The implementation of four labour codes viz the Code on Wages, 2019 (“Wage Code”); the Code on Social Security, 2020 (“SS Code”); the Industrial Relations Code, 2020; and the Occupational Safety Health and Working Conditions Code, 2020 (collectively, the “Labour Codes”) has not only brought forth a seismic shift in the landscape of labour laws in India but has also led to considerable apprehensions amongst employers and industry practitioners. A prominent concern, amongst others, is the newly introduced uniform definition of ‘wages’. This definition becomes crucial owing to the fact that benefits associated with employment under the Labour Codes including gratuity, leave encashment, overtime etc. are computed based on ‘wages’; for example, gratuity under the SS Code, must now be calculated on the now-expanded definition of wages, significantly increasing payout liabilities.
Under the erstwhile regime of labour laws in India, benefits like gratuity and provident fund were calculated at basic wages and dearness allowance/retaining allowance, the latter generally not paid in the private sector. Historically, salary structures have had inflated or outsized proportions of other allowances such that the quantum of basic wages stands reduced. This practice lowered the quantum of statutory benefits and therefore, the corresponding cost incurred by the employer. The definition introduced under the Labour Codes mandates payment of benefits at 50% of remuneration or higher amount, if provided under the salary structure, which has rendered the aforementioned practice nugatory. Consequently, there has been a sizeable impact on the cost incurred by employers. This impact is visible across Indian industry; for example, in India’s largest Information Technology/Information Technology Enabled Services employers Tata Consultancy Services and Infosys Limited, INR 2128 crores and INR 1289 crores respectively were provisioned towards retiral and statutory benefits such as gratuity and leave encashment due to implementation of Labour Codes.1
Definition of wages
Under Section 2(y) of the Wage Code, ‘wages’ include all remuneration payable by way of salary, allowance or otherwise if the terms of employment are fulfilled and includes basic pay, dearness allowance and retaining allowance. Such component or allowance which an employee receives as a matter of right upon fulfilment of the terms of employment would potentially be considered wages. The right of a worker to wages and the obligation of the employer to pay should follow as a consequence of the services rendered or work done.2
The definition lists certain exclusions for the purposes of computing wages such as conveyance allowance, sum paid to defray special expenses, house rent allowance, overtime allowance and so on. (collectively, the “Excluded Components”). The definition uses two terms i.e., wages and remuneration, the latter being the aggregate of Excluded Components and wages. By virtue of the first proviso to the definition, if the Excluded Components (not counting gratuity and retrenchment compensation or other retirement benefit) exceed one-half of all the remuneration, the amount which exceeds such one-half shall be deemed as remuneration and added back to wages. In its FAQs on Labour Codes (“FAQ”) dated December 30, 2025, the Ministry of Labour and Employment reiterates this position, stating that if allowances and benefits exceed 50% of remuneration, the excess amount shall be added back to wages and treated as wages for statutory purposes.3
The legislative intent is clear that, for statutory purposes, the amount treated as wages should not be less than 50% of the total remuneration. In other words, irrespective of the compensation structure, at least 50% of total remuneration shall be treated as wages for calculating retiral benefits such as gratuity, leave encashment etc. It is pertinent to mention at this juncture that the Labour Codes do not require a restructuring of wages or compensation as a statutory mandate.
Impact of the 50% rule
In the given context, two situations may arise in a compensation structure – (a) compensation structure in which wages constitute less than 50% of total remuneration; and (b) compensation structure in which wages constitute more than 50% of total remuneration.
In the first scenario, where wages are less than 50% of the total remuneration, i.e., Excluded Components exceed 50% of the total remuneration, by virtue of the first proviso to Section 2(y) of the Wage Code, the amount exceeding 50% shall be treated as wages for statutory purposes. This is a statutory deeming fiction or notional addition for the purpose of determining wages, in line with the legislative intent of ensuring that the specified Excluded Components do not reduce wages below 50% of the total remuneration for statutory purposes.
In the second scenario, where wages are more than 50% of the total remuneration, i.e., the Excluded Components are less than 50% of the total remuneration, such higher amount shall be treated as wages for statutory purposes. The definition of wages has been given a liberal and wide construct in the past, particularly premised on the use of ‘includes’ as the opening term indicates the intention of the legislature to include something which is not strictly within the ambit of the definition by creating a legal fiction.4 Therefore, any allowance which may not be part of the Excluded Components or may be payable as a matter of right upon fulfilment of terms of employment would stand to be included in wages. Consequently, the cost incurred by the employer may increase beyond the statutory minimum. It is in these circumstances that compensation restructuring would become a commercially prudent choice for the employer.
Key considerations – determining wages
For the purpose of compensation restructuring, the following guiding principles may be taken into consideration; at the outset, these are neither exhaustive nor solely determinative but are indicative:
- The allowance utilised as an Excluded Component should genuinely fall within the ambit of exclusion, mere labelling or change in nomenclature would not include an allowance under the Excluded Components.5 It should not be an attempt to camouflage what constitutes wages as an Excluded Component.
- Any allowance paid as a matter of right against the work performed by the employee as per the terms of the employment would be classified as wages.6
- For an allowance to qualify as special expense and classify under the exclusion ‘sum paid to defray special expenses’, it should have a nexus with the employment and must be unique or specific to the nature of employment.7 Such nexus and uniqueness must be proved through records of the employer. An allowance that may be paid to all employees may not necessarily qualify as a special expense.
- If the nature of an allowance is discretionary or variable which is not payable as a fixed or uniform component including part of any incentive scheme against which the employer has a right to modify or amend or annual performance bonus, such allowance may not ordinarily fall within the ambit of wages per se. This understanding is further confirmed under the FAQ.8
- Any allowance paid or payable as reimbursement against actual expenditure is not part of wages.9 Reimbursements are dependent upon the employee incurring actual expenditure and may not be equated with fixed allowances described as reimbursements.
- Balancing allowances or flexible allowances which do not form part of Excluded Components, are ordinarily paid and recurring in nature are likely to be classified as wages.
While the aforementioned principles provide guidance on compensation restructuring, however, it may be worthwhile to consider Section 124 of the SS Code which prohibits an employer to reduce wages of any employee or the total quantum of benefits to which such employee is entitled to under terms of employment “only by reason of his liability for the payment of any contribution…..or any charges”. This is particularly relevant for cases where the compensation restructuring may impact the contributions to provident fund or employees’ state insurance. Therefore, compensation restructuring, if undertaken, would invariably require the employer to consider relevant factors including exercising due diligence to obviate any unforeseen risk of regulatory interference in future.
Concluding remarks
The uniform definition of wages under the Labour Codes represents a deliberate legislative shift towards maximising statutory benefits payable to employees. While the definition encompasses included and Excluded Components along with a deeming provision, the determination of what constitutes ‘wages’ continues to hinge on the substance of the allowance.
In light of the expansive definition, while it is not mandatory as such to revise or revisit compensation structures, it may be prudent to undertake a careful review of existing compensation structures to ensure, inter alia, that the exclusions are utilised meaningfully while ensuring that the company remains compliant vis-à-vis payment of retiral and other statutory benefits. Such change is not merely one that requires only computation, it may require the payroll and human resources teams to proactively structure wages supported by documents and policies, evidencing the conditional, discretionary and substantive nature of allowances, in order to mitigate risk, reduce the cost incurred by the employer and ensure compliance.
Footnotes
1. New labour codes cost TCS, Infosys, HCLTech over Rs 4,000 crore in Q3
(https://www.moneycontrol.com/news/business/information-technology/new-labour-codes-cost-tcs-infosys-hcltech-over-rs-4-000-crore-in-q3-13773833.html)
2. Indian Drugs & Pharmaceuticals Ltd. v. ESI Corpn., (1997) 9 SCC 71.
3. Ministry of Labour and Employment, FAQ on Labour Codes ( de4758d5bfeffc456d7de97a801891b0.pdf.)
4. Indian Drugs & Pharmaceuticals Ltd. v. ESI Corpn., (1997) 9 SCC 71; Harihar Polyfibres v. Reg. Director, ESI Corpn., (1984) 4 SCC 324.
5. Ref: Employees’ State Insurance Corporation v. UNO Security Services, 2016 SCC OnLine Ker 9207.
6. Southern Roadways (Private) Ltd. v. D. Venkateswarlu, 1969 SCC OnLine Mad 364.
7. Oriental Insurance Co. Ltd. v. T. Pitchaimani, 1997 SCC OnLine Mad 963; supra note 5.
8. Response to Question No. 3, FAQ.
9. K.R. Tyagi v National Textile Corporation, (1997) 3 LLN 226.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
