfeiture of their pro-rata gratuity entitlements.

Calculation Methodology and Practical Implementation for Fixed-Term Employees

The calculation of gratuity for fixed-term employees follows the same basic formula as permanent employees but with pro-rata adjustment for the shorter service period. Under Section 53 of the Code on Social Security, 2020, gratuity is calculated at the rate of fifteen days’ wages or such number of days as may be notified by the Central Government, based on the rate of wages last drawn by the employee, for every completed year of service or part thereof in excess of six months. For a fixed-term employee who has worked for one year and eight months, the calculation would be as follows: the last drawn monthly wages divided by twenty-six, multiplied by fifteen, multiplied by two years (since eight months exceeds six months and counts as a completed year). For piece-rated employees engaged on fixed-term contracts, the Code provides that daily wages shall be computed on the average of the total wages received for a period of three months immediately preceding the termination of employment, excluding wages paid for overtime work.

Employers engaging fixed-term employees must maintain accurate records of contract periods, wages paid, and service rendered to correctly calculate gratuity obligations. The requirement to pay gratuity on a pro-rata basis means that employers can no longer rely on the five-year threshold to avoid gratuity liability for short-term workers. This change has significant financial implications, particularly for sectors that extensively use fixed-term contracts for project-based work or seasonal operations. From an administrative perspective, employers must implement systems to track fixed-term contract expirations and ensure timely payment of gratuity. Under Section 7 of the Payment of Gratuity Act, 1972, which continues to apply through the Code on Social Security, 2020, the employer must determine the amount of gratuity and pay it within thirty days from the date it becomes payable. Failure to make timely payment attracts interest at the rate notified by the Central Government, and the Controlling Authority can issue recovery certificates to enforce payment through the Collector as arrears of land revenue.

Impact on Employers and Compliance Challenges

The extension of gratuity benefits to fixed-term employees after completion of just one year of service substantially increases the cost of engaging workers on temporary contracts. For small and medium enterprises, which comprise over ninety percent of India’s business establishments and often face constrained cash flows, the mandatory gratuity payments for fixed-term employees add to deferred compensation liabilities that must be provisioned in financial planning. While the policy objective of ensuring social security for all workers is laudable, critics argue that increasing the financial burden on employers may paradoxically discourage formal employment and push businesses toward more informal arrangements. The requirement to maintain parity in wages, allowances, and benefits between fixed-term and permanent employees performing similar work further constrains the cost advantages that employers previously enjoyed through temporary hiring arrangements.

Compliance with the new gratuity provisions requires employers to revise their human resource policies, payroll systems, and financial accounting practices. The Code on Social Security, 2020 mandates that employers issue wage slips to all employees and file returns with authorized officers. For organizations managing large numbers of fixed-term employees with varying contract periods and expiration dates, implementing systems to track gratuity eligibility and calculate pro-rata payments adds administrative complexity. The Draft Rules under the Code on Social Security, 2020 circulated in November 2020 provide detailed procedures for application and payment of gratuity, including prescribed forms for employees to claim their entitlements. Employers must familiarize themselves with these procedural requirements to ensure compliance and avoid penalties for non-payment. The increase in penalties under the new Codes, though accompanied by provisions for compounding certain offences, creates additional compliance risk for organizations that fail to accurately calculate and timely disburse gratuity to fixed-term employees.

Benefits and Protections for Fixed-Term Employees

From the perspective of workers engaged on fixed-term contracts, the new gratuity provisions represent a significant advancement in social security protection. Prior to these reforms, contractual and temporary workers were systematically excluded from gratuity benefits due to the five-year continuous service requirement, despite often performing the same work as permanent employees. The reduction of the eligibility threshold to one year for fixed-term employees recognizes the legitimate expectation that all workers, regardless of their employment status, should receive some form of retirement benefit proportionate to their service. This change particularly benefits workers in industries characterized by project-based employment, such as construction, information technology, and manufacturing sectors where the nature of work does not always permit long-term permanent employment relationships.

The pro-rata calculation method ensures that even workers engaged for relatively short periods receive fair compensation for their service. For example, a fixed-term employee working for two years at a monthly wage of fifty thousand rupees would receive gratuity calculated as follows: fifty thousand divided by twenty-six, multiplied by fifteen, multiplied by two, resulting in approximately fifty-seven thousand six hundred ninety-two rupees. While this amount may seem modest compared to gratuity received by permanent employees with decades of service, it provides meaningful financial support to workers transitioning between jobs or facing unemployment after contract expiration. The mandatory nature of these payments, backed by enforcement mechanisms through Controlling Authorities and appellate forums, ensures that employers cannot arbitrarily deny benefits to fixed-term workers. The statutory framework creates enforceable rights that workers can pursue through labour authorities without depending on employer goodwill or discretion.

Comparative Analysis with Permanent Employment

The new gratuity regime for fixed-term employees achieves near-parity with permanent workers in terms of benefit calculation methodology while maintaining some distinctions based on the temporary nature of the employment relationship. Both categories of employees receive gratuity calculated at fifteen days’ wages per completed year of service. The key difference lies in the qualifying period: permanent employees must complete five years of continuous service, while fixed-term employees become eligible after one year. This differential treatment reflects the legislative recognition that fixed-term contracts by their nature involve shorter tenure and greater job insecurity for workers. However, fixed-term employees do not receive retrenchment compensation when their contracts expire, since contract termination is not classified as retrenchment under the Industrial Relations Code, 2020. This distinction partially offsets the enhanced gratuity entitlement, as permanent employees facing retrenchment receive both statutory retrenchment compensation and gratuity.

Another important distinction relates to job security and conversion to permanent status. Under the previous legal framework, the Industrial Employment Standing Orders Central Rules, 1946 provided for conversion of temporary employees to permanent status after completion of three months of service in certain circumstances. However, the new Codes do not incorporate similar provisions for automatic conversion of fixed-term employees to permanent status upon completion of contract periods[7]. Employers retain the discretion to renew fixed-term contracts or allow them to lapse without creating permanent employment relationships. Critics argue that this flexibility, while beneficial for employers managing workforce fluctuations, creates a category of perpetually temporary workers who receive statutory benefits but lack long-term job security. The absence of limits on the number of times fixed-term contracts can be renewed potentially enables employers to maintain workers in temporary status indefinitely through repeated contract renewals, denying them the enhanced protections and career advancement opportunities associated with permanent employment.

Future Outlook and Policy Considerations

The implementation of gratuity provisions for fixed-term employees under the new Labour Codes represents an ongoing experiment in balancing worker welfare with employer flexibility in India’s evolving labour market. As businesses and workers adapt to these new requirements, several policy considerations warrant attention. The Central Government must issue clear and comprehensive rules clarifying ambiguities in the interaction between the Code on Social Security, 2020 and the Industrial Relations Code, 2020, particularly regarding the minimum qualifying period for gratuity eligibility. The Draft Rules under both Codes should harmonize provisions to eliminate interpretative disputes and provide certainty to stakeholders. Additionally, the government should consider establishing sector-specific guidelines recognizing that different industries face distinct challenges in managing fixed-term employment relationships.

From a broader policy perspective, the extension of gratuity to fixed-term employees aligns with international labour standards emphasizing equal treatment for all workers regardless of employment status. The International Labour Organization has consistently advocated for eliminating discrimination between temporary and permanent workers in access to social security benefits. However, the effectiveness of these provisions in achieving their intended objectives will depend on robust enforcement mechanisms and adequate resources for labour administration. The appointment of sufficient numbers of Controlling Authorities and Appellate Authorities, along with capacity building for labour officers, will be essential to ensure that fixed-term employees can effectively assert their rights under the new framework. The success of these reforms will ultimately be measured not merely by the statutory provisions enacted, but by the extent to which they translate into tangible improvements in the living standards and economic security of India’s temporary workforce.

Conclusion

The gratuity conundrum for fixed-term employees reflects broader tensions inherent in modern labour regulation: how to protect workers’ rights and ensure social security while maintaining sufficient flexibility for businesses to respond to market dynamics. The Code on Social Security, 2020 and the Industrial Relations Code, 2020 attempt to navigate this challenge by extending gratuity benefits to fixed-term employees on a pro-rata basis after one year of service, while preserving employers’ ability to engage workers on temporary contracts without creating permanent employment relationships. This represents a significant advancement in social security protection for temporary workers, who have historically been excluded from retirement benefits despite performing work equivalent to permanent employees. However, the regulatory framework remains incomplete, with ambiguities in the interaction between the two Codes and pending rules that will shape practical implementation. The coming years will reveal whether this balance struck by the new Labour Codes succeeds in achieving the twin objectives of worker welfare and economic efficiency, or whether further refinements will be necessary to address emerging challenges in India’s dynamic labour market. What remains clear is that the days of treating fixed-term employment as a means to evade statutory obligations have ended, and employers must now factor gratuity costs into their decisions regarding temporary hiring arrangements.

References

[1] Wikipedia. (2025). The Payment of Gratuity Act, 1972. Retrieved from https://en.wikipedia.org/wiki/The_Payment_of_Gratuity_Act,_1972

[2] Indian Kanoon. (1959). Indian Hume Pipe Co. Ltd vs The Workmen And Another. Supreme Court of India. Retrieved from https://indiankanoon.org/doc/1154235

[3] GreytHR. (2025). Industrial Relations Code, 2020. Retrieved from https://www.greythr.com/wiki/acts/industrial-relations-code-2020/

[4] GreytHR. (2025). The Code on Social Security, 2020. Retrieved from https://www.greythr.com/wiki/acts/code-on-social-security-2020/

[5] PRS Legislative Research. (2025). The Code on Social Security, 2020. Retrieved from https://prsindia.org/billtrack/the-code-on-social-security-2020

[6] Indian Kanoon. (1986). Bharath Gold Mines Ltd. vs Regional Labour Commissioner. Karnataka High Court. Retrieved from https://indiankanoon.org/doc/32629/

[7] Centre for Labour Laws. Fixed-Term Employment Under the Industrial Relations Code: Analysing the Legal Flaws and Limitations. National Law Institute University. Retrieved from https://cll.nliu.ac.in/fixed-term-employment-under-the-industrial-relations-code-analysing-the-legal-flaws-and-limitations/