Notice Period Buyout and Shortfall Recovery: Settling It Within Two Working Days
Under section 17(2) of the Code on Wages, wages due to an employee who resigns must be paid within two working days of the last working day. Unserved notice pay is not on the Code's list of permitted deductions, so pay the wage part on time and recover the shortfall separately, by agreement or a buyout payment.
An employee resigns, serves 30 of the 60 days' notice and asks to leave. Most companies have handled this by subtracting the unserved notice from the final settlement and paying whenever clearances are done. Since the Code on Wages came into force on 21 November 2025, that habit carries risk on both counts: the timing and the deduction. This post covers how to show a buyout or shortfall, what you can and cannot deduct from final wages, and how the amount is taxed. To work out the amount, use the notice pay recovery calculator.
The two-working-day rule
Section 17(2) of the Code on Wages says that when an employee is removed, dismissed, retrenched, or resigns, or becomes unemployed because the establishment closes, the wages payable must be paid within two working days. For a resignation, section 17(2) counts the two days from "his resignation". The common reading is the date it takes effect (the last working day), not the date of the letter.
Points that matter for F&F:
- ✓No salary ceiling. The Code covers managers and professionals too, unlike the old Payment of Wages Act.
- ✓"Wages" is the trigger. Salary up to the last day with its allowances falls inside the two-day rule. Gratuity is excluded from wages and follows its own 30-day timeline under the Code on Social Security. Leave encashment is not clearly excluded, so the cautious course is to pay it with the wages.
- ✓Clearance is not a condition. The Code does not make payment depend on a no-dues certificate or exit clearance. A policy that pays F&F "within 45 days after clearance" needs rewriting.
What you may deduct from final wages
Section 18 of the Code says no deduction may be made from wages except those it authorises, and total deductions in a wage period cannot exceed 50% of wages.
| Deduction | Allowed under section 18? |
|---|---|
| Income-tax (TDS) | Yes |
| Employee PF, ESI and other social security contributions | Yes |
| Recovery of salary advances and loans | Yes, within the Code's conditions |
| Absence from duty | Yes, for days actually absent |
| Loss of goods expressly entrusted to the employee | Yes, subject to the Code's conditions |
| Company housing and amenities provided | Yes, as authorised |
| Unserved notice pay | Not on the list |
| Joining bonus clawback or training bond | Not on the list |
Some HR guides still describe notice recovery as a "permitted adjustment" where the contract provides for it. A strict reading of section 18, which overrides other laws and contracts, does not support deducting it from wages. The employer still has a claim for the shortfall, and can recover it in other ways.
Showing a buyout or shortfall in the F&F
Keep the wage part and the notice part separate.
- Wage statement: salary to the last working day, leave encashment, pending reimbursements, less only section 18 deductions (TDS, PF, ESI, advances). Pay it within two working days.
- Notice statement: days of notice required, days served, shortfall, the rate in the contract (basic or gross) and the amount due.
- Recovery: the employee pays the shortfall by bank transfer, or the new employer pays it as a buyout on the employee's behalf. Issue a receipt.
- Waiver: if the manager agrees to release early, record the waiver in writing so no shortfall is claimed later.
- Relieving letter: issue it on the last working day or soon after. Holding it to force payment of notice pay invites a complaint.
If the employee will not pay, send a demand letter and pursue it as a civil claim. Do not hold back the wage part.
If the employer ends the employment without notice and pays notice pay in lieu, that is a payment to the employee and part of the final wages. Pay it within the same two days. GST on notice pay recovered from employees is a separate question; see GST on employee perks.
How the money is taxed
| Who pays whom | Tax treatment |
|---|---|
| Employer pays notice pay in lieu to the employee | Salary. Deduct TDS under section 392 and show it in Form 130 |
| New employer pays the old employer to buy out the notice | Taxable salary of the employee from the new employer. Include it in TDS |
| Employee pays the shortfall to the old employer | No deduction for it in the Income-tax Act; the salary paid stays taxable |
| Old employer deducts the shortfall from salary already paid | Disputed. A 2017 Ahmedabad tribunal ruling taxed only the net salary actually received, but the department's view is that salary is taxed as it falls due |
For payroll, report the gross salary you paid in Form 130 and do not reduce it for notice amounts the employee paid back separately. An employee who wants to argue the net-salary position does so in their own return.
A worked example
A Gurugram IT services firm works Monday to Friday. An analyst on a monthly gross of ₹60,000 (basic ₹30,000) resigns with 60 days' notice and is released after 30 days. Her last working day is Friday 30 October 2026. The contract recovers unserved notice at gross pay, on a 30-day month.
Wage statement, payable by Tuesday 3 November (the two working days are Monday 2 and Tuesday 3 November):
- October salary in full, as 31 October is a paid weekly off: ₹60,000.
- Pending fuel reimbursement against bills: ₹2,500.
- Employee PF at 12% of ₹25,000 (she contributes on the ceiling): ₹3,000.
- TDS on the year's re-projected salary: ₹5,200.
- Deductions ₹8,200 are 13.7% of ₹60,000, within the 50% cap.
- Net payable: ₹60,000 + ₹2,500 − ₹3,000 − ₹5,200 = ₹54,300.
Notice statement, kept separate:
- Shortfall: 60 − 30 = 30 days.
- Amount: ₹60,000 ÷ 30 × 30 = ₹60,000.
Even if notice pay were a permitted deduction, the 50% cap would allow only ₹30,000 − ₹8,200 = ₹21,800 more to be taken from October's wages. The firm pays ₹54,300 on 3 November, and sends a request for ₹60,000. Her new employer pays it as a buyout. The new employer adds the ₹60,000 to her taxable salary.
Frequently asked questions
Can the employee agree in writing to a deduction from the F&F?
Consent does not add a deduction that section 18 does not authorise. A separate payment by the employee, after receiving full wages, is cleaner.
Can we pay the F&F on the next payroll date instead?
Not for the wage part. It is due within two working days of the last working day, unless the state government has prescribed otherwise.
Is notice pay recovery capped at basic pay?
The law does not fix the rate. Use what the appointment letter says, and apply it the same way to every leaver.
Sources
- ✓The Code on Wages, 2019, Gazette of India
- ✓Two working days: the Code on Wages and an employee’s final settlement, LiveLaw
- ✓Actual salary received after deduction of notice pay is taxable, BCAJ
This is a summary, not legal advice. Confirm the Code on Wages and your state's rules on labour.gov.in or with an employment lawyer.
Written by
HR Manager, Airwix Technologies (Sleet)
Nihit Dobariya is the HR Manager at Airwix Technologies in Ahmedabad, where he runs HR and payroll for the team behind Sleet. He writes about payroll, PF and ESIC, professional tax, the labour codes and everyday HR practice for Indian employers, and checks each rule against the official notification before it is published.
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