India’s new labour codes—which restructures 29 existing labour laws into four labour codes—has wide-ranging ramifications of what you earn today and save for the future.
The 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
The most significant component impacting employees’ salaries is the Code on Wages, 2019, which introduces a uniform and expanded definition of “wages”.
How take-home salary will change under new wage rule
The new definition of “wages” mandates a critical structural change to the cost-to-company (CTC) framework. The core rule is:
- Non-allowance components—basic pay, dearness allowance and retaining allowance—must constitute at least 50% of the employee’s total CTC.
- Allowances—house rent allowance, conveyance—are restricted. Their total cannot exceed 50% of the total remuneration. If they do, the excess amount is notionally added back to the “Wages” for calculating statutory contributions.
The shift in salary structure
Prior to the new codes, many employers kept the basic pay low (often less than 50% of the CTC) and inflated various allowances. This was done to minimise mandatory statutory contributions, as provident fund (PF) and gratuity are primarily calculated based on basic pay.
Under the new codes, companies that previously had a basic pay structure below the 50% threshold will be mandated to restructure their CTC structure.
- The basic pay component will now need to increase to meet the 50% floor.
- To keep the CTC unchanged, the allowance components will be reduced.
This shift ensures that the base used for calculating mandatory long-term benefits is substantially higher, directly linking an employee’s total compensation to their retirement security.
Take-home salary to decrease under new labour codes
The primary consequence of the new wage definition is a potential reduction in monthly net take-home salary for many employees, even if their total CTC remains the same.
1. Higher Statutory Deductions: Statutory contributions like provident fund (PF) and gratuity are calculated as a percentage of the basic pay (or the new unified “wages” base).
- Increased basic pay = Increased deduction: Since the new rule forces the “wages” component to be at least 50% of the CTC, the base used for calculating PF and gratuity contributions automatically increases.
- Higher PF contribution: The mandatory employee contribution to PF— currently at 12% of the basic pay—will increase because it’s calculated on a larger base amount.
- Higher gratuity accrual: Gratuity is calculated based on the last drawn wages and years of service. A larger wage base means the employer’s liability for gratuity also increases, which may be factored into the CTC budget.
Trade-off: Immediate Cash vs Long-Term Security
Since the total CTC is a fixed budget, when a larger portion is moved from non-taxable or lightly-taxed allowances (which form part of the take-home pay) into mandatory statutory deductions (PF/gratuity), the immediate in-hand cash flow decreases.
Essentially, employees will see less money in their bank accounts each month, but this is balanced by significantly higher long-term retirement savings (PF corpus and gratuity payout). The goal of the codes is to strengthen the social security net for the entire formal workforce by reducing employers’ practice of manipulating salary components to minimize their statutory liability.