Retrenchment compensation under the IR Code: rules and example

Retrenchment compensation under the Industrial Relations Code, 2020 is 15 days' average pay for every completed year of continuous service, or any part of a year above six months, payable to a worker with at least one year of continuous service. The worker must also get one month's written notice or wages in lieu (three months in establishments with 300 or more workers, which also need prior government permission). On top of that, the employer contributes 15 days' last drawn wages to the worker reskilling fund.

This guide explains how retrenchment differs from lay-off and closure, how to calculate compensation, the notice and permission rules by establishment size, and how it all lands in the full and final settlement. For the settlement mechanics, see our full and final settlement guide, and for the wider Labour Code picture, our summary of the four labour codes.

Retrenchment vs lay-off vs closure: what is the difference?

	Retrenchment	Lay-off	Closure
What it is	Termination of a worker's service by the employer for any reason, other than the exclusions below	Temporary inability to give work (for example shortage of raw material, power or orders, or a breakdown), while the worker stays on the rolls	Permanent closing of a place of employment or part of it
Employment	Ends	Continues	Ends
Worker's payment	Retrenchment compensation, plus notice or wages in lieu	Lay-off compensation for the days laid off	Closure compensation, plus notice or wages in lieu
Typical trigger	Surplus staff, restructuring, automation	Short-term disruption	Shutting a unit or line

What is not retrenchment?

The IR Code excludes these from retrenchment, so no retrenchment compensation is payable:

• Voluntary retirement.
• Retirement on reaching the age of superannuation under the contract.
• Non-renewal of a contract on its expiry, or termination under a stipulation in the contract.
• Termination on the ground of continued ill-health.
• Completion of the tenure of fixed term employment; see our guide to fixed term employment.
• Termination as a punishment inflicted by way of disciplinary action, after a proper domestic enquiry.

Everything else that ends a worker's service at the employer's instance, including "position eliminated" and "role made redundant" exits, is retrenchment, whatever the letter calls it.

Who is entitled to retrenchment compensation?

Two conditions:

1. The person is a worker under the IR Code. People employed mainly in a managerial or administrative capacity, and supervisors drawing wages above ₹18,000 a month (or a higher notified amount), are outside the definition. Their severance is whatever the contract or company policy provides.
2. At least one year of continuous service. The Code has rules on what counts as continuous service, broadly treating a worker as in continuous service for a year if they actually worked a minimum number of days in the preceding twelve months (240 days for most establishments). Check the exact rule for your establishment.

How is retrenchment compensation calculated?

The formula is:

Compensation = 15 days' average pay × completed years of continuous service, where a part of a year above six months counts as a full year.

Three inputs need care:

• Average pay. For a monthly-paid worker, it is the average of wages over the three complete calendar months before retrenchment (shorter reference periods apply for weekly and daily-paid workers). "Wages" uses the single definition under the Codes, including the 50% add-back, so a low-Basic structure produces a higher base than payroll may expect. Our guide to the 50% wage rule shows how.
• 15 days' pay. The Code does not fix the divisor. Many employers use 26, following the gratuity convention for monthly-paid staff; others use 30. Use 26 unless advised otherwise, document the choice and apply it consistently.
• Rounding of service. 7 years and 7 months counts as 8 years. 7 years and 6 months counts as 7.

Worked example: retrenchment in a 180-worker plant

A machine operator is retrenched from a plant with 180 workers, so prior permission is not needed. Service is 7 years and 8 months. Average wages over the last three complete months, and last drawn wages, are ₹36,000 a month.

1. Completed years: 7, plus 8 months (above six) = 8 years.
2. Daily rate: ₹36,000 ÷ 26 = ₹1,384.62.
3. Fifteen days' average pay: ₹1,384.62 × 15 = ₹20,769.23.
4. Retrenchment compensation: ₹20,769.23 × 8 = ₹1,66,154.
5. Notice: one month's wages in lieu, as the employer releases the worker immediately: ₹36,000.
6. Reskilling fund contribution, paid by the employer to the fund: 15 days' last drawn wages = ₹20,769.

With a 30-day divisor, step 4 would give ₹36,000 ÷ 30 × 15 × 8 = ₹1,44,000, which is ₹22,154 less. That gap is why the divisor must be a documented decision.

The employer's cash cost for this exit is ₹1,66,154 + ₹36,000 + ₹20,769 = ₹2,22,923, before gratuity, leave encashment and the final month's salary.

What notice and permission does the IR Code require?

Establishment size (workers)	Lay-off	Retrenchment	Closure
Fewer than 50	Lay-off compensation provisions generally do not apply	One month's notice or wages in lieu, compensation, notice to the government	Closure compensation
50 to 299	Lay-off compensation payable	One month's notice or wages in lieu, compensation, notice to the government	At least 60 days' notice to the government, plus closure compensation
300 or more (or as notified)	Prior permission of the government	Three months' notice or wages in lieu, prior permission, compensation	Prior permission applied for at least 90 days in advance, plus closure compensation

The 300 threshold, up from 100 under the Industrial Disputes Act, 1947, is the biggest single change here; the appropriate government can notify a different number. Seasonal establishments and some categories are treated differently, and the notice to the government follows the prescribed form. Verify the rules for your state before you act.

Lay-off compensation

A laid-off worker who is not a badli or casual worker and has a year of continuous service gets 50% of basic wages and dearness allowance for each day of lay-off, other than weekly holidays. Compensation is limited to 45 days in a twelve-month period unless there is an agreement otherwise, and where lay-off continues beyond that, the employer may retrench, adjusting lay-off compensation paid in the preceding twelve months. Check the precise conditions in the Code.

Closure compensation

On closure, a worker with a year of continuous service gets compensation on the same 15-day formula, plus notice or wages in lieu. Where the closure is due to unavoidable circumstances beyond the employer's control, the Code limits compensation in some cases; take advice rather than assuming the cap applies.

What is the worker reskilling fund?

The IR Code creates a worker reskilling fund. On retrenchment, the employer contributes an amount equal to 15 days' wages last drawn by the worker. The Code provides for the amount to reach the retrenched worker, broadly within 45 days of retrenchment, for reskilling. How the contribution is deposited, and through which portal, is set by the rules, and implementation has been uneven. Budget for it in every retrenchment and confirm the current deposit process with the Ministry of Labour and Employment or your state labour department.

What procedure must the employer follow?

1. Identify the category and the surplus, with documented business reasons.
2. Apply last come, first go within the category, unless there are recorded reasons for departing from it.
3. Seek prior permission if the establishment has 300 or more workers.
4. Serve notice on the worker, with reasons, and on the government in the prescribed form.
5. Pay compensation at the time of retrenchment, and wages due within two working days under the Code on Wages; our guide to wage payment deadlines explains the rule.
6. Deposit the reskilling fund contribution.
7. Offer re-employment preference if you hire into the category within the period the Code specifies.

Skipping notice or compensation can make the retrenchment invalid, with reinstatement and back wages as the risk.

How does retrenchment flow into the full and final settlement?

Component	Treatment
Salary to the last working day	As usual, with PF, ESI, PT and LWF
Notice pay in lieu	Wages for the notice period
Retrenchment compensation	Separate line, not part of wages under the Codes' definition
Gratuity	If eligible, on last drawn wages
Leave encashment	As per policy and law
Reskilling fund	Employer deposit, not paid through the payslip

On tax, retrenchment compensation has long had an exemption up to the lower of the actual amount, the amount under the statutory formula, and ₹5,00,000. Section numbers changed under the Income-tax Act, 2025, so confirm the current provision on the Income Tax Department website before computing TDS. Our full and final calculator and notice period calculator help with the other components.

Common mistakes

• Calling a retrenchment a "mutual separation" without a genuine voluntary choice.
• Leaving out part-years above six months.
• Using Basic alone as average pay, ignoring the Codes' wage definition.
• Forgetting the reskilling fund contribution.
• Treating supervisors under ₹18,000 as managers outside the Code.
• Paying compensation weeks after the exit instead of at the time of retrenchment.

FAQs

How is retrenchment compensation calculated? Fifteen days' average pay for every completed year of continuous service, with any part above six months counted as a year.

Is prior permission needed for retrenchment? Only in industrial establishments with 300 or more workers, or a different number the appropriate government notifies.

What is the notice period for retrenchment? One month's written notice or wages in lieu; three months in establishments with 300 or more workers.

Is retrenchment compensation taxable? It is exempt up to a limit, long set at ₹5,00,000 subject to the statutory formula. Confirm the current provision under the Income-tax Act, 2025.

Do managers get retrenchment compensation? Not under the IR Code, as they are not workers. Their severance depends on the contract and company policy.

How NeevHR helps

NeevHR exit management runs the separation from approval to clearance, with severance and F&F rules configured by exit type. The full and final settlement worksheet brings severance, gratuity, leave encashment, notice pay and final-month statutory deductions together and posts them to a full and final payroll run. To walk through a restructuring scenario with your own data, book a demo.

This article provides general information for educational purposes. Statutory rules, thresholds, rates and filing requirements may change; verify with the relevant authority or a qualified professional. Last reviewed: 27 Oct 2026.