Employee Termination in India: Settlement Timelines, Retrenchment Rules, and Employer Compliance

March 24, 2026 Posted by India Briefing Written by Tom Sedzro and Archana Rao Reading Time: 7 minutes

With the nationwide implementation of the four labor codes and the Income Tax Act, 2025, we examine the evolving regulatory framework governing employee termination in India. In this article, we provides global investors with a clear and timely overview of retrenchment rules, settlement timelines, and employer compliance obligations under the new regime.

Employee termination in India has become a more structured compliance exercise under the country’s new labor-code regime. Since the four labor codes took effect on November 21, 2025, employers must treat termination not merely as an HR decision, but as a multi-layered process involving legal review, payroll coordination, statutory compliance, and documentation.

In practice, businesses must first classify the nature of an employee exit; whether resignation, dismissal, fixed-term contract expiry, or retrenchment, before applying the relevant notice requirements, compensation rules, and settlement procedures. Compliance obligations may still vary depending on the type of establishment and the applicable central or state rules, making contextual legal assessment critical.

Regulatory framework governing employee termination in 2026

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For companies operating in India, it is essential to understand how the new regime differs from India’s earlier fragmented labor-law framework, which is increasingly important for employers seeking to manage terminations lawfully and reduce dispute, penalty, and business-continuity risks. In practice, however, compliance can still vary by establishment type and by applicable central or state rules.

India’s Four Labor Codes and Their Relevance to Employee Termination
Labor code	What it regulates	Why it matters for termination
Code on Wages, 2019	Wage definitions, payment of wages, and permitted deductions	Governs exit wage timing, final wage calculations, and the two-working-day rule for wages due on resignation, dismissal, retrenchment, or closure-linked unemployment
Industrial Relations Code, 2020	Industrial disputes, standing orders, trade unions, lay-off, retrenchment, and closure	Sets the main termination rules for retrenchment, notice, compensation, prior-permission thresholds, and dispute exposure
Code on Social Security, 2020	Gratuity, provident fund, employee state insurance, and other social security benefits	Matters for post-exit gratuity and related benefit obligations, including timing for gratuity payment
Occupational Safety, Health and Working Conditions Code, 2020	Working conditions, hours, leave, contractor licensing, registers, and workplace safety	Less directly about dismissal, but still relevant for contractor establishments, records, compliance, and establishment-level obligations

Alongside these central codes, state-level Shops and Establishments (S&E) Acts continue to influence termination outcomes, particularly for commercial establishments.

What constitutes as an employee termination

The labor codes do not define termination in a single, consolidated provision. Instead, they adopt a broad approach that captures multiple forms of employment exit. These include:

Resignation initiated by the employee,
Dismissal or discharge based on misconduct,
Retrenchment driven by business or economic reasons,
Retirement outside of superannuation, and
Expiry of fixed-term contracts.

Classification of termination types

Under the IR framework, employee termination in India is structured into distinct legal categories, each with different consequences.

Retrenchment applies where termination arises from business or economic considerations rather than misconduct. In such cases, employers must provide notice or wages in lieu of notice, along with statutory compensation. For larger establishments employing 300 or more workers, retrenchment also requires prior government approval and longer notice periods.

Dismissal or discharge, by contrast, is linked to employee misconduct. Here, the focus shifts to procedural fairness. Employers must conduct a domestic inquiry and adhere to principles of natural justice. Unlike retrenchment, such cases typically do not trigger statutory compensation.

Fixed-term employment operates differently. Termination occurs automatically upon contract expiry, without the need for notice, provided the terms are clearly defined. However, an important shift under the new regime is that gratuity becomes payable even if the employee has not completed five years of service.

Voluntary exits, including resignation and early retirement, are primarily governed by contractual terms and internal company policies, though statutory dues still apply where relevant.

Notice, final settlement, and statutory dues

Termination activates a series of financial obligations that must be handled within strict timelines. One of the most significant changes under the new regime is the emphasis on speed. Wages payable upon exit, whether due to resignation, dismissal, retrenchment, or closure, must generally be settled within two working days.

Notice requirements, however, are not uniform. In standard retrenchment cases, one month’s notice or wages in lieu is typically required.

Termination Notice and Final Settlement Under India’s New Labor Codes
Item	What the new protocols say
Exit wages	Wages payable on resignation, dismissal, retrenchment, or closure-linked unemployment must be paid within 2 working days
Notice period/notice pay	There is no single universal notice period for every termination; ordinary retrenchment requires 1 month’s notice or wages in lieu, while covered larger establishments require 3 months’ notice or wages in lieu plus prior permission
Retrenchment compensation	In ordinary retrenchment, compensation is 15 days’ average pay for every completed year of service, or part above six months
Re-skilling fund	For retrenched workers, the employer must contribute an amount equal to 15 days’ last drawn wages to the worker re-skilling fund. The fund must credit that amount to the worker within 45 days of retrenchment.
Gratuity	Gratuity must be paid within 30 days from the date it becomes payable; delay can trigger simple interest, subject to the statutory exception
Allowances and leave encashment	The cited central code provisions do not set one single universal exit deadline for all allowance and leave-encashment items
Tax and other deductions	Final deductions must remain within the categories permitted by law

Retrenchment rules and workforce restructuring obligations

Under India’s new labor-code regime, retrenchment remains a distinct legal category rather than a catch-all term for any employee exit. The Code also preserves related protections around last-in-first-out retrenchment in the absence of an agreement and preferential re-employment of retrenched workers if hiring resumes within one year.

The rules become stricter for establishments covered by Chapter X of the Industrial Relations Code. That chapter applies to certain industrial establishments, specifically factories, mines, and plantations, with 300 or more workers on average per working day in the preceding 12 months.

Compliance Thresholds for Large Establishments Covered Under IR Code
Parameter	Requirement	Applicability
Worker threshold	300 or more workers	Factories, mines, plantations
Retrenchment notice	3 months or wages in lieu	Chapter X
Government approval	Mandatory	Retrenchment, lay-off, closure
Closure notice	90 days prior	Large establishments
Standing orders	Mandatory	≥300 workers

Workforce restructuring can also trigger the Code’s notice of change rules: if an employer proposes to alter service conditions on matters listed in the Third Schedule, it must give notice and generally wait 21 days before implementing the change.

Income compensation on employee termination

The labor codes create a clear distinction between statutory and contractual compensation.

Statutory compensation

Retrenchment compensation
Lay-off compensation (typically 50 percent of wages + DA)
Closure compensation

Contractual compensation

Notice pay
Ex-gratia or severance packages
Additional benefits as per employment agreements

A key principle under the Industrial Relations Code, 2020 is that termination is legally valid only when both procedural compliance and compensation obligations are fulfilled.

Role of Shops and Establishments Acts in severance

While central labor codes define the core structure of termination, state-level Shops and Establishments laws play a critical supporting role, particularly for commercial establishments.

These laws do not define severance as a standalone concept. Instead, they influence key components such as notice periods, wage settlement timelines, and leave encashment. In many states, they prescribe minimum notice requirements and mandate payment in lieu of notice where applicable. They also reinforce the obligation to settle all wages and accrued benefits promptly upon termination.

Leave encashment is another area where these laws are significant, as they typically require employers to compensate employees for unused earned leave at the time of exit.

Tax treatment of employee termination compensation

The taxation of termination payouts is governed separately under the income tax act, 2025, which determines how these payments are treated in the hands of employees.

Most termination-related payments are taxed as salary or profits in lieu of salary. However, certain components benefit from exemptions.

Tax Treatment Overview
Component	Tax treatment	Exemption
Gratuity	Partially exempt	Up to INR 2 million
Retrenchment compensation	Partially exempt	Up to INR 500,000
VRS compensation	Exempt	Up to INR 500,000
Leave encashment	Partially exempt	Yes
Notice pay	Fully taxable	No
Ex-gratia	Fully taxable	No

Employees receiving large lump-sum payments may also claim income-spreading relief, which helps mitigate the impact of progressive tax rates.

A key distinction to remember is that labor law determines what must be paid, while tax law determines how those payments are taxed.

Procedural requirements and documentation

Procedural compliance is equally critical. Employers must issue proper notices, follow due process in disciplinary cases, and obtain approvals where required. Documentation should include termination letters, settlement statements, payment records, and employee acknowledgments.

Tax compliance adds another layer, requiring deduction of tax deducted at source (TDS), issuance of Form 130 under Income Tax Rules, 2026 (formerly known as Form 16— Annual TDS certificate), and maintenance of supporting records.

CLICK HERE: Year Zero: Why India’s Income-tax Rules 2026 Demand an Urgent Payroll Audit

Legal exposure for non-compliant terminations in India

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The compliance risk from a defective termination is not limited to retrenchment penalties. The Industrial Relations Code prohibits unfair labor practices, provides a formal pathway through conciliation officers and industrial tribunals, and gives tribunals power to grant meaningful remedies where a discharge, dismissal, or other termination is found unjustified. In those cases, a tribunal may set aside the termination, order reinstatement, or award other relief, including a lesser punishment. The Code also allows recovery of money due from the employer under settlements, awards, or retrenchment-related chapters through the appropriate government and collector machinery.

Legal Risks for Non-Compliant Terminations Under New Labor Codes
Risk area	What it means
Chapter X retrenchment and closure violations	Breaches of the prior-permission regime can trigger fines of INR 100,000 to INR 1 million. Repeat violations can rise to INR 500,000 to INR 2 million, with possible imprisonment of up to six months.
General retrenchment violations	Breaches of the general retrenchment rules can trigger fines of INR 50,000 to INR 200,000. Repeat violations can rise to INR 100,000 to INR 500,000, with possible imprisonment of up to six months.
Unfair labor practices	Unfair labor practices can trigger fines of INR 10,000 to INR 200,000. Repeat violations can rise to INR 50,000 to INR 500,000, with possible imprisonment of up to three months.
Wage-settlement non-compliance	Wages payable on resignation, dismissal, retrenchment, or closure-related unemployment must generally be paid within two working days. Non-compliance can lead to claims, enforcement action, and penalties.
Misconduct process failures	Where Chapter IV on standing orders applies, meaning industrial establishments with 300 or more workers, disciplinary proceedings linked to suspension should ordinarily be completed within 90 days, and subsistence allowance must be paid during suspension.

Key takeaways

Under the new labor-code regime, employee termination in India has become a time-sensitive compliance issue that requires employers to align legal procedure, payroll processing, and internal documentation before ending an employment relationship. The obligations also vary depending on the nature of the exit, whether it involves resignation, dismissal, fixed-term contract expiry, retrenchment, or closure-related separation.

For businesses, the main challenge is not only determining the correct termination route, but also ensuring that wage payments, compensation, statutory dues, and supporting records are handled within the required timelines. In practice, this means companies should adopt a structured termination checklist that brings together HR, legal, payroll, and finance functions. As India’s labor-law framework and new income tax framework enters its first full year of implementation, employers that fail to follow the prescribed process may face disputes, payment claims, penalties, and wider operational and reputational risks.

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