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Labour code impact – How prepared is India Inc

By Ritobrata Sarkar | October 17, 2022

While several companies have assessed the impact, few have implemented any significant changes to their salary structure.
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It has been close to two years since the four labour codes were cleared by both Houses of Parliament. While several states have issued draft rules, the codes’ implementation date is still unclear. Some of the anticipated changes because of the implementation of these codes could have a significant effect on employer costs and liabilities. Yet, a recent WTW study found that the level of preparedness among companies in India to address the related impact is at varied levels.

Majority of the organisations seem to have taken some action to assess the impact of the labour codes. Small to medium-sized companies are generally hesitant and seem to be waiting for more clarity, especially around the implementation timeframe. Moreover, while several companies have assessed the impact, few have implemented any significant changes to their salary structure.

Wage in India is composed of included items, specified exclusions and a condition wherein excluded items that exceed 50% of remuneration get added back to wage. Given that several components in a typical salary structure are not mentioned in the list of exclusions, the industry is deliberating as to whether these should form a part of wage. Infact it appears that most of companies are looking to exclude items such as Variable Pay and Stock Options from the definition of wage. This may make sense in the absence of further clarification, as most companies seem to be taking a practical view and may exclude components which are largely variable, and performance linked.

Even after ignoring variable and incidence-based components of pay, the impact of the new definition of wage on most companies is significant. Balancing items (e.g. special / supplementary allowance) which are paid by most companies are likely to get added to wage. In essence, wage is turning out to be much higher than 50% of total fixed pay, for most organisations.

Compensation restructuring

While it may be prudent to increase basic salary, most companies may not be very keen to do so immediately, as this will have implications on employees’ take-home salary. Moreover, increasing Basic salary will have a significant impact on voluntary plans, e.g. Superannuation, NPS or legacy pension plans, where benefits are linked to basic salary.

Wherever compensation restructuring is being done, House Rent Allowance and Conveyance Allowance are the two major components that companies are looking to increase. Interestingly, many organisations may not be looking to change the salary structure. This again, indicates that several companies are still not prepared to minimise the related potential impact.

Impact on gratuity and leave encashment

The maximum impact will perhaps be on gratuity, where majority of the organisations expect a significant impact on their P&L. Given that the basic structure of the gratuity payment formula remains unaltered at 15 days' last drawn wages, for the number of years of service, it would mean that last "wage" is used to reckon for all the years of service. It seems that the impact will extend to prior service as well, making the impact very significant.

While some companies are considering options to update their gratuity plans to mitigate the impact, this may not be possible if the benefit provided is the minimum stipulated by law.

Impact on provident fund

About half the organisations are not considering any immediate change in PF contributions and will maintain status-quo of 12% of basic salary. Most companies feel that the concept of wage ceiling for EPF contributions may continue to exist post labour codes as well, and therefore are not keen to contribute on full wage. This is also another reason why companies are not keen to increase the basic salary of employees, wherever possible. The rationale is similar to the interpretation post the landmark 2019 Supreme Court judgement of inclusion of allowances, wherein, companies continued to contribute on basic salary on the ground that it is higher than the wage ceiling of INR 15,000. This is however, a very sensitive and significant matter and one which needs to be clarified by the Government; in particular, whether a wage ceiling would continue to apply for the purpose of provident fund.

While further clarity is awaited from the Government, especially around the treatment of various components that will form part of the wage definition, it is clear that there is likely to be a significant financial impact of the new wage definition, especially on the cost of retirement and long-term benefits. While the financial impact cannot be fully eliminated, companies are advised to look at possible options to mitigate the impact. Compensation restructuring and updating benefit policies are two options that may help mitigate the impact.

* The article was first published in The Times of India on October 12, 2022


Head of Retirement, India
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