Employment Contracts: Mandatory Clauses Often Missed

Why Foreign Employment Contracts Fail in India

Under the definition of "wages" in section 2(y) of the Code on Wages, 2019 — in force since the Labour Codes were brought into effect on 21 November 2025 — the components excluded from "wages" must not exceed one-half of an employee's total remuneration, with any excess added back to wages — a floor that foreign employers importing parent-company templates routinely miss, along with mandatory gratuity calculations, a POSH policy reference, and DPDP Act data-handling clauses. Standard employment agreements used in the United States, United Kingdom, Singapore, or Australia also carry post-termination non-compete language that is void under Section 27 of the Indian Contract Act, 1872.

India's employment law framework is uniquely complex: it operates at both the central and state level, with different statutes applying based on the employee's location, salary bracket, industry sector, and establishment type. A contract that works in Karnataka may need modifications for Maharashtra. And with the four new Labour Codes now in effect since November 2025, the compliance landscape has shifted further.

This guide identifies the specific mandatory clauses that foreign employers most frequently miss, explains the legal basis for each, and provides practical guidance on implementation.

Clause 1: Compensation Structure with Statutory Breakup

Foreign employers typically state a single gross salary figure. Indian law requires a structured breakup that separates statutory components.

What Must Be Included

• Basic salary — Under section 2(y) of the Code on Wages, 2019, excluded components may not exceed one-half of total remuneration; anything above that is added back to "wages". This is not merely a guideline; it directly drives PF, gratuity and ESI calculations.
• House Rent Allowance (HRA) — Not legally mandated, but standard practice, and it carries tax implications under the house-rent-allowance exemption in the income-tax law in force for the relevant tax year. Set it against the exemption formula in that law rather than a rule of thumb.
• Dearness Allowance (DA) — May be required depending on the industry and applicable wage orders.
• Special allowances — The catch-all category for the remaining compensation. This component is fully taxable.

Why It Matters

If the wage component is set too low (a common practice to reduce PF and gratuity liability), the add-back in section 2(y) neutralises it. An employer paying total remuneration of INR 12,00,000 per annum must keep the excluded components at or below INR 6,00,000, so the wage component is effectively at least INR 6,00,000. This increases the employer's PF contribution (12% of basic) and gratuity liability significantly.

Clause 2: Provident Fund (PF) Contribution Details

The Employees' Provident Fund and Miscellaneous Provisions Act, 1952 has been repealed and re-enacted as Chapter III of the Code on Social Security, 2020, which mandates PF contributions for establishments with 20 or more employees.

What Must Be Included

• Employee contribution: 12% of basic wages + dearness allowance
• Employer contribution: 12% of basic wages + dearness allowance (of which 8.33% goes to Employee Pension Scheme and 3.67% to PF)
• Administrative charges: 0.50% of basic wages paid by employer
• EDLI (Employees Deposit Linked Insurance): 0.50% of basic wages paid by employer

The contract must clearly state whether PF is included in or excluded from the CTC. Most foreign companies include it within CTC, but the employee must understand the breakup.

Threshold Considerations

Employees earning basic wages above INR 15,000 per month can opt out of PF, but only if they have never been a PF member before. In practice, nearly all employees in India are PF members, making this exemption rarely applicable.

Clause 3: Employees' State Insurance (ESI)

The ESI scheme applies to establishments with 10 or more employees (in some states, 20 or more) where employees earn gross wages up to INR 21,000 per month.

What Must Be Included

• Employee contribution: 0.75% of gross wages
• Employer contribution: 3.25% of gross wages
• Coverage details: medical benefits, sickness benefits, maternity benefits, disablement benefits, and dependants' benefits

Foreign employers often miss ESI because their initial hires are senior professionals earning above the INR 21,000 threshold. But as the team grows and includes junior staff, ESI compliance becomes mandatory and must be reflected in employment contracts.

Clause 4: Gratuity Entitlement

The Payment of Gratuity Act, 1972 has been repealed and re-enacted as Chapter V of the Code on Social Security, 2020; gratuity applies to every establishment employing 10 or more persons.

What Must Be Included

• Eligibility: after five years of continuous service under section 53(1) of the Code on Social Security, 2020 — reduced to one year of service under the contract for a fixed-term employee, under the proviso to the definition of "fixed term employment" in section 2(o) of the Industrial Relations Code, 2020
• Calculation formula: Last drawn salary (basic + DA) multiplied by 15/26, multiplied by years of service
• Maximum gratuity: INR 20,00,000
• Payment timeline: Within 30 days of it becoming payable

Why Foreign Employers Miss This

Gratuity does not exist in most Western employment systems. US, UK, and Australian contracts have no equivalent clause. Foreign employers either omit it entirely or fail to accrue for the liability in their financial statements, creating a surprise cost when long-tenured employees resign.

Clause 5: Leave Entitlements with State-Specific Details

India does not have a single national leave policy. Leave entitlements are governed by a combination of central acts (Factories Act, Shops and Establishments Act) and state-specific rules.

Minimum Statutory Leave Is Set State by State

Each state's Shops and Establishments Act sets its own entitlements, and the categories themselves differ: some states grant earned (privilege) leave plus separate casual and sick leave, while others combine casual and sick leave into a single pool. The number of paid national and festival holidays is fixed by a separate state holiday statute. Because the figures and the categories both vary, the contract must reproduce the entitlements of the state in which the employee actually works — read the applicable state act rather than carrying a single national schedule across locations.

Maternity Leave

Under the Maternity Benefit Act, 1961 (as amended in 2017), women employees are entitled to:

• 26 weeks of paid maternity leave for the first two children
• 12 weeks for the third child onwards
• 12 weeks for adoption (child under 3 months) and commissioning mothers
• Eligibility: Must have worked at least 80 days in the 12 months preceding the expected delivery date

Employers with 50 or more employees must also provide a creche facility.

The Common Mistake

Foreign employers often apply their home country's leave policy uniformly, which may be more generous in some areas but fall short of Indian statutory minimums. The contract must specify leave entitlements that meet or exceed the applicable state's requirements.

Clause 6: Notice Period and Termination Provisions

Indian employment law heavily regulates termination, and the clauses required vary based on the employee's classification and the state of employment.

What Must Be Included

• Probation period — typically 3-6 months, during which a shorter notice period (7-15 days) applies. Must be explicitly stated.
• Notice period after confirmation — commonly 30-90 days. Must comply with the applicable state's Shops and Establishments Act.
• Payment in lieu of notice — the right of either party to pay wages instead of serving notice must be explicitly included.
• Grounds for termination without notice — misconduct, fraud, or breach of confidentiality can be grounds for immediate termination, but the specific grounds and inquiry process must be documented.

State-Specific Requirements

The statutory floor for notice comes from the Shops and Establishments Act of the employee's state of work. Both the length of notice and the minimum continuous service that triggers it differ by state, so check the applicable state act before fixing a number in the contract.

Separately, an employee who is a "worker" under the Industrial Relations Code, 2020 has statutory protections on top of the contract, including retrenchment compensation of fifteen days' average pay for every completed year of continuous service. The Code's definition of "worker" turns on function, not simply pay: it covers employees doing manual, skilled, technical, operational, clerical or supervisory work, and excludes those employed in a managerial or administrative capacity, and those in a supervisory capacity drawing wages above INR 18,000 a month. The Industrial Relations Code, 2020 has replaced the Industrial Disputes Act, 1947 since 21 November 2025.

Clause 7: Prevention of Sexual Harassment (POSH) Policy Reference

The Sexual Harassment of Women at Workplace (Prevention, Prohibition and Redressal) Act, 2013 requires every employer to:

• Constitute an Internal Committee (IC) if the establishment has 10 or more employees
• Develop and display a POSH policy
• Conduct annual awareness training

What Must Be in the Employment Contract

The contract must:

• Reference the company's POSH policy
• State the employee's right to file complaints under the Act
• Name the Internal Committee or provide contact details for the Local Committee
• Specify that the company's POSH policy is available for review upon joining

Penalties and Board-Report Disclosure

Under section 26 of the POSH Act, failure to constitute an Internal Committee or to comply with the Act attracts a fine of up to INR 50,000; a repeat contravention attracts twice that punishment and can lead to cancellation or non-renewal of the employer's licence or registration.

Separately, the Companies (Accounts) Second Amendment Rules, 2025 require companies to carry POSH compliance data in the Board's Report. Confirm the current text of rule 8(5) of the Companies (Accounts) Rules, 2014 before drafting the disclosure, and note that a defective Board's Report is penalised under section 134(8) of the Companies Act, 2013, not under the POSH Act.

Clause 8: Non-Compete and Non-Solicitation

This is the clause where foreign employers make the most costly mistake: copying their home country's non-compete provision verbatim.

What Indian Law Says

Section 27 of the Indian Contract Act, 1872 declares void any agreement that restrains a person from exercising a lawful profession, trade, or business. Indian courts have consistently refused to enforce post-employment non-compete clauses, finding them contrary to the fundamental right to earn a livelihood under Article 19(1)(g) of the Constitution.

In Varun Tyagi v. Daffodil Software Private Limited (Delhi High Court, 25 June 2025, Tejas Karia J.), the court held that "any terms of the employment contract that imposes a restriction on right of the employee to get employed post-termination of the contract of employment shall be void being contrary to Section 27 of the ICA", and refused to enforce the restrictive covenant on the facts before it. Post-termination non-solicitation covenants are judged case by case; they are not automatically saved simply because they are labelled non-solicitation rather than non-compete.

What You Can Include Instead

• During-employment non-compete — valid and enforceable while the employee is employed
• Non-solicitation of clients — partially enforceable if limited in scope and duration (typically 6-12 months), though enforcement varies by court
• Non-solicitation of employees — generally upheld if reasonable
• Confidentiality and non-disclosure — fully enforceable without time limits for genuine trade secrets
• Garden leave clauses — enforceable because the employee remains employed (and paid) during the restriction period

Clause 9: Intellectual Property Assignment

Foreign employers must include a clear IP assignment clause, as India's default position differs from many Western jurisdictions.

What Must Be Included

• Assignment of all intellectual property created during employment and in the course of duties to the employer
• Waiver of moral rights to the extent permitted by law
• Obligation to assist in patent/trademark filings
• Survival of IP obligations post-employment

The Patents Act, 1970 contains no provision vesting employee inventions in the employer — an application is made by the true and first inventor or by an assignee, so the employer needs a written assignment to stand in the inventor's place. Section 17(c) of the Copyright Act, 1957 does vest first ownership of a work made in the course of employment under a contract of service in the employer, but that reaches only copyrightable works, not patents, designs or trade secrets. Without an explicit, written IP assignment clause, ownership disputes can arise.

Clause 10: Data Protection Under the DPDP Act

The Digital Personal Data Protection Act, 2023 (DPDP Act) and its Rules (notified November 2025, with phased implementation through May 2027) create new obligations for employers handling employee data.

What Must Be Included

• Purpose limitation — state the specific purposes for which employee personal data is collected (payroll, benefits administration, performance management, etc.)
• Consent or legitimate use basis — employee data can be processed without explicit consent for employment-related purposes under the "legitimate use" exemption, but this must be documented
• Data breach notification — obligation to notify employees and the Data Protection Board in case of a personal data breach
• Cross-border transfer — if employee data is transferred to the parent company's servers outside India, this must be disclosed and must comply with any restrictions notified by the government
• Data retention and deletion — specify how long employee data will be retained after the employment relationship ends

Why Foreign Employers Miss This

Many foreign companies process Indian employee data on global HR platforms (Workday, BambooHR, SAP SuccessFactors) hosted outside India. The DPDP Act requires disclosure of such cross-border transfers and compliance with India's data localization requirements as they are phased in.

Clause 11: Shops and Establishments Act Registration

Every commercial establishment in India must register under the applicable state's Shops and Establishments Act. The employment contract should reference this registration and comply with the specific provisions of the applicable state act.

What Must Be Documented

• Shop/establishment registration number
• Working hours (typically 9 hours/day, 48 hours/week; subject to state variations)
• Weekly holiday entitlements
• Overtime provisions (double the ordinary rate of wages under most state acts)
• Record-keeping obligations

Clause 12: Dispute Resolution and Governing Law

Foreign employers often include governing law clauses specifying their home jurisdiction. This is problematic in India.

What Must Be Included

• Governing law — Indian employment contracts must be governed by Indian law. Attempting to apply foreign law to an Indian employment relationship is generally unenforceable.
• Arbitration clause — while commercial disputes can be arbitrated, an industrial dispute involving a "worker" under the Industrial Relations Code, 2020 belongs before the statutory forum and a private arbitration clause cannot displace it. For senior employees outside the definition of "worker", arbitration seated in India is permissible.
• Jurisdiction — specify the courts of the city where the employee works as having exclusive jurisdiction.

Clause 13: Equal Opportunity and Anti-Discrimination Policy

While India does not have a single comprehensive anti-discrimination employment statute equivalent to the US Civil Rights Act or UK Equality Act, several laws create enforceable equal opportunity obligations.

Applicable Laws

• Rights of Persons with Disabilities Act, 2016 — establishments with 20 or more employees must appoint a liaison officer, maintain records of persons with disabilities, and provide reasonable accommodation. Government establishments must reserve 4% of positions for persons with disabilities.
• Equal remuneration — the Equal Remuneration Act, 1976 was repealed by section 69 of the Code on Wages, 2019, and the equal-pay obligation now sits in the Code itself: employers must pay equal remuneration for the same or similar work regardless of gender. The contract must not include pay differentials based on gender.
• Transgender Persons (Protection of Rights) Act, 2019 — prohibits discrimination in employment, including recruitment, promotion, and other employment matters.

What the Contract Should Include

A reference to the company's equal opportunity policy, a non-discrimination statement covering gender, disability, religion, caste, and transgender status, and the grievance redressal mechanism for discrimination complaints. While not every law mandates a specific contractual clause, including these provisions protects both the employer and employee and demonstrates compliance commitment.

Clause 14: Background Verification and Probation Conditions

Employment contracts must clearly state the terms of background verification and the consequences of adverse findings.

What Must Be Included

• Scope of background checks — criminal record, educational qualification verification, previous employment history, and reference checks
• Consent — under the DPDP Act, employee consent for background verification must be explicit and documented
• Consequences of misrepresentation — the contract should state that misrepresentation in background verification constitutes grounds for termination without notice
• Probation period terms — duration (typically 3-6 months), performance review criteria, extension provisions (typically up to 3 additional months), and the simplified termination process during probation

Foreign employers frequently apply their home country's at-will employment concept during probation, but Indian law still requires a notice period (typically 7-15 days) even during the probationary period. The contract must explicitly state this.

Checklist: 15 Mandatory Clauses for India Employment Contracts

Use this quick-reference checklist when drafting or reviewing employment contracts for Indian employees:

1. Structured compensation with basic salary at 50%+ of total remuneration
2. PF contribution details (employee and employer shares)
3. ESI applicability and contribution rates (if wages below INR 21,000/month)
4. Gratuity entitlement and calculation formula
5. State-specific leave entitlements (earned, casual, sick, national holidays)
6. Maternity leave (26 weeks for first two children)
7. Probation period and confirmation process
8. Notice period compliant with state Shops and Establishments Act
9. Termination grounds and inquiry process
10. POSH policy reference and Internal Committee details
11. Indian-law-compliant non-compete (during employment only) and confidentiality clauses
12. IP assignment with explicit written terms
13. DPDP Act data protection provisions and cross-border transfer disclosure
14. Governing law (Indian law) and dispute resolution mechanism
15. Tax withholding (TDS) and Form 130 (formerly Form 16) issuance obligations

Key Takeaways

• Never use a foreign employment contract template in India without comprehensive local legal review — at minimum 12-15 India-specific clauses are required
• The Labour Codes (in force from 21 November 2025) cap excluded components at one-half of total remuneration under section 2(y) of the Code on Wages, 2019, fundamentally changing PF and gratuity cost structures
• Post-employment non-compete clauses are void under Section 27 of the Indian Contract Act — use confidentiality and garden leave clauses instead
• State-level variations in leave, notice periods, and establishment registration mean contracts must be tailored to the employee's work location
• The DPDP Act (Rules notified November 2025) adds new data protection clauses that most foreign employers have not yet incorporated into their contracts
• Consider engaging professional incorporation and tax advisory services to ensure your employment framework is compliant from day one