Proposed Reforms to the Payment of Gratuity Act, 1972

Introduction

The roots of the term gratuity can be traced to the French word gratuité or from the Latin term gratuitus, both the terms loosely mean the voluntary payment of money for favour or services. At its most basic level, payment of gratuity is a sum tendered to employees following longevity of service and is generally paid towards their retirement fund. In foreign countries it is also used synonymously with tipping, however, in India it is the former definition that prevails.

The Payment of Gratuity Act, 1972 brought in a mandatory requirement for employers to pay gratuity to employees at the time of their retirement. At the time of its enactment, several state governments had brought in similar measures in their respective states. Thus, the enactment of a central law aimed to introduce uniformity to avoid dissimilar treatment to workers in similar circumstances, for example workers of one undertaking that has establishments in different states. The Act is one of nine laws being subsumed in the draft Code on Social Security bill that has been tabled for discussion during Parliament’s Monsoon session.

Reforms to Payment of Gratuity Act, 1972

The first noticeable change under the Code is the addition of two extra clauses to the provision on payment of gratuity. While Section-4 of the soon to be erstwhile Act provided for superannuation, retirement/resignation and death/disablement as conditions that triggered payment of gratuity, Section-53 of the Code has added two additional clauses. The first makes fixed term employees eligible to receive gratuity on termination of their contract period and the second is an enabling provision that allows the central government to notify events that can make one eligible for gratuity. The proviso to sub-clause (2) of Section-53 specifies that the amount of gratuity to be paid to an employee employed on a fixed-term basis shall be provided on pro rata basis.

There is also talk of a proposal to reduce the period of eligibility for gratuity payments from 5 years to 1 year. The government has hinted at this proposal as a part of the Code on Social Security.

Problem Areas and Potential Reforms

While the reform efforts being undertaken by the government are commendable, there are areas that need to be addressed for reforms to be effective. One such area is the way companies fund their payment of gratuity to employees. As per Section-4A of the Act and Section-57 of the draft Code, employers are required to procure an insurance towards their liability for gratuity. An exemption may be provided to employers who have set up an approved gratuity fund. Nevertheless, this increases the cost of compliance considerably for employers and the government must consider alternate means of funding gratuity payments [s21].

One possible way of ensuring that the cost of compliance remains low while employees’ interests are protected is by providing different thresholds for acquiring insurance based on the size of companies either in terms of number of employees or the number of establishments in different States.

Another area that potentially poses problems is the proposal to reduce the period of eligibility for payment of gratuity from five years to one year. This is fundamentally opposed to the philosophy behind gratuity in the Indian context as gratuity is seen as a payment towards longevity of service. From a legal perspective it creates issues as compliance needs change drastically and the object of the Act is somewhat diluted. The incentive for employers to provide gratuity is to retain employees who have rendered five years of continuous service [s22] .

This proposal seems to place weight on the monetary benefits for an employee at the cost of the mutual benefits that come with long-term association between an employer and the employee. High rates of attrition are already a problem for several businesses and removing the one incentive for longevity will not help the same. Furthermore, it will only increase rent-seeking behaviour as individuals will work until they become eligible for the benefit only to leave after the same. This erodes the mutual trust between employer and employee and fails to account for the mutual benefits of long-term association.

It is very often the case that an employee takes one year to become fully productive in a new job as it takes time for an individual to grasp the different aspects of a company’s workflow, work ethic and office culture. This is especially true in the case of freshers who often take time to find their footing in a professional setting.

The above may also act as a disincentive to formalization as employers choose to employ unorganised workers who do not incur these costs, thereby bringing their cost of compliance down. This is an outcome that is counterproductive when seen in light of the government’s concerted efforts to promote formalization.

Will the reduction of eligibility period for payment of gratuity from 5 years to 1 year achieve the desired objective? What in your opinion should be the changes made to the scheme of gratuity under the draft Code on Social Security, 2019?

Drop your thoughts in the comments below.

Disclaimer: This blog is meant for informational purposes and discussion only. It contains only general information about legal matters. The information provided is not legal advice and should not be acted upon without seeking proper legal advice from a practicing attorney. Simpliance makes no representations or warranties in relation to the information on this article.