Key Update: Higher Gratuity Liability under New Labour Codes

 


India’s labour law landscape is undergoing a significant transformation with the introduction of the new Labour Codes. Among the most impactful changes is the revision in the definition of wages, which has a direct and substantial effect on gratuity calculations and employer liabilities.

For businesses across sectors, this update is not merely a regulatory change—it has financial, accounting, and strategic implications. Employers must act proactively to reassess wage structures, provisioning, and compliance to avoid unexpected costs and audit issues.

This blog explains what has changed, why gratuity liability will increase, and what employers should do now.

Understanding the New Labour Codes

The Government of India has consolidated 29 central labour laws into four comprehensive codes:

  1. Code on Wages, 2019

  2. Industrial Relations Code, 2020

  3. Code on Social Security, 2020

  4. Occupational Safety, Health and Working Conditions Code, 2020

While the implementation date is awaited, organisations are already advised to prepare for compliance, as financial reporting and provisioning cannot be ignored once notified.

One of the most critical changes introduced under these codes is the uniform definition of “wages.”

Redefinition of Wages – The Core Change

Under the new labour codes, wages must constitute at least 50% of the total remuneration paid to an employee.

What counts as wages?

  • Basic Pay

  • Dearness Allowance (DA)

  • Retaining Allowance (if applicable)

What is excluded?

  • House Rent Allowance (HRA)

  • Bonuses

  • Commission

  • Overtime

  • Conveyance allowance

  • Employer’s contribution to PF

  • Gratuity payments

However, if exclusions exceed 50% of total pay, the excess amount must be added back to wages.

Why does this matter?

Gratuity is calculated based on last drawn wages, and a higher wage base means higher gratuity payouts.

Impact on Gratuity Calculation

Existing Gratuity Formula

Gratuity is calculated as:

(Last drawn wages × 15 × years of service) / 26

With wages being redefined and increased, the base used for gratuity computation rises, directly increasing the employer’s gratuity liability.

Key Implications

  • Employees with structured salaries (low basic, high allowances) will see a sharp increase in gratuity entitlement

  • Long-serving employees create significant accumulated liability

  • Companies with large workforces face material financial exposure

Major Change: Eligibility of Fixed-Term Employees

Earlier, gratuity eligibility required 5 years of continuous service.

Under the new labour codes:

  • Fixed-term employees become eligible after just 1 year of service

This is a major shift for industries that rely on:

  • Contract staffing

  • Project-based employment

  • Seasonal workforce

  • IT and services sectors

Employers must now factor gratuity costs even for shorter employment tenures.

Accounting and Financial Reporting Impact

Recognition of Additional Liability

The increase in gratuity due to wage redefinition is considered a past service cost.

As per ICAI guidance:

  • This additional gratuity liability must be recognised immediately as an expense

  • It cannot be deferred or amortised over future periods

Impact on Interim Financials

Companies are advised to:

  • Recognise gratuity provisions in interim financial statements (e.g., December quarter)

  • Update actuarial valuations accordingly

Effect on Profitability

  • One-time spike in employee benefit expense

  • Reduced net profits

  • Impact on EBITDA and key financial ratios

For listed companies and entities under statutory audit, this becomes a critical audit matter.

Increased Provisioning and Compliance Burden

With higher gratuity liability, employers must:

  • Increase provisions in books of accounts

  • Update actuarial valuations more frequently

  • Revisit funding mechanisms such as gratuity trusts or insurance-backed gratuity plans

Failure to adequately provide for gratuity can lead to:

  • Audit qualifications

  • Regulatory scrutiny

  • Non-compliance under the Companies Act and accounting standards

Industries Most Affected

While all employers are impacted, certain sectors will feel the effect more strongly:

  • IT & ITES – due to salary structuring practices

  • Manufacturing – large employee base and long tenure

  • Construction & Infrastructure – fixed-term workforce

  • Retail & Hospitality – high attrition with structured wages

  • NBFCs and Service Companies – compliance-intensive operations

What Employers Should Do Now

1. Review Wage Structures Immediately

  • Analyse current salary break-ups

  • Ensure compliance with the 50% wage rule

  • Rebalance allowances and wages where required

2. Conduct Actuarial Valuation

  • Obtain updated gratuity valuation under revised wage definitions

  • Assess additional liability arising from past service

3. Update Financial Provisions

  • Recognise additional gratuity costs in current financial year

  • Reflect changes in interim and annual financial statements

4. Revisit Employment Contracts

  • Review fixed-term and long-term employment agreements

  • Update HR policies and offer letters where required

5. Plan Funding Strategies

  • Consider gratuity trusts or insurance funding

  • Avoid large cash outflows at retirement or separation

6. Seek Professional Guidance

  • Labour law interpretation, accounting treatment, and tax impact require expert handling

  • Professional advice ensures compliance without business disruption

Risks of Ignoring This Update

Employers who delay action may face:

  • Sudden financial shocks

  • Non-compliance penalties

  • Adverse audit remarks

  • Employee disputes and claims

  • Reputational risks

Early preparation helps businesses spread the financial impact and remain compliant.

Conclusion

The new labour codes mark a decisive shift in how employee benefits, especially gratuity, are structured and accounted for in India. The redefinition of wages and expansion of eligibility significantly increase gratuity liability, making it a critical issue for employers.

This is not a change that can be addressed at the last minute. It requires strategic planning, accounting adjustments, and proactive compliance.

Businesses that act now will not only avoid regulatory and financial stress but also demonstrate strong governance and employee-centric practices.

Need Expert Assistance?

Navigating labour law changes, actuarial valuations, and financial reporting can be complex. Professional guidance ensures accuracy, compliance, and peace of mind.

📞 Contact us today: +91 7305701454
📧 Email: auditsiva2@gmail.com
🌐 Website: www.taxlaservices.com

Taxla Services P. Ltd.
Your trusted partner for taxation, labour law compliance, and financial advisory.

#LabourCodes #GratuityUpdate #EmployerCompliance #PayrollChanges
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