The implementation of India’s four new Labour Codes—which consolidate 29 existing laws—marks a significant overhaul of the country’s employment and social security framework.
India’s four new labour codes are:
- Code on Wages 2019
- Industrial Relations Code 2020
- Code on Social Security 2020
- Occupational Safety, Health & Working Conditions Code 2020
These codes, particularly the Code on Social Security, 2020, introduce major changes to gratuity, Provident Fund (PF), and salary structure, aiming for wider worker protection and formalisation.
Impact on PF, Gratuity, Income Tax
India’s new Labour Codes introduce a uniform definition of “wages” across all four codes. This change is designed to curb practice of companies deliberately keeping the basic salary component low while inflating various allowances to reduce statutory contributions.
PF and Gratuity Increase: The new definition of ‘wages’ mandates that the sum of an employee’s basic pay, dearness allowance, and retaining allowance must constitute at least 50% of the total remuneration (CTC). Since statutory contributions like provident fund (PF) and gratuity are calculated based on this ‘Wage’ component, this rule will lead to:
- Higher PF contribution: Mandatory PF contributions (12% of wages) will increase, resulting in a larger retirement corpus for the employee.
- Higher gratuity payout: The base for gratuity calculation will be larger, leading to a potentially higher final payout when the employee separates from the company.
- Impact on take-home salary: While the overall CTC remains the same, the shift of non-statutory allowances into the wage component to meet the 50% threshold means that a greater portion of the salary will go toward statutory deductions (PF, gratuity). This will likely result in a dip in the monthly take-home salary for many employees, offset by higher long-term savings.
New Gratuity Rules 2025
The most notable change in India’s new Labour Codes (specifically for the Code on Social Security, 2020) concerns the eligibility period for gratuity, which is a statutory, lumpsum payment given by an employer to an employee for long-term service.
Fixed-term employees (FTEs): Under the old regime (Payment of Gratuity Act, 1972), an employee needed to complete a minimum of five years of continuous service to be eligible for gratuity. The new codes substantially reduce this requirement for fixed-term employees (FTEs), who are now eligible for pro-rata gratuity after completing just one year of service.
Pro-rata payment: This means an FTE will receive gratuity proportionate to their service period upon the expiry of their contract, even if it is less than five years.
Parity with permanent staff: The rules mandate that FTEs must receive the same wages, benefits, and social security coverage as permanent employees, effectively ending the previous disparity in benefits based solely on the contract type.
For permanent employees, the minimum service requirement for gratuity generally remains five years of continuous service.
Is gratuity compulsory for private companies?
Yes, gratuity is compulsory for most private companies in India. The rules for payment of gratuity apply to every establishment—including factories, mines, oilfields, plantations, ports, railways, and shops or establishments—that employ 10 or more people on any day in the preceding 12 months.
Under the new codes, this requirement continues, and the enhanced social security coverage now also extends—for the first time—to include gig and platform workers, with aggregators mandated to contribute a percentage of their annual turnover towards a social security fund for these workers.
Is gratuity tax-free?
Gratuity remains a partially tax-exempt benefit, and the new labour rules have not changed the exemption limit set previously:
New Labour Rules (Post-2019 Amendments): The maximum amount of gratuity that is tax-free for private-sector employees (covered under the Act) upon retirement, resignation, or termination is ₹20 lakh.
Old Labour Rules (Pre-2019 Amendments): Prior to the 2019 amendment to the Income Tax Act, the tax-exempt limit for private employees was ₹10 lakh.
Government employees: Gratuity received by central and state government employees is fully exempt from income tax.
Any gratuity amount received above the ₹20 lakh limit by private sector employees is added to their taxable income and taxed according to their applicable income tax slab.