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2021

An Overview of the New Labour Code and its Financial Impact

An Overview of the New Labour Code and its Financial Impact

• While offering salaries in the private sector the employers generally restrict the component of basic salary to bare minimum to keep its minimum its own contribution for employee provident fund (EPF) as well as payment of gratuity when the employee leaves the employment.
• The balance part of the salary is paid to the employee in the form of various allowances like house rent allowance, conveyance allowance, leave travel allowance and special allowance being the biggest component for people in high salary range.


• The employee does not object to the employer keeping his basic salary at bare minimum because he feel that to that extent his own contribution towards employee provident fund comes down and his in hand salary goes up.
• Since the salary is understood in terms of cost to the company (CTC), in the private sector, in which even the employer’s contribution to EPF is also considered to be part of the CTC.
• Keeping the basic salary to bare minimum level keeps employer and employee both happy without the employee realizing its long term implications.
• In order to simplify and consolidate the various labour legislations the government has introduced four codes collectively known as labour codes.
• These codes have put a cap on the quantum of allowance which can form part of salary in relation to the basic salary. This single change in the definition of wages i.e. salary in labour laws will have significant impacts for the employees in the long run. Let us understand the provisions and its implications on the employees.

Major Changes due to the new Labour Code:

• For the purpose of computation of various benefits to the employee all the four codes have common definition of wages.
• In order to ensure that the various component of salary of an employee are not arbitrarily structured to minimize the cost of the employer when it comes to providing various the law has put a cap on the various allowances which can form part of the salary.
• Under the code salary has to be structured in such a way that various allowances shall not exceed than 50% of the salary of the employee.
• Any excess shall be treated as part of the basic salary. In other words aggregate of the basic salary and dearness allowance shall not be less than the various allowances. These allowances may be called by any name whether special allowances or any other name.
• There is no blanket ban on payment of special allowance but aggregate of all the allowances shall in no circumstances exceed the amount of basic salary and dearness allowance taken together.
• The allowances may include commission, HRA, conveyance allowance or travel allowance etc.
• Even contribution made by employer towards EPS and pension account of the employee will be taken into account while computing the threshold limit.

Impact of such changes due to Labour Code on the Salary of the Employees:

• With increased proportion of basic salary in the overall remuneration package, the employer contribution to various retirement schemes like EPF/NPS (National Pension Scheme) will go up in monetary term.
• Likewise the contribution of the employee will also go up correspondingly.
• Since remuneration packages in private sectors is computed as CTC, the in hand salary of employees will go down significantly due to increased contribution of employer and employee towards their retirement schemes specially for those employees whose salary structure is skewed and the contribution towards EPF is made on the threshold limit of Rs. 15,000/-.
• This will have other implication as well. Within the same CTC the in hand salary as well as his tax liability will come down due to increase employer contribution to EPF which is not treated as salary under the tax laws.
• One major benefit for the employees in private sector will be that they will be able to accumulate large retirement corpus under NPS/PF.
• Moreover these employees will be eligible for a lower home loan as the home loan eligibility is considered on the in hand salary.

Example:

The impact of these changes on the salary of employees can be better understood from the following table for a person whose CTC is assumed to be 12 lakhs per annum. His basic salary is Rs. 15,000/- presently on which his EPF contribution is made by both the employee and employee.

Particulars Under Present Definition Under Proposed Definition
Monthly CTC 1,00,000 1,00,000
Basic Salary 15,000 50,000
Employer contribution to PF @ 12% of basic salary 1,800 6,000
Other Allowances 83,200 44,000
Employee contribution to PF @ 12% of basic salary 1,800 6,000
In Hand Salary 96,400 88,000
Salary for tax purpose 98,200 94,000
Annual Salary for tax purpose 11,78,400 11,28,000
Deduction under VIA A 1,50,000 1,50,000
Standard Deduction 50,000 50,000
Taxable Salary 9,78,400 9,28,000
Tax payable 1,08,180 98,100
Annual Tax Saving under new labour code   10,080
Additional Contribution towards retirement benefits   1,00,800
Gratuity payable after 5 years (Assuming constant Salary) 37,500.00 1,25,000.00
Difference in gratuity   87,500.00

 

• From the above working it becomes apparent that with the same CTC his take home salary will be lower but will be entitled to higher gratuity in case he leaves the organisation after 5 years.
• It also becomes clear that that he will be able to save more income tax every year because of higher component of employer’s contribution to provident fund which does not form part of employee’s salary.
• Since employer and employee both are contributing higher amounts to EPF part of which goes to EPS, he will get bigger amount as retirement corpus from EPF as well as higher pension from EPFO.

 

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