Article: Legal HR: What does the Law say about Bonus

Legal & Compliance Outsourcing

Legal HR: What does the Law say about Bonus

The absence of a clear definition as to the term causes complications in calculating payments to employees, and what sort of payments would be considered as bonus, and what would be outside its purview.
Legal HR: What does the Law say about Bonus

Government of India had enacted the Payment of Bonus Act 1965 (“Act”) with a view to entitle employees to partake in the profits generated by the employer or the production/productivity of the establishment.  This was seen as a way of motivating the employees by providing them additional payment in the form of bonus. As the law stands today, the Act is applicable to every factory and every other establishment in which 20 (twenty) or more persons are employed. 

As the productivity is a need of modern businesses to survive and sustain in long run, organisations have been linking their pay packages to certain performance parameters and often such salary components are called ‘bonus’. And more often than not, this (performance) bonus is significantly higher then the bonus prescribed under the Act. Therefore, companies often have doubts whether they must still pay bonus under the Act, despite the payment of performance-linked bonus that they usually pay to their employees. This article seeks to analyze this aspect.

Non-existent definition of “Bonus”

The Act is unfortunately silent on the definition and the nature of the term “bonus”. The absence of a clear definition as to the term causes complications in calculating payments to employees, and what sort of payments would be considered as bonus, and what would be outside its purview. Even the amendments made subsequently have provided no clarity on the scope of the term “bonus”.

However, if we see the trend prior to the enactment of the Act, employers would pay bonus based on their whims and fancies, the regulation of which was intended by the Act. Therefore, now there exists only one type of bonus today, which is the statutory bonus payable under the provisions of the Act.

Distinguishing between “profits” and “production/productivity”

The Preamble of the Act clearly outlines the two methods based on which bonus can be paid: (1) profits,2 and (2) production/ productivity. Section 31A of the Act allows for payment of bonus on the basis of production/productivity. There is a logical presumption that whatever is statutorily payable under the Act would be on the basis of profits. 

Production/ Productivity-linked bonus under an Agreement

The Act contains a special provision, Section 31A, which deals with payment of bonus linked with production or productivity. The section applies only when there is an agreement between the employer and the employees to this effect, and not otherwise. The purpose of this section was to allow the employer to pay annual bonus linked with production/productivity in lieu of statutory bonus, and it allows the employer to pay bonus over and above the required statutory bonus payable under the Act. The section further states that such an agreement between the employers and the employees does not take away the right of the latter to be entitled to their minimum bonus as prescribed in this Act. The section also states an upper limit which the employees would be entitled to under such an agreement, which is 20%. 

So what does this upper limit mean? Does it prohibit organisations from paying bonus higher than 20%? Section 31A was inserted by way of an amendment in 1976, and in order to understand the true legislative intent of the section, it would be prudent to analyze the pre-amendment and the post-amendment position. The pre-amendment position can be seen in section 32(vii), which was eventually renumbered as section 31A, and modified in its content. The pre-amendment position did not set upper or lower limits for bonus payment in the agreements so entered into. The originally enacted provision was made to protect the interest of employees who were able to bargain and secure bonus more than what was mandated by the Act. However, coercion from certain well-organized trade unions gave power to the employees to demand excessively high bonus payments, more than what was statutorily mandated under the Act.

Therefore, the Act, through its 1976 amendment set upper and lower limits which put a fetter on the freedom to contract and set bonus payments over and above the 20% statutory limit. 

The interpretation made by the judiciary has also been in line with rationale behind the amended position of Section 31A. The Bombay High Court in Petroleum Employees Union v. Industrial Court Maharashtra and Anr.,3  held “Prohibition implicit in the section against contracting out of the statute is for the benefit of the employee and not to his detriment. Section 31A is an exception to this policy. It permits the employees and employers to alter the basis of bonus by linking it to production and delinking it from profits. Section 34 does not prevent the employers from paying to the employees anything not covered or contemplated by the Act.”  In Titaghar Paper Mills Co. Ltd v. Its Workmen,4  the Supreme Court laid down the following four conditions that have to be fulfilled in order to attract the exemption under Section 31A (previously Section 32(vii)):

  • There must be an agreement or settlement entered into between the employees and the employer;5 
  • The said agreement or settlement must be for payment of annual bonus;
  • The said bonus was linked with production or productivity;
  • The said payment was in lieu of bonus based on profits.

Therefore, the way Section 31A is worded, it may be concluded that such an agreement can be entered into so long as the production/productivity-linked bonus payable under it does not fall short of the statutory bonus payment, ie, 8.33% does not exceed 20% of the salary or wages, and adheres to the four conditions laid down by the Supreme Court, mentioned above. While this may be logical when the amendment was introduced way back in 1976, in the present context everything is dependent on productivity and employers are ready to go all out to incentivize their best resources. Moreover, decreasing influence of trade unions in modern businesses and considering the fact that the Act is a welfare legislation, having a 20% cap on overall bonus may not seem appropriate in the present scenario.  

Performance-linked bonus not under an Agreement

An understanding of the previous section of this article would indicate that Section 31A applies only where there is an agreement between the employer and the employee. Therefore, the absence of an agreement would not entitle the employer to take benefit of the provision. 

The Act has given powers to the Central Government to make Rules for the purpose of carrying into effect the provisions of the Act, and pursuant to this power, the Central Government has made the Payment of Bonus Rules, 1975 (“Rules”). Rule 4 mandates the maintenance of registers for the computation of allocable surplus, its set-on and set-off, and the amounts due, deductions and the amounts disbursed as bonus under the Act. Therefore, establishments covered under the Act, would have to pay bonus as prescribed under the Act and the Rules, and over and above that, there is no limit on how much they can pay. However, a perusal of Section 11 of the Act, that deals with payment of maximum bonus, would indicate that any payment more than the upper limit of 20% would not be considered as bonus payment under the Act. It could be termed as ex-gratia payment or performance-linked bonus, but they would not be considered as statutory bonus payments. Therefore, if a company is making only such kind of bonus payments, then they would nevertheless be required to make statutory payments under the provisions of the Act and the Rules.

Concept of “interim bonus” and “customary bonus”

The Act makes mention of the terms “customary bonus” and “interim bonus”, and provides for their adjustment against the bonus payable under the Act.6  Section 17 of the Act essentially deals with those bonus payments made to the employees as a customary one (for instance, bonus on the occasion of diwali or any other customary bonus). The adjustment provision under Section 17 indicates the independent existence of customary bonus, the quantum of which is adjustable towards the statutory bonus payable under the Act. 

In The Graham Trading Co. (India) Ltd. v. Its Workmen,7 the court laid down the following points that would have to be considered while adjudicating questions of customary or traditional bonus:

  • Whether the payment has been over an unbroken series of years; 
  • Whether it has been for a sufficiently long period, though the length of the period might depend on the circumstances of each case: even so the period may normally have to be longer to justify an inference of traditional and customary puja bonus than may be the case with puja bonus based on an implied term of employment; 
  • The circumstance that the payment depended upon the earning of profits would have to be excluded and therefore it must be shown that payment was made in years of loss. In dealing with the question of custom, the fact that the payment was called ex gratia by the employer when it was made, would, however, make no difference in this regard because the proof of custom depends upon the effect of the relevant factors enumerated by us; and it would not be materially affected by unilateral declarations of one party when the said declarations are inconsistent with the course of conduct adopted by it; and 
  • The payment must have been at a uniform rate throughout to justify an inference that the payment at such and such rate had become customary and traditional in the particular concern.

Therefore, unless these four conditions can be fulfilled, the bonus would not be considered as “customary bonus” and would not be eligible for adjustments under Section 17 of the Act.


Those employers who have entered into an agreement under Section 31A of the Act must ensure that the agreement does not contravene the minimum and maximum bonus payable under the Act, i.e., 8.33% or Rs 100, and 20% respectively. While having 20% cap may not seem to be workable in the present scenario where performance and efficiency hold great value, as an abundant caution it may be advisable to have any additional incentive in form of a variable pay or performance linked incentive or ex-gratia. In such a case, they would be exempt from making the statutory bonus payable under the Act.

If companies are paying performance-linked bonus to their employees not under any agreement, then they would nevertheless have to make bonus payments under the Act. In other words, they could structure the total performance-linked bonus money into two parts: (1) as statutory bonus under the Act to ensure compliance with the Act, and (2) performance-linked bonus (as there is no prohibition from any other type of bonus under the Act)/ or ex-gratia payment.

Preamble to the Payment of Bonus Act, 1965.
2 The Supreme Court in Mumbai Kamgar Sabha v. Abdulbhai Fazalbhai (AIR 1976 SC 1455) made it clear that the Payment of Bonus Act deals only with the law relating to profit-sharing bonus, and not any other bonus.
3 Special Civil Application No. 5548 of 1976, decided on 14 February 1980 (Bombay HC)
4 1959 (Suppl. 2) SCR 1012
5 See also S.G. Pharmaceuticals v. Sarabhai Chemical Staff Association and Others, 1999 LLR 291 (Guj)
6 Section 17, Payment of Bonus Act 1965
7 AIR 1959 SC 1151

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Topics: Legal & Compliance Outsourcing, Benefits & Rewards, Performance Management

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