The question of gratuity liability for a contractual employee completing five years of service at a client’s location has no single, straightforward answer. The legal position has been fundamentally altered by the enforcement of the four Labour Codes, which came into force on November 21, 2025. The Contract Labour (Regulation and Abolition) Act, 1970 has been subsumed and repealed by the Occupational Safety, Health and Working Conditions Code, 2020 (OSH Code). The Payment of Gratuity Act, 1972 continues to operate, but its interpretation must now be understood within the new regulatory architecture.
Under the Payment of Gratuity Act, 1972, the primary liability to pay gratuity is cast on the ’employer’ as defined under Section 2(f). This definition points to the person who employs the worker. For a contractual employee, the immediate employer is the contractor who hires, pays, and exercises disciplinary control over the worker. The Act does not create a vicarious liability for a principal employer.
SECTION 55 OF THE OSH CODE: THE FALLBACK LIABILITY PROVISION
Section 55 of the Occupational Safety, Health and Working Conditions Code, 2020 explicitly establishes the principal employer’s liability when the contractor defaults on wage payments. The provision reads:
(1) A contractor shall be responsible for payment of wages to each contract labour employed by him and such wages shall be paid before the expiry of such period as may be prescribed by the appropriate Government.
(2) Every contractor shall make the disbursement of wages referred to in sub-section (1) through bank transfer or electronic mode and inform the principal employer electronically the amount so paid.
(3) In case the contractor fails to make payment of wages referred to in sub-section (1) within the prescribed period or makes short payment, then, the principal employer shall be liable to make payment of the wages in full or the unpaid balance due, as the case may be, to the concerned contract labour employed by the contractor and recover the amount so paid from the contractor either by deduction from any amount payable to the contractor under any contract or as a debt payable by the contractor .
The Ministry of Labour and Employment has reiterated that under Section 55(3) of the OSH Code, the principal employer is responsible for ensuring that contractors pay wages on time . Government directives have also empowered principal employers to directly pay contract workers in cases of inordinate delay by contractors, with provisions for blacklisting and wider debarment action in repeat cases .
THE CRITICAL DISTINCTION: WAGES VS. GRATUITY
The key question that remains unresolved is whether “wages” under Section 55 of the OSH Code includes “gratuity” for the purpose of principal employer fallback liability.
Under the Old CLRA Regime
The Madras High Court in Superintending Engineer, Mettur Thermal Power Station v. Appellate Authority (2012) held that gratuity, being a termination payment required to be paid under law, would constitute ‘wages’ under Section 2(h) of the CLRA. Consequently, by virtue of Section 21(4), the principal employer was liable .
The Bombay High Court in Cummins (I) Limited v. Industrial Cleaning Services & Ors. (January 5, 2017), however, held that a principal employer lacking ‘ultimate control’ over the contractor’s workers does not qualify as an employer under Section 2(f) of the Gratuity Act .
The Definition of “Wages” Under the New Code Regime
Under Section 2(88) of the Code on Social Security, 2020, “wages” is defined inclusively. The definition expressly excludes certain items, including:
Any gratuity payable on the termination of employment
Any retrenchment compensation or other retirement benefit
Any ex gratia payment made on the termination of employmentÂ
This is significant. Since “gratuity” is expressly excluded from the definition of “wages” under the Code on Social Security, it follows that for purposes of Section 55(3) of the OSH Code (which uses the same “wages” definition), gratuity may not fall within the ambit of the principal employer’s fallback liability.
Judicial Divergence Continues
The Calcutta High Court in State Bank of India v. The Appellate Authority (April 16, 2026) categorically rejected the importation of CLRA provisions to impose gratuity liability on a principal employer. The court held that the Payment of Gratuity Act is a complete code with clearly defined definitions of ’employer’ and ’employee’ under Sections 2(e) and 2(f).
The Telangana High Court in Air India v. Appellate Authority (July 7, 2025), however, held that a principal employer cannot escape liability for gratuity payments merely by labeling the arrangement as a works contract .
The Bombay High Court in Indian Institute of Technology, Bombay v. Tanaji Babaji Lad (October 4, 2024) held IIT Bombay liable for gratuity, noting that the workers had served for decades under multiple contractors and that IIT Bombay exercised supervision and control over them .
THE “SHAM CONTRACT” DOCTRINE
The ‘sham contract’ doctrine remains applicable. The Supreme Court in Bhilwara Dugdh Utpadak Sahakari S Ltd. v. Vinod Kumar Sharma (2011) condemned the practice of using contractors as a ‘subterfuge’ to avoid labour law liabilities. The test to determine whether a contract is a sham was laid down in General Manager, (OSD) Bengal Nagpur Cotton Mills v. Bharat Lal: (i) whether the principal employer pays the salary; and (ii) whether the principal employer controls and supervises the work.
THE CODE ON SOCIAL SECURITY, 2020: FIXED-TERM EMPLOYEES
Under Section 53 of the Code on Social Security, 2020, the eligibility requirement for gratuity for Fixed Term Employees (FTEs) has been reduced from five years to one year. Where the employee completes one year of continuous service, gratuity shall be applicable on proportionate basis. The Code defines “fixed term employment” as engagement based on a written contract for a fixed period.
The definition of “employer” under Section 2(27) of the Code explicitly includes a contractor. The definition of “employee” under Section 2(26) includes any person employed by an establishment either directly or through a contractor.
IMPLEMENTATION DELAYS AND STATE RULES
A critical practical consideration is that while the Centre has notified the Labour Codes, most provisions are not yet enforceable on the ground. Labour is a concurrent subject, and states must separately notify and operationalise rules before companies can act on them. Until state notifications are issued, companies continue to follow the old five-year rule, fearing legal ambiguity and compliance risks .
LEGACY FRAMEWORK VS. MODERN CODE REGIME COMPARISON
Parameter
Legacy Framework
Modern Code Regime
Practical Operational Impact
Status of CLRA
Separate statute in force
Repealed and subsumed under OSH Code, 2020
Section 21(4) replaced by Section 55(3)
Principal Employer Fallback Liability
Section 21(4) of CLRA
Section 55(3) of OSH Code for “wages”
Liability exists for wages; gratuity coverage is unresolved
Definition of “Wages”
Section 2(h) of CLRA
Section 2(88) of CSS Code (applied to OSH Code)
Gratuity is expressly excluded from wages definition
Gratuity Eligibility Period
5 years of continuous service
5 years for permanent; fixed-term employees eligible after 1 year under Section 53
Contractors issuing fixed-term contracts face gratuity liability after just one year
Definition of “Employer”
Section 2(f) of Gratuity Act
Section 2(27) of CSS Code includes “contractor”
Liability remains on contractor
Contractor Licensing
Multiple licences under CLRA
Section 47 of OSH Code: single licence, 5-year validity, 50-worker threshold
Simplified licensing for contractors
Core Activity Restriction
Not under Central CLRA
Section 51 of OSH Code prohibits contract labour in core activities
Certain activities must now be performed by direct employees
OPERATIONAL IMPLEMENTATION FRAMEWORK FOR HR & LEGAL TEAMS
Step 1: Understand the New Regulatory Architecture The CLRA has been repealed and its provisions replaced by the OSH Code. Section 55(3) of the OSH Code provides fallback liability for principal employers for “wages.” However, since “gratuity” is expressly excluded from the definition of “wages” under Section 2(88) of the CSS Code, the applicability of Section 55(3) to gratuity remains unresolved and will likely require fresh judicial interpretation.
Step 2: Vendor Contract Restructuring The principal employer must insert an indemnity clause in the service agreement. The clause must explicitly state:
The contractor is the “employer” under the Payment of Gratuity Act and the Code on Social Security, 2020
The contractor shall be solely liable for all statutory dues, including gratuity, provident fund, and ESI
The contractor must produce a certificate of compliance every quarter
The contractor shall indemnify the principal employer against any claim, interest, or penalty arising from non-payment of gratuity
This indemnity should be backed by a performance bank guarantee
Step 3: Assessment of Control and Supervision The principal employer must conduct an internal audit to assess the degree of control and supervision exercised over contract workers. This is the critical factor that courts examine. Key indicators include:
Does the principal employer pay salary or wages directly, even partially?
Does the principal employer have the right to hire, discipline, or terminate the worker?
Does the principal employer supervise and direct the work, or is this done by the contractor’s own supervisors?
Has the worker been engaged for a prolonged period with the same principal employer, even through multiple contractors?
Step 4: Fixed-Term Contract Management Under Section 53 of the CSS Code, fixed-term employees are entitled to proportionate gratuity even if service is less than 5 years. Contractors must factor this into billing. However, with implementation delayed pending state rules, companies continue to follow the old five-year rule.
Step 5: Digital Compliance and the Unified Portal The government’s unified labour portal (Shram Suvidha) is being upgraded to align with the new Codes. Employers (including contractors) must file annual returns. Principal employers must ensure their contractors are “active” on the portal.
PENAL CONSEQUENCES, INSPECTION TRIGGERS, AND CORPORATE LIABILITY
For the Contractor (Immediate Employer)
Penalty:Â Failure to pay gratuity within 30 days attracts interest under Section 7(3A) of the Gratuity Act
Prosecution:Â Non-payment can lead to prosecution under the Gratuity Act, with potential imprisonment for up to 2 years and a fine
Inspection Trigger:Â Complaints from workers, failure to file statutory returns, or random sampling by the labour department
For the Principal Employer (Client)
Fallback Liability:Â Section 55(3) of OSH Code for “wages”; coverage of gratuity unresolved
“Sham Contract” Liability:Â If the contract is deemed a sham, the principal employer is treated as the direct employer, making it liable for all statutory dues
Liability of Directors/Occupiers:Â Under the Gratuity Act, directors and persons in charge can be prosecuted in “sham contract” scenarios
STRATEGIC ADVISORY
The Calcutta High Court View (2026) clarified that the Payment of Gratuity Act does not permit imposition of gratuity liability on a principal employer in the absence of a direct employment relationship.
The Telangana High Court (2025) held that a principal employer cannot escape liability merely by labeling the arrangement as a works contract, particularly when workers had been continuously employed for years .
The Bombay High Court (2024) held IIT Bombay liable for gratuity, noting that the workers had served for decades under multiple contractors and that IIT Bombay exercised supervision and control over them .
The Madras High Court view (2012) that gratuity constitutes “wages” under the CLRA is now of limited relevance, as the CLRA has been repealed and replaced by the OSH Code with a new definition of “wages.”
Disclaimer: This guide constitutes statutory commentary and operational analysis based on notifications published up to the current date in 2026. The legal position regarding the liability of principal employers for gratuity is subject to judicial interpretation and varies across High Courts. The Labour Codes came into force on November 21, 2025, but state rules are being progressively notified. The applicability of Section 55(3) of the OSH Code to gratuity remains unresolved and will require judicial interpretation. This document does not replace formal lawyer-client counsel. You are strongly advised to seek specific legal advice tailored to your contractual arrangements, operational model, and the jurisdiction of your establishment before implementing any compliance strategy. The firm assumes no liability for actions taken based on this analysis.
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Principal Employer Gratuity Liability for Contract Workers: Legal Analysis 2026
STATUTORY GENESIS & CURRENT LEGAL POSTURE
The question of gratuity liability for a contractual employee completing five years of service at a client’s location has no single, straightforward answer. The legal position has been fundamentally altered by the enforcement of the four Labour Codes, which came into force on November 21, 2025. The Contract Labour (Regulation and Abolition) Act, 1970 has been subsumed and repealed by the Occupational Safety, Health and Working Conditions Code, 2020 (OSH Code). The Payment of Gratuity Act, 1972 continues to operate, but its interpretation must now be understood within the new regulatory architecture.
Under the Payment of Gratuity Act, 1972, the primary liability to pay gratuity is cast on the ’employer’ as defined under Section 2(f). This definition points to the person who employs the worker. For a contractual employee, the immediate employer is the contractor who hires, pays, and exercises disciplinary control over the worker. The Act does not create a vicarious liability for a principal employer.
SECTION 55 OF THE OSH CODE: THE FALLBACK LIABILITY PROVISION
Section 55 of the Occupational Safety, Health and Working Conditions Code, 2020 explicitly establishes the principal employer’s liability when the contractor defaults on wage payments. The provision reads:
(1) A contractor shall be responsible for payment of wages to each contract labour employed by him and such wages shall be paid before the expiry of such period as may be prescribed by the appropriate Government.
(2) Every contractor shall make the disbursement of wages referred to in sub-section (1) through bank transfer or electronic mode and inform the principal employer electronically the amount so paid.
(3) In case the contractor fails to make payment of wages referred to in sub-section (1) within the prescribed period or makes short payment, then, the principal employer shall be liable to make payment of the wages in full or the unpaid balance due, as the case may be, to the concerned contract labour employed by the contractor and recover the amount so paid from the contractor either by deduction from any amount payable to the contractor under any contract or as a debt payable by the contractor .
The Ministry of Labour and Employment has reiterated that under Section 55(3) of the OSH Code, the principal employer is responsible for ensuring that contractors pay wages on time . Government directives have also empowered principal employers to directly pay contract workers in cases of inordinate delay by contractors, with provisions for blacklisting and wider debarment action in repeat cases .
THE CRITICAL DISTINCTION: WAGES VS. GRATUITY
The key question that remains unresolved is whether “wages” under Section 55 of the OSH Code includes “gratuity” for the purpose of principal employer fallback liability.
Under the Old CLRA Regime
The Madras High Court in Superintending Engineer, Mettur Thermal Power Station v. Appellate Authority (2012) held that gratuity, being a termination payment required to be paid under law, would constitute ‘wages’ under Section 2(h) of the CLRA. Consequently, by virtue of Section 21(4), the principal employer was liable .
The Bombay High Court in Cummins (I) Limited v. Industrial Cleaning Services & Ors. (January 5, 2017), however, held that a principal employer lacking ‘ultimate control’ over the contractor’s workers does not qualify as an employer under Section 2(f) of the Gratuity Act .
The Definition of “Wages” Under the New Code Regime
Under Section 2(88) of the Code on Social Security, 2020, “wages” is defined inclusively. The definition expressly excludes certain items, including:
This is significant. Since “gratuity” is expressly excluded from the definition of “wages” under the Code on Social Security, it follows that for purposes of Section 55(3) of the OSH Code (which uses the same “wages” definition), gratuity may not fall within the ambit of the principal employer’s fallback liability.
Judicial Divergence Continues
The Calcutta High Court in State Bank of India v. The Appellate Authority (April 16, 2026) categorically rejected the importation of CLRA provisions to impose gratuity liability on a principal employer. The court held that the Payment of Gratuity Act is a complete code with clearly defined definitions of ’employer’ and ’employee’ under Sections 2(e) and 2(f).
The Telangana High Court in Air India v. Appellate Authority (July 7, 2025), however, held that a principal employer cannot escape liability for gratuity payments merely by labeling the arrangement as a works contract .
The Bombay High Court in Indian Institute of Technology, Bombay v. Tanaji Babaji Lad (October 4, 2024) held IIT Bombay liable for gratuity, noting that the workers had served for decades under multiple contractors and that IIT Bombay exercised supervision and control over them .
THE “SHAM CONTRACT” DOCTRINE
The ‘sham contract’ doctrine remains applicable. The Supreme Court in Bhilwara Dugdh Utpadak Sahakari S Ltd. v. Vinod Kumar Sharma (2011) condemned the practice of using contractors as a ‘subterfuge’ to avoid labour law liabilities. The test to determine whether a contract is a sham was laid down in General Manager, (OSD) Bengal Nagpur Cotton Mills v. Bharat Lal: (i) whether the principal employer pays the salary; and (ii) whether the principal employer controls and supervises the work.
THE CODE ON SOCIAL SECURITY, 2020: FIXED-TERM EMPLOYEES
Under Section 53 of the Code on Social Security, 2020, the eligibility requirement for gratuity for Fixed Term Employees (FTEs) has been reduced from five years to one year. Where the employee completes one year of continuous service, gratuity shall be applicable on proportionate basis. The Code defines “fixed term employment” as engagement based on a written contract for a fixed period.
The definition of “employer” under Section 2(27) of the Code explicitly includes a contractor. The definition of “employee” under Section 2(26) includes any person employed by an establishment either directly or through a contractor.
IMPLEMENTATION DELAYS AND STATE RULES
A critical practical consideration is that while the Centre has notified the Labour Codes, most provisions are not yet enforceable on the ground. Labour is a concurrent subject, and states must separately notify and operationalise rules before companies can act on them. Until state notifications are issued, companies continue to follow the old five-year rule, fearing legal ambiguity and compliance risks .
LEGACY FRAMEWORK VS. MODERN CODE REGIME COMPARISON
OPERATIONAL IMPLEMENTATION FRAMEWORK FOR HR & LEGAL TEAMS
Step 1: Understand the New Regulatory Architecture
The CLRA has been repealed and its provisions replaced by the OSH Code. Section 55(3) of the OSH Code provides fallback liability for principal employers for “wages.” However, since “gratuity” is expressly excluded from the definition of “wages” under Section 2(88) of the CSS Code, the applicability of Section 55(3) to gratuity remains unresolved and will likely require fresh judicial interpretation.
Step 2: Vendor Contract Restructuring
The principal employer must insert an indemnity clause in the service agreement. The clause must explicitly state:
Step 3: Assessment of Control and Supervision
The principal employer must conduct an internal audit to assess the degree of control and supervision exercised over contract workers. This is the critical factor that courts examine. Key indicators include:
Step 4: Fixed-Term Contract Management
Under Section 53 of the CSS Code, fixed-term employees are entitled to proportionate gratuity even if service is less than 5 years. Contractors must factor this into billing. However, with implementation delayed pending state rules, companies continue to follow the old five-year rule.
Step 5: Digital Compliance and the Unified Portal
The government’s unified labour portal (Shram Suvidha) is being upgraded to align with the new Codes. Employers (including contractors) must file annual returns. Principal employers must ensure their contractors are “active” on the portal.
PENAL CONSEQUENCES, INSPECTION TRIGGERS, AND CORPORATE LIABILITY
For the Contractor (Immediate Employer)
For the Principal Employer (Client)
STRATEGIC ADVISORY
The Calcutta High Court View (2026) clarified that the Payment of Gratuity Act does not permit imposition of gratuity liability on a principal employer in the absence of a direct employment relationship.
The Telangana High Court (2025) held that a principal employer cannot escape liability merely by labeling the arrangement as a works contract, particularly when workers had been continuously employed for years .
The Bombay High Court (2024) held IIT Bombay liable for gratuity, noting that the workers had served for decades under multiple contractors and that IIT Bombay exercised supervision and control over them .
The Madras High Court view (2012) that gratuity constitutes “wages” under the CLRA is now of limited relevance, as the CLRA has been repealed and replaced by the OSH Code with a new definition of “wages.”
Disclaimer: This guide constitutes statutory commentary and operational analysis based on notifications published up to the current date in 2026. The legal position regarding the liability of principal employers for gratuity is subject to judicial interpretation and varies across High Courts. The Labour Codes came into force on November 21, 2025, but state rules are being progressively notified. The applicability of Section 55(3) of the OSH Code to gratuity remains unresolved and will require judicial interpretation. This document does not replace formal lawyer-client counsel. You are strongly advised to seek specific legal advice tailored to your contractual arrangements, operational model, and the jurisdiction of your establishment before implementing any compliance strategy. The firm assumes no liability for actions taken based on this analysis.