Retrenchment Compensation for Broken Service 2026 Guide

The Short Answer

Under the Industrial Relations Code, 2020, broken service periods are resolved through a strict deeming fiction: the 240-day rule for standard establishments, or the 75% operating days test for seasonal businesses. If an employee meets the applicable threshold within a 12-month block, that year legally qualifies as one completed year of continuous service. The employer must pay 15 days of average pay for each qualifying year, calculated using actual calendar days rather than the 26-day gratuity divisor.

The Legal Framework: Defining Continuous Service

Section 70 of the Industrial Relations Code, 2020 (IR Code), which replaced Section 25F of the Industrial Disputes Act, 1947 (IDA) upon implementation on November 21, 2025, mandates that employers pay retrenchment compensation equivalent to 15 days of average pay for every completed year of continuous service or any part thereof in excess of six months.

When an employee’s tenure includes unauthorized gaps, HR heads must determine which years qualify for compensation by applying the statutory definition of “continuous service” located in the definition clause (Section 2) of the IR Code. This provision substantially retains the structure of the legacy Section 25B of the IDA and bifurcates the assessment into statutorily ignored interruptions and a deeming fiction for actual breaks.

Statutorily Ignored Interruptions

Not all breaks constitute legally “broken” service. The statute explicitly protects workers from losing continuous service status due to events outside their control. Service remains continuous if interrupted by:

  • Sickness or authorized leave.
  • Workplace accidents.
  • A legal strike or a lock-out.
  • Cessation of work not due to the worker’s fault (such as a temporary lay-off).

Employers must count these periods as regular continuous service. They do not break the tenure.

The 240-Day Deeming Fiction for Actual Breaks

If an employee has an actual break in service (such as an unauthorized absence or resignation followed by rehiring), the statutory deeming fiction applies. As established by the Supreme Court in Mohan Lal v. Management of M/s. Bharat Electronics Ltd., a worker is deemed to have completed one year of continuous service if they actually worked under the employer for not less than 240 days (190 days for below-ground mine workers) during the 12 months preceding the date of calculation. For a part-year in excess of six months, the threshold is proportionally reduced to 120 days (95 days for mine workers) in the preceding six-month period.

When calculating these 240 days, Supreme Court precedents (Workmen of American Express International Banking Corp. and Standard Motor Products of India Ltd.) mandate the inclusion of:

  • Days the worker was laid off under an agreement.
  • Days the worker was on earned leave with full wages.
  • Days a female worker was on maternity leave.
  • Paid Sundays and public holidays, even if no physical work was performed.

The Seasonal Establishment Exception (75% Rule)

The 240-day rule does not apply universally. The IR Code’s continuous service definition dictates a separate threshold for seasonal establishments (such as sugar mills or agro-processing units). If a worker in a seasonal establishment actually worked for not less than 75% of the days the establishment was in operation during that period, they are deemed to be in continuous service. This is a material compliance point, as 75% of a short operating season usually represents an absolute number far below 240 days.

Clubbing of Broken Periods and the Counting Backward Method

The 12-month calculation block is not the calendar year or the financial year. It consists of the 12 complete months immediately preceding the exact date of retrenchment.

Courts strictly prohibit clubbing fractured work periods across different years to satisfy the threshold. Each 12-month block is assessed independently counting backward. If a worker completes 240 days in Year 1 (the 12 months immediately preceding retrenchment), drops to 100 days in Year 2 due to an unauthorized break, and hits 240 days in Year 3, the employer owes retrenchment compensation only for Year 1 and Year 3. Year 2 is legally severed.

Calculating Average Pay: The Supreme Court Formula

For every year that survives the threshold test, the employer pays 15 days of average pay. Average pay is calculated based on the wages paid in the three complete calendar months preceding the retrenchment. For example, if the termination takes effect on March 15, the relevant wage period comprises December, January, and February.

Employers frequently err by applying the Payment of Gratuity Act formula, which divides the monthly wage by 26. In Guru Jambheshwar University v. Dharam Pal, the Supreme Court ruled that retrenchment laws must be strictly interpreted without importing the 26-day divisor. Employers must divide the total wages earned during the preceding three complete calendar months by the actual total number of calendar days in those months (e.g., 90, 91, or 92 days).

This correct statutory method yields a lower daily wage rate than the 26-day gratuity method, thereby reducing the total severance liability and favouring employers.

Explicit Statutory Penalties for Non-Compliance

Miscalculating continuous service or inflating the divisor triggers severe legal and financial liabilities under the IR Code, governed by the Central Rules notified on May 8, 2026:

  • Void Ab Initio Terminations: Retrenchment compensation is a strict condition precedent. Underpaying it renders the retrenchment void ab initio. The normal remedy ordered by the Labour Court is immediate reinstatement with full back wages, although courts retain judicial discretion to award compensation in lieu of reinstatement in specific circumstances (such as establishment closure or total loss of trust).
  • Tiered Statutory Fines: Non-compliance carries severe monetary penalties. Section 86(3) imposes statutory fines ranging from Rs. 50,000 to Rs. 2,00,000 for contravening Chapter IX retrenchment conditions in standard establishments (50 to 300 workers). For large establishments employing 300 or more workers governed by Chapter X, Section 86(1) imposes massive fines ranging from Rs. 1,00,000 to Rs. 10,00,000 for illegal retrenchment.

What Employers Must Do Now [FREE]

To execute a legally compliant and mathematically optimized retrenchment calculation, corporate management must implement the following steps:

  • Determine the Applicable Threshold: Apply the 75% operating days test if running a seasonal business; otherwise, apply the 240-day test counting backward exactly 12 months from the intended termination date.
  • Audit Muster Rolls for Statutory Inclusions: Program payroll software to automatically include paid holidays, lay-off days, earned leaves, and maternity leave when calculating the 240-day or 75% threshold for employees with broken service.
  • Calculate Part-Years Accurately: Assess whether the employee worked 120 days in the six months preceding the calculation date to determine if a fraction of a year qualifies as a “part thereof in excess of six months,” which requires an additional 15 days of compensation.
  • Separate Gratuity and Retrenchment Formulas: Mandate that the finance department divides the preceding three complete calendar months’ wages by the actual calendar days (90, 91, or 92), expressly prohibiting the 26-day gratuity divisor to lawfully minimize the severance payout.

Are you facing an issue regarding retrenchment compensation calculation? Miscalculating compliance can lead to severe statutory penalties. Fill out the Claim Your Free Confidential Consultation form on our homepage, and our legal team at Key4Comply will assist you instantly.

Disclaimer: All articles, blogs, guides, and resources published on this website relate to Indian labour laws and compliance frameworks. The content is provided for general informational and educational purposes only and must not be construed as legal advice. Readers should consult our legal team or a qualified advocate for advice on specific workplace disputes or compliance audits.