When and how to pay a ‘bonus’ to employees? Must-know for Entrepreneurs

Monday November 14, 2011,

4 min Read

Lawyers at VakilSearch answer

As the name suggests, ‘bonus’ is an amount given to an employee in addition to his / her salary. There are many reasons why a Company gives a bonus, but the basic purpose is to encourage an employee to go the proverbial extra mile.

Most often, Companies give a ‘performance’ bonus, or an ‘incentive’ bonus. In an age where productivity, as opposed to production has become the key factor, an incentive bonus can go a long way in increasing employee productivity. It works out cheaper to pay a few employees more than to pay many employees less. Here, we shall analyze the common and recommended basis for giving a bonus, sector by sector.

Bonus for Sales and Marketing Employees

Even a performance bonus can be given on many criteria. The first is the overall growth or revenue brought in because of the employee. In sales and marketing, this is the basis used. For instance, if an employee has brought in Rs. 200,000 in revenues in a certain year, he deserves a bonus to ensure that the performance is repeated.

You have to be very clear in the employment contract what the numbers are going to be. For instance, you could set the target at Rs. 2 lakh, but also be clear how the Rs. 2 lakh is going to be calculated. Many employer–employee disputes arise because there is no clarity on how the employee’s contribution is going to be calculated.

Bonus for Manufacturing Businesses

On the manufacturing side, bonus is given on the number of units produced. So if you are a company manufacturing, say, Stainless Steel Products, you could use this as the criteria (i.e. pay your workers based on how many sheets or units they produce).

Remember that using this [number of units produced] criteria to determine bonus is fraught with one danger – you have to accurately calculate the number of units produced by the employee – else you will have an employer – employee dispute on your hands.

Bonus for the Software & IT Sector

Bonus for the IT Sector is tricky – It all depends on what the priorities of your business are. If the priority of your business is on time delivery, it should be the basis on which you give your employees bonus. Higher on-time delivery = higher bonus.

If on the other hand, the priority is the product or features in a product, you can even structure the bonus to ensure that an employee gets an additional bonus if he / she can program those additional features you want [naturally, within the stipulated time frame].

In certain cases, it is mandatory to pay bonus

The payment of bonus for a small company is an option. We recommend that you pay a bonus because it offers an incentive to your employees to perform, and that is the only way in which you can grow. Most clients who include this see benefits in the near term itself, so a bonus has a short gestation period.

However, for a larger company with more than 20 employees, you have to pay bonus as per the Payment of Bonus Act, 1965.

The Payment of Bonus Act 1965 states that for any company having more than 20 employees, bonus which is equal to at least one month’s minimum wages has to be paid to the employee.

The bonus can be paid at any time, and businesses usually pay the bonus during Diwali. You can also divide the bonus into 12 equal parts and add that to the employee’s salary every month.

The preamble of the Payment of Bonus Act reads:

“An Act to provide for the payment of bonus to persons employed in certain establishments on the basis of profits or on the basis of production or productivity and for matters connected therewith.”

Therefore, the Act gives you flexibility to pay the bonus on any basis (productivity or returns / profits), as per your convenience.

Remember to include this aspect of bonus in your employment contract.

About VakilSearch

VakilSearch is India’s leading online legal services provider for businesses and individuals. As the official partner of the Confederation of Indian Industry (CII) and knowledge contributor to Sulekha.com, the Hindu Business Line, Entrepreneur Magazine and the All India Rubber Association, VakilSearch reaches out to thousands of businesses, entrepreneurs and individuals on a regular basis. So when you visit vakilsearch.com, you can be assured of quality legal guidance and comprehensive documentation for your business and personal needs, at affordable prices.

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