Full and final settlement calculation is the last payroll an employee sees from you, and it is often the one they remember. It brings together pending salary, leave encashment, gratuity, bonus, notice pay and recoveries into a single statement, followed by a final TDS computation and statutory updates. Since the Code on Wages came into force on 21 November 2025, the timeline has tightened: wages due on resignation, removal, dismissal or retrenchment are to be paid within two working days. This guide lists every component, gives a worked example and provides a checklist that makes the two-day target realistic.
What Full and Final Settlement Includes
| Component | Type | Typical basis |
|---|---|---|
| Salary for days worked in the last month | Earning | Monthly gross × days payable ÷ days in month (or company divisor) |
| Leave encashment | Earning | Unused encashable leave × daily rate per policy |
| Gratuity | Earning | 15/26 × last drawn wages × years, if eligible |
| Statutory bonus (pro rata) | Earning | For the current year, if eligible |
| Pending reimbursements and incentives | Earning | As approved |
| Notice pay (if employer releases early) | Earning | Gross per day × unserved notice days, per contract |
| Notice pay recovery (if employee leaves early) | Deduction | Per contract |
| Loan and advance recovery | Deduction | Outstanding balance |
| Employee PF, ESI, PT | Deduction | On applicable earnings |
| TDS | Deduction | Recomputed for the full year |
| Asset recovery | Deduction | Only if allowed by contract and law |
The Two-Working-Day Rule
The Code on Wages requires wages payable on separation to be paid within two working days. Gratuity has its own rule (within 30 days of becoming payable), and PF withdrawal is the employee's claim with EPFO. In practice, companies now aim to:
- Pay last-month salary and leave encashment within two working days.
- Pay gratuity within 30 days, often together if ready.
- Settle reimbursements that need verification separately but promptly.
Meeting this needs work before the last day: clearances, attendance cut-off and loan balances confirmed during the notice period, not after.
Worked Example: Full and Final Settlement
Neha resigns. Her last working day is 20 October (31-day month). Details:
- Monthly gross ₹62,000: basic ₹31,000, HRA ₹15,500, special allowance ₹15,500.
- Service: 6 years 8 months.
- Encashable leave balance: 12 days, encashed on basic at basic ÷ 30 per day per company policy.
- Notice period 60 days; she served 50, so 10 days short.
- Outstanding salary advance: ₹15,000.
- PF on actual basic. Professional tax ₹200 (Karnataka). TDS for the month computed at ₹9,500 (illustrative; see Step 5).
Step 1: Salary for days worked
₹62,000 × 20 ÷ 31 = ₹40,000. Earned basic: ₹31,000 × 20 ÷ 31 = ₹20,000.
Step 2: Leave encashment
₹31,000 ÷ 30 × 12 = ₹1,033.33 × 12 = ₹12,400. Leave encashment on separation is taxable unless the retirement exemption applies; see our separate guide on leave encashment taxation for the limits.
Step 3: Gratuity
Service of 6 years 8 months rounds up to 7 years (part year above six months). Gratuity = ₹31,000 × 15 ÷ 26 × 7 = ₹17,884.62 × 7 = ₹1,25,192.31, paid as ₹1,25,192. If excluded allowances exceeded 50% of total remuneration, the wage base would increase; here basic is exactly 50% of gross, so no add-back. Our guide on how to calculate gratuity explains the rule.
Step 4: Notice shortfall recovery
Per contract, recovery is on gross: ₹62,000 ÷ 31 × 10 = ₹20,000.
Step 5: Statutory deductions
- Employee PF: 12% of earned basic ₹20,000 = ₹2,400. Leave encashment and gratuity are not PF wages.
- Professional tax: ₹200.
- TDS: recompute annual tax including leave encashment and the taxable portion of gratuity (gratuity within the exempt limit is not taxable). Assume the recomputed balance for this payout is ₹9,500.
Step 6: Settlement statement
| Earnings | ₹ | Deductions | ₹ |
|---|---|---|---|
| Salary (20 days) | 40,000 | Notice shortfall recovery | 20,000 |
| Leave encashment (12 days) | 12,400 | Salary advance recovery | 15,000 |
| Gratuity (7 years) | 1,25,192 | Employee PF | 2,400 |
| Professional tax | 200 | ||
| TDS | 9,500 | ||
| Total earnings | 1,77,592 | Total deductions | 47,100 |
Net payable: ₹1,77,592 minus ₹47,100 = ₹1,30,492.
Tax Treatment of Settlement Components
- Salary and notice pay received: fully taxable.
- Leave encashment on resignation or retirement: exempt for non-government employees up to the least of prescribed limits (including an overall cap of ₹25 lakh as last notified), available in both regimes.
- Gratuity: exempt up to the statutory limit; excess taxable.
- Notice pay recovered: some employees claim it reduces taxable salary; tax authorities have taken different views. Treat salary on a gross basis unless your adviser says otherwise.
- Retrenchment compensation and VRS payments: have separate exemption rules; take advice.
Recompute TDS for the whole year with these amounts and deduct any shortfall from the settlement. If the settlement is not enough to cover the tax, the employer remains responsible for the shortfall, so get the calculation right before paying.
Pro Rata Bonus and Other Variable Items
If the employee is eligible for statutory bonus (wages within the notified eligibility ceiling and at least 30 working days in the year), include a pro rata amount for the current year in the settlement, unless your policy pays it at the usual date. For example, an eligible employee leaving on 30 September whose bonus base is ₹11,000 a month at 8.33% would get ₹11,000 × 6 × 8.33% = ₹5,497.80, paid as ₹5,498, for April to September.
Performance bonuses and incentives depend on the plan document. Many plans pay only if the employee is on the rolls on the payout date; others pay pro rata. Whatever the rule, apply it consistently and state it in the settlement statement.
Special Exits
Death of an employee
Dues are paid to the nominee or legal heirs. Gratuity is payable regardless of length of service. Collect the death certificate and nominee identity proof, and do not wait for a succession certificate where a valid nomination exists. Help the family with PF, EDLI and ESI claims, which can be significant.
Termination for misconduct
Wages earned are still payable within two working days. Gratuity may be forfeited in whole or in part only in the circumstances the law allows, usually after a documented inquiry. Take legal advice before withholding anything.
Absconding employees
Follow your policy on notices before treating the employee as separated. Once the separation date is fixed, compute dues the same way and keep them available for payment; do not simply cancel the amount.
Statutory Updates After Exit
- Update the date of exit on the EPFO portal so the employee can withdraw or transfer PF.
- Include final wages in the last ECR and ESI return.
- Report the employee in the quarterly TDS statement with the exit date.
- Issue the salary TDS certificate (formerly Form 16) after year-end, or earlier on request with year-to-date figures.
- Close the employee's professional tax and LWF records.
Documents to Give the Employee
- Full and final settlement statement with every line explained.
- Relieving letter and experience letter.
- Payslip for the final month.
- Year-to-date tax computation for the next employer.
- Gratuity computation and payment advice.
Full and Final Settlement Checklist
- Record resignation date, notice period and last working day on day one.
- Confirm leave balance and freeze leave applications for the notice period.
- Collect outstanding claims and approve reimbursements before the last day.
- Get loan and advance balances from finance.
- Complete asset clearance (laptop, ID card, access) on the last day.
- Run attendance cut-off and compute last-month salary.
- Compute leave encashment, gratuity and pro rata bonus.
- Recompute annual TDS.
- Get approval, release payment within two working days for wages.
- Update EPFO, ESIC, TDS and PT records.
Common Mistakes
- Holding all dues for 30 to 45 days by habit, now inconsistent with the two-working-day rule for wages.
- Deducting PF on leave encashment or gratuity.
- Forgetting the part-year rounding in gratuity.
- Recovering asset costs without a contractual and legal basis.
- Not recomputing TDS, leaving a shortfall the company has to bear.
- Not updating the exit date with EPFO, delaying the employee's PF claim.
Communicating the Settlement
Most settlement disputes come from surprise, not from the amount. Share a draft statement with the employee before the last day, showing each earning and deduction with its basis (days, rates, years of service). Explain notice recovery and tax in plain language, and give a named contact for questions. When the employee can check the arithmetic, they rarely escalate, and your team spends less time on post-exit emails.
Settlements in Fininvo Payroll
Fininvo Payroll covers gratuity calculation, arrears and TDS on salary, and generates salary payments through bank files, so the settlement uses the same configured components as monthly payroll. See compliance features, bank payments and pricing.
Frequently Asked Questions
What is the time limit for full and final settlement?
Under the Code on Wages, wages due on separation should be paid within two working days. Gratuity must be paid within 30 days of becoming payable.
Is notice pay deducted from full and final settlement?
If the employee leaves without serving the full notice and the contract provides for recovery, yes. If the employer releases early, notice pay is paid to the employee.
Is PF deducted on leave encashment?
No. Leave encashment is not part of PF wages.
Is full and final settlement taxable?
Salary components are taxable. Leave encashment and gratuity have exemptions within limits under both regimes. TDS is recomputed for the full year.
Is this legal advice?
No. This is general information. Labour Code rules and tax treatment can vary by facts, so consult a professional for specific exits.
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