One of the major changes under the new labor code The introduction of a similar definition of the word is ‘salary‘ In all four Codes, a uniform definition of ‘wages’ includes all monetary payments and benefits of any kind except specified exclusions. The specified exclusions include components such as conveyance allowance, house rent allowance (Play), amount paid to meet special expenses (eg, telephone reimbursement etc.) and contribution pension And Provident Fund (PF).
Under the new definition of wages, the specified exclusion is to be limited to 50% of the total remuneration. This means for the purpose of social security contribution like PF, Gift (Accrual and Payment), etc. At least 50% of the ‘Total Remuneration’ will be considered. This ‘total remuneration’ includes wages (as defined in the paragraph above) and specified exclusions (eg HRA, conveyance).
Typically, employers identify a basket of perks and leave the option to pick and choose the specific components relevant to employees to include in their pay structure within the overall CTC. This helps employees optimize their taxes. However, a flexible pay structure may result in complicity in determining “wages” under labor codes, effects such as PF, gratuity, retirement and thus taking employees home.
effect on Income tax due on new salary definition
Here is an example of an employee with a CTC of Rs 12 lakh (monthly Rs 1 lakh) with a basic salary of 40%. There are two situations, one where HRA is covered under flexible components and an employee decides not to avail it (Situation A), and another where HRA has a fixed salary component (Situation B).
| Component | Reference | under existing law | under the new labor code | ||
| Monthly Amount (Rs.) – Case A | Monthly Amount (Rs.) – Case B | Monthly Amount (Rs.) – Case A | Monthly Amount (Rs.) – Case B | ||
| basic salary | a | 40,000 | 40,000 | 40,000 | 40,000 |
| HRA (40% Basic for Position B) | b | , | 16,000 | , | 16,000 |
| Retirement – Employer’s contribution to PF | C | 4,800 | 4,800 | 10,273 | 8,629 |
| Retired – Gratuity | D | 1,924 | 1,924 | 4,118 | 3,459 |
| Special allowance (ie, balance figure) | I | 53,276 | 37,276 | 45,609 | 31,912 |
| gross monthly salary | F | 100,000 | 100,000 | 100,000 | 100,000 |
| Income tax * | Yes | 10,055 | 7,457 | 7,220 | 5,545 |
| Take Home Pay (F-C-D-G-Employee PF Contribution) | h | 78,421 | 81,019 | 68,116 | 73,738 |
| Retirement Benefits (C+D) | I | 6,724 | 6,724 | 14,391 | 12,088 |
| Wages as per New Labor Codes (Total Salary – Exclusion i.e. Gratuity accrual, PF contribution and HRA) | Jay | 85,609 | 71,912 | ||
* Income tax is calculated as per old tax regime assuming rent payment of Rs 16,000 per month and that PF contribution is the only eligible deduction under section 80C of the Income Tax Act.
Essentially, the employer is required to consider “wages” as the basis for determination of gratuity, coverage under ESI, statutory bonus, etc. as per the new labor codes (once notified).
In the above example, the wages as per the new labor codes are determined from the total monthly salary excluding HRA, gratuity accrual and PF contribution.
The above table clearly indicates that allocation for retirement benefits has increased and take home pay has decreased. It is currently being treated as “salary” (including other allowances) for the purpose of PF and gratuity as opposed to basic pay. There is a similar reduction in tax outflow as the taxable salary gets reduced to the extent of increased allocation towards PF and gratuity.
From the table above, one will also notice that even though the monthly salary remains constant at Rs 100,000, the wages fixed in case A and situation B are different. Having HRA as a fixed component has less impact on gratuity (see row D) i.e. gratuity amount is less. This results in a higher take-home pay (see row H) once the Labor Code goes into effect in situation B (HRA as a fixed component).
Therefore, it may be beneficial for the organizations as well as the employees to move in a fixed structure as far as possible. The increase in gratuity benefit due to the new definition of pay is certainly attractive to the employees.
However, a significant increase in gratuity earnings (payable if a person resigns after 5 years by organizations covered under the Gratuity Act) and PF may affect their take-home pay. Furthermore, moving to a fixed structure would mean that some flexibility in receiving tax benefits could be reduced, however, it would provide certainty in arriving at take-home pay.
Overall, moving to a well-balanced compensation structure under the new labor codes can prove beneficial to both the employer and the employee – reducing employer costs as well as being tax efficient for an employee.
To conclude, there are important areas where greater clarity is expected from the government, such as – (i) whether variable pay can be treated as an exclusion, and (ii) whether we should consider the “final drawn” for this purpose. specific definition of “wages”. Why gratuity? It will be interesting to watch out for any changes in the final rules or the definition of salary that could have an impact on both the employer and the employee.
(Saraswati Kasturirangan is a partner with Deloitte India. Ratna is a director and Ankit Agarwal is a manager with Deloitte Haskins and sells the LLP)