Fixed-Term Employment Contracts : Can a foreign subsidiary hire staff on short contracts in India without paying gratuity? Until recently, the answer was usually yes. The Payment of Gratuity Act, 1972 required five years of continuous service, so contract staff almost never qualified. That has changed. Fixed-term employment contracts now carry a pro-rata gratuity entitlement after just one year of service under the Code on Social Security, 2020, which the Government of India brought into force in November 2025.
This matters to every foreign company, global startup, MNC, NRI founder and overseas investor running an Indian entity. A project-based hire, a seasonal sales team or a two-year engineering contract can now create a gratuity liability that your budget never anticipated. This guide explains the rule, the legal framework, the calculation and the practical steps to stay compliant. Startup Solicitors LLP regularly advises international businesses on these employment-law questions during India market entry.
Understanding Fixed-Term Employment in the Indian Context
Fixed-term employment means engaging a worker directly on a written contract for a defined period, instead of an open-ended permanent role. It is different from hiring through a contractor or staffing agency. The fixed-term employee is on your payroll, and the contract simply ends on an agreed date.
The Code on Social Security, 2020 and the Industrial Relations Code, 2020 now recognise this model across all sectors. The core principle is parity. A fixed-term employee must receive the same wages, working hours, allowances and statutory benefits as a comparable permanent employee. The only real difference is the contract end date.
Quick answer: Under the Code on Social Security, 2020, a fixed-term employee becomes eligible for gratuity, pro rata to the service rendered, after completing one year of service. Permanent employees still need five years.
For international readers, this is similar to the “fixed-term worker” protections in the EU and UK. India’s version is narrower, but it is now enforceable.
Legal Framework and Regulations in India
Several laws interact here:
- Code on Social Security, 2020: governs gratuity, provident fund and ESIC, and defines fixed-term employment.
- Industrial Relations Code, 2020: allows fixed-term contracts and requires that non-renewal be handled as a lawful contract expiry.
- Code on Wages, 2019: defines “wages” for gratuity calculation, and basic pay plus dearness allowance generally must form at least 50% of total remuneration.
- Income-tax law: the tax exemption on gratuity is capped at ₹20 lakh. Details are on the Income Tax Department portal.
- Companies Act, 2013: relevant for director-level and governance obligations of the subsidiary. See the Ministry of Corporate Affairs.
Foreign entities should note that gratuity is a statutory liability of the Indian subsidiary, not the parent. Parent-company policies or foreign-law contracts do not override it. Cross-border payroll structures also need review under FEMA and RBI compliance rules when funds move between entities.
Step-by-Step Process to Structure Compliant Fixed-Term Contracts
- Confirm the entity. Gratuity applies to establishments covered under the Code. If you are still choosing a structure, review private limited company registration or the subsidiary company route before hiring.
- Define the contract term. State start date, end date and renewal terms clearly. Avoid repeated back-to-back renewals that look like disguised permanent roles.
- Align wages and benefits. Match permanent-employee parity for pay, leave, PF, ESIC and other benefits.
- Set up payroll correctly. Use a payroll management system that tracks continuous service and accrues gratuity from day one.
- Compute gratuity on exit. Use the formula below.
- Pay within the statutory timeline and document the settlement.
Gratuity formula (monthly-paid employees):
Last drawn monthly wages × 15 ÷ 26 × completed years of service.
Example: An employee earns ₹80,000 per month as basic plus DA and completes two years on a fixed-term contract. Gratuity = 80,000 × 15 ÷ 26 × 2 = ₹92,307.69.
Considerations by profile:
| Employer / Hirer | Key Consideration |
|---|---|
| Indian residents (resident-owned company) | Direct application of the Code; maintain gratuity accrual in books |
| NRIs running an Indian company | Same obligations; personal residency does not change employer liability |
| Foreign companies | Indian subsidiary carries liability; parent guarantees do not replace compliance |
| Global startups | Budget gratuity into short-term hiring costs from the first contract |
| Overseas investors | Include gratuity liabilities in due diligence of the target company |
Foreign nationals employed on fixed terms also need a valid employment visa. The visa term and contract term should be aligned.
Key Challenges and Practical Issues
- Assuming the five-year rule still applies. This is the most common and most expensive mistake.
- Wage structuring. Heavily allowance-based pay packages shrink the basic salary and conflict with the 50% wage definition, which may cause under-calculation of gratuity.
- Rolling renewals. Serial short contracts for the same role invite disputes and may undermine the fixed-term classification.
- Missing continuity records. Gaps and re-hires complicate the one-year threshold.
- Foreign-law templates. Contracts copied from the US or UK often miss Indian statutory clauses.
- Rule clarity. Central and state rules under the labour codes are still being finalised and refined, so verify current notifications before finalising policies.
Strategic Insights and Expert Recommendations
- Budget gratuity from month one. Treat it as a provision, not a surprise. A simple accrual of roughly 4.81% of basic wages plus DA (15/26 ÷ 12) keeps the balance sheet accurate.
- Use fixed-term contracts for genuinely time-bound work. Projects, seasonal demand and pilot launches are legitimate. Core roles are not.
- Run a pre-hire contract audit. A short review by corporate law and legal advisory professionals costs far less than a labour dispute.
- Integrate with tax planning. Employer deductions and employee exemptions interact, so coordinate with your taxation and compliance team.
- Strengthen governance. Board-level approval of HR policy and statutory registers fits within corporate governance compliance.
- Time your entry well. Labour cost modelling should be part of Company Setup in India planning, not an afterthought.
For foreign entrants without a local founder, business setup in India for foreign nationals and resident director appointment are also worth reviewing early.
Conclusion
Fixed-term employment contracts remain a flexible hiring tool in India, but the one-year pro-rata gratuity rule means short-term no longer means cost-light. Foreign subsidiaries should align contracts, payroll and accounting with the Code on Social Security, 2020 before the first hire, not after the first exit.
Strong labour compliance should be part of every Company Formation In India decision, alongside tax, FEMA and governance planning. If your team wants a second opinion on contract structure, Startup Solicitors LLP can help; you can reach out through the contact page.
This article is for general information and is not legal advice. Verify current notifications with the Ministry of Labour and Employment before acting.
3. FAQs
Q1. Is gratuity payable to fixed-term employees in India?
Yes. Under the Code on Social Security, 2020, fixed-term employees are entitled to gratuity on a pro-rata basis after completing one year of service. The amount depends on last drawn wages and completed years of service under the contract.
Q2. How is gratuity calculated for fixed-term employees?
Gratuity equals last drawn monthly wages (basic plus dearness allowance) multiplied by 15, divided by 26, multiplied by completed years of service. For example, ₹80,000 wages and two years of service gives ₹92,307.69.
Q3. Does this rule apply to foreign subsidiaries in India?
Yes. An Indian subsidiary is a domestic legal entity and must follow Indian labour codes. Parent-company policies or overseas contracts do not replace statutory gratuity obligations for employees working in India.
Q4. Can an NRI-owned company avoid gratuity on short contracts?
No. The NRI status of the owner does not change employer obligations. If the Indian establishment is covered under the Code, eligible fixed-term employees must receive gratuity after one year of service.
Q5. What is the gratuity tax exemption limit?
Gratuity received by eligible employees is exempt from income tax up to ₹20 lakh, subject to applicable income-tax provisions. Amounts above the limit are taxable. Check current rules on the Income Tax Department website.