India’s new labour codes are set to significantly change how employee wages are calculated and with it, how statutory benefits such as provident fund (PF), gratuity and other social security contributions are determined.
The government on Tuesday pre-published draft rules for all four labour codes- the Code on Wages (2019), the Industrial Relations Code (2020), the Code on Social Security (2020), and the Occupational Safety, Health and Working Conditions Code (2020)- inviting objections and suggestions from the public over the next 45 days.
The detailed draft rules, which rationalise 29 existing labour laws and were notified on November 21, were published in the Gazette on Tuesday.
"The draft rules (which are out for public comments for a period of 45 days) provide clarity on a number of operational aspects under the Codes and also repeal the existing rules framed under the 29 Central Legislations," said Sowmya Kumar, Partner, Cyril Amarchand Mangalda.
While the codes are yet to be fully operationalised across states, the definition of “wages” under the Code on Wages, 2019 has been notified and will apply uniformly across all four labour codes.
What changes under the new wage definition?
Under the new framework, “wages” will include:
The key shift lies in the 50 percent rule. If allowances and benefits (excluding gratuity and retrenchment compensation) exceed 50 percent of an employee’s total remuneration, the excess amount will be added back to wages for statutory calculations.
In simple terms, employers will no longer be able to structure salaries with a very low basic pay and high allowances to reduce PF and gratuity liabilities.
What is excluded from “wages”?
Not all salary components are impacted. The new definition specifically excludes:
These components will not be added back while applying the 50 percent rule.
A simple illustration
Consider an employee with the following monthly salary structure:
Total remuneration: Rs 76,000
Basic pay + DA: Rs 20,000
Allowances: Rs 40,000
Other components (gratuity and retrenchment compensation): Rs 16,000
Step 1: Check the 50 percent cap on allowances
50 percent of total remuneration = Rs 38,000
Total allowances paid = Rs 40,000
Step 2: Identify excess allowance
Excess over 50 percent limit = Rs 2,000
Step 3: Add excess allowance back to wages
Original wages (Basic + DA): Rs 20,000
Excess allowance added back: Rs 2,000
Revised wages for statutory purposes: Rs 22,000
PF, gratuity and other statutory benefits will now be calculated on Rs 22,000, not Rs 20,000
Impact on provident fund (PF)
Currently, many companies calculate PF on basic pay (and DA, where applicable), which in some cases forms a small portion of total salary. Under the new labour codes, if allowances cross the 50 percent threshold, the excess will be treated as wages. This higher wage base will increase: Employer PF contributions and Employee PF deductions
While this may reduce monthly take-home pay, it also means higher retirement savings over time.
What employees should expect
"Compliance costs for organised employers will rise in the short term because of expanded reporting, registration of gig and platform workers, and higher social security linkage," said Keyur D. Gandhi, Managing Partner, Gandhi Law Associates.
In my view this is more a compliance-reallocation than a net cost explosion, especially for companies already digitise real burden shifts decisively to states, which must now build IT systems, fund welfare boards, and enforce uniform standards despite differing administrative capacities, making uneven implementation almost inevitable, added Gandhi.
What happens during the transition?
Until states notify the final rules, existing rules will continue to apply to the extent they are consistent with the labour codes, as per the General Clauses Act, 1897.
What happens to gratuity?
Gratuity calculations will also be affected, as gratuity is linked to the last drawn wages. The FAQs released by the labour ministry clarifies that gratuity under the new code will apply prospectively from November 21, 2025, the date of enforcement of the relevant provisions
Gratuity will continue to be calculated at 15 days’ wages for every completed year of service, subject to the statutory cap (currently Rs 20 lakh). Since wages may now be higher due to the allowance cap, gratuity payouts could increase for many employees.
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