Last updated 14 August 2026 · By Devendra Khandegar, Founder & CEO, Kredily
About this article. Kredily builds payroll and HR compliance software, so we have a commercial interest in employers getting this right. This is our reading of the law as at 14 August 2026, written to be checkable — statutory claims are quoted from the bare Acts or the Ministry’s own FAQs and linked, and where we are interpreting rather than quoting we say so. It is general information, not legal, tax, accounting or actuarial advice. In particular, our reading of “special allowance” against clause (e) of Section 2(y) — which every number below depends on — has no case law behind it yet. Before you change a salary structure, a booked provision or an employee classification, confirm it with your auditor, CA or counsel.
The four labour codes have been in force since 21 November 2025. In the months since, a shorthand has taken hold: that basic pay must now be 50% of CTC. That shorthand does not match the text of Section 2(y), and structuring your payroll around it will give you the wrong number.
The actual mechanism works differently. For a lot of Indian salary structures the financial consequence is considerably larger than the 50% framing implies — and it arrives from a direction most summaries don’t mention at all.
Is it applicable from April 2026?
No, and the confusion is worth unpicking because it turns on two things that are easy to conflate.
The codes are the law. They commenced on 21 November 2025 (Government of India). The rules made under them are implementation detail — drafted from December 2025, with the final Central Rules notified on 8 May 2026 and state rules still arriving on their own timelines through 2026. April 2026 belongs to the rules. It has no bearing on when your obligations started.
On gratuity the Ministry is explicit: “Gratuity, based on revised definition of wages will be applicable w.e.f. 21.11.2025 i.e. date of implementation of the Codes” (Ministry of Labour & Employment, Additional FAQs, Sl. No. 6, 16 March 2026).
| Status | |
|---|---|
| Four codes in force | 21 November 2025 — binding |
| Revised definition of wages | 21 November 2025 — binding |
| Gratuity on revised wages | 21 November 2025 — binding |
| Central Rules | In progress through 2026 |
| State rules | Varies by state |
What changed
Twenty-nine central labour laws were consolidated into four codes (PIB, Government of India):
| Code | Acts replaced | Governs |
|---|---|---|
| Code on Wages, 2019 | 4 | Wages, minimum wages, bonus, payment timelines |
| Industrial Relations Code, 2020 | 3 | Unions, standing orders, retrenchment, disputes |
| Code on Social Security, 2020 | 9 | PF, ESI, gratuity, maternity benefit, gig workers |
| OSH & Working Conditions Code, 2020 | 13 | Working hours, leave, safety, contract labour |
Two of them drive payroll. The Code on Wages defines what counts as wages, and the Code on Social Security applies that definition to gratuity and — with complications set out below — to provident fund.
How the wage definition actually works
Section 2(y) of the Code on Wages does not begin by listing what wages are. It begins by capturing everything:
“all remuneration whether by way of salaries, allowances or otherwise, expressed in terms of money or capable of being so expressed… and includes basic pay, dearness allowance, retaining allowance”
Everything you pay is wages. The section then carves out a closed list of eleven exclusions, and the entire calculation turns on that list being closed. If a component is not on it, the component is wages.
| Excluded under Section 2(y) | |
|---|---|
| (a) | Bonus under any law not forming part of employment terms |
| (b) | Value of house accommodation, light, water, medical attendance or other amenity excluded by order |
| (c) | Employer contribution to PF or pension, and interest accrued |
| (d) | Conveyance allowance or value of travelling concession |
| (e) | Sums paid to defray special expenses entailed by the nature of employment |
| (f) | House rent allowance |
| (g) | Remuneration under an award, settlement or court order |
| (h) | Overtime allowance |
| (i) | Commission payable to the employee |
| (j) | Gratuity payable on termination |
| (k) | Retrenchment compensation, other retirement benefit or ex gratia |
Two further provisions sit beneath the list. A second proviso requires clauses (d), (f), (g) and (h) to be counted for equal-remuneration and payment-of-wages purposes. An Explanation treats remuneration paid in kind, where given in lieu of money wages, as part of wages up to 15% of total wages — a narrower rule than the blanket “15% can be non-cash” it is sometimes reported as.
Where special allowance lands
This is the classification that moves the most money, and it is the one to take advice on before acting.
A generic special allowance — the residual balancing line that absorbs whatever is left of CTC once basic, HRA and conveyance are set — appears nowhere on the list of eleven. Clause (e) is the only candidate, and it covers sums paid to defray special expenses entailed by the nature of the employment: a reimbursement for costs the job imposes on the employee. On our reading it is not a catch-all for any component that happens to carry the word “special” in its name.
⚠️ This is an interpretation, not a quotation — and it is the load-bearing one. Section 2(y) does not name “special allowance” either way. The codes commenced nine months ago, there is no case law on clause (e), and the Ministry’s FAQs do not address it. We think the reading above is right and we have set out the reasoning so you can judge it yourself. But if your special allowance has genuine reimbursement characteristics, or your structure differs materially from the examples below, confirm the classification with your CA or counsel before you change any provisioning. Every figure further down this page follows from this one point.
The 50% rule, stated correctly
The first proviso to Section 2(y):
“if payments made by the employer to the employee under clauses (a) to (i) exceeds one-half… of the all remuneration calculated under this clause, the amount which exceeds such one-half… shall be deemed as remuneration”
Three consequences follow that the “basic must be 50%” shorthand obscures. It is a ceiling on what you may exclude rather than a floor under basic pay, so you test the exclusions, not basic. It covers clauses (a) to (i) only, which leaves gratuity and retrenchment compensation outside the test altogether. And in a great many real structures it never triggers, because once special allowance is counted as wages the excluded components fall well short of half.
Worked example 1 — a gross-salary structure
Take a ₹50,000 monthly structure of a shape common across Indian SMEs.
| Component | Amount | Wages? | Why |
|---|---|---|---|
| Basic | ₹15,000 | ✅ Wages | Expressly included |
| House rent allowance | ₹7,500 | ❌ Excluded | Clause (f) |
| Conveyance allowance | ₹1,600 | ❌ Excluded | Clause (d) |
| Special allowance | ₹25,900 | ✅ Wages | Not on the list of eleven |
| Total | ₹50,000 |
Wages are ₹15,000 + ₹25,900 = ₹40,900.
Now the 50% test. Excluded components under (a)–(i) come to ₹7,500 + ₹1,600 = ₹9,100, which is 18.2% of total remuneration — comfortably under half. No add-back applies. The 50% rule, the thing most of the commentary leads with, turns out to be irrelevant to this structure. The classification of special allowance was the whole story.
Note what the shorthand would have produced: setting basic to half of CTC gives ₹25,000, which is neither the old figure nor the correct one.
Worked example 2 — a full CTC structure with employer contributions
Most real Indian CTC structures carry more than four lines. Take ₹50,000 CTC including employer-side items:
| Component | Amount | Treatment |
|---|---|---|
| Basic | ₹15,000 | ✅ Wages |
| House rent allowance | ₹7,500 | ❌ Clause (f) |
| Conveyance allowance | ₹1,600 | ❌ Clause (d) |
| Employer PF contribution | ₹1,800 | ❌ Clause (c) — expressly excluded |
| Gratuity provision line | ₹722 | ⚠️ See below |
| Special allowance | ₹23,378 | ✅ Wages |
| Total CTC | ₹50,000 |
Employer PF is straightforward — clause (c) excludes it by name.
The gratuity provisioning line is not, and the statute does not squarely address it. Clause (j) excludes gratuity payable on termination — the exit payment, not an ongoing accrual shown on an offer letter. Reading the list mechanically would pull a CTC gratuity line into wages, which is circular: your gratuity provision would feed the wage base that computes gratuity. We do not think that is the intended result, but the text does not say so. This is a question for your CA, and it matters most if your structure sits near the 50% threshold.
The related question — whether “all remuneration” in the test means full CTC including employer-side contributions, or only remuneration payable to the employee — is genuinely open. The opening words of Section 2(y) refer to remuneration “payable to a person employed”, which points towards the narrower reading, but we are not aware of anything that settles it. If you are close to the line, take advice rather than picking the answer that suits you.
What this does to gratuity
Gratuity is 15 days’ wages for each completed year of service on last drawn wages — (15 ÷ 26) × wages × years, under Section 53 of the Code on Social Security, 2020.
| Wage base | Per year of service | 5 years |
|---|---|---|
| ₹15,000 (basic and DA only) | ₹8,654 | ₹43,269 |
| ₹40,900 (worked example 1) | ₹23,596 | ₹117,981 |
On that structure, gratuity accrual rises by 173% with no change to anyone’s salary.
That comparison holds only if you were previously computing gratuity on basic plus DA — a common shorthand for wages under the Payment of Gratuity Act, though we have no figures on how widely it was used. If your structure already computed gratuity on total non-excluded remuneration, nothing here changes your number.
Service before 21 November 2025
Many employers assume service is bifurcated: old basis up to 21 November 2025, new basis after. The Ministry’s answer points the other way. Asked whether gratuity for pre-code service is computed under the Payment of Gratuity Act with post-code service under the Codes, it replied that “the employee will be paid gratuity based on the rate of wages last drawn by the employee at the time of superannuation or retirement or resignation or death etc, on and after 21.11.2025 as per the provisions of Code on Social Security, 2020” (Sl. No. 11 and 17).
Read plainly, that is last-drawn wages under the new definition applied to the whole period of service, with no split. The FAQ does not use the words “no bifurcation,” and it is clarificatory administrative guidance rather than a notification, rule or judgment — so we are reading it, not quoting a conclusion. For an employer with long-tenured staff this is the largest number on this page, and it is worth putting to counsel or your actuary rather than treating as settled on the strength of a website.
Two gratuity changes most employers have missed
Fixed-term employees qualify in one year, not five. “Fixed Term Employee (FTE) will be eligible for gratuity if he/she renders service under the contract for a period of one year” (Sl. No. 14/19).
⚠️ Open question. Many employers run 11-month renewable contracts precisely to sit under one-year thresholds. Whether service across renewed back-to-back contracts aggregates to “one year” is not addressed in the Ministry’s FAQs. If you run rolling fixed-term contracts this is a question for counsel, not for a website — including this one. Do not assume renewal resets the clock.
Contract labour gratuity sits with the contractor. “The employer (i.e. Contractor) will pay gratuity on rendering of five years continuous service at the rate of 15 days wages for each completed year of service based on the last drawn wages” (Sl. No. 16).
⚠️ Checking the contract clause is necessary, not sufficient. Section 21 of the Contract Labour (Regulation and Abolition) Act, 1970 makes a principal employer liable to pay wages to contract workers where the contractor fails to do so, recoverable from the contractor (full text). Whether that principle extends to gratuity is a contested question that the Ministry’s FAQs do not resolve, and we are not going to assert an answer to it. Two further unknowns: whether five years’ continuous service survives a change of contractor when the same workers remain on site, and what your practical exposure is if a contractor cannot pay. If your contract is silent on gratuity, ask counsel what protection fits your arrangement.
For the gratuity-specific changes in one place — the wage base, service before 21 November 2025, fixed-term eligibility at one year and contract labour — see our deeper look at what the codes do to gratuity.
Provident fund
PF runs at 12% employee and 12% employer, against a statutory wage ceiling of ₹15,000 per month, reaffirmed by Gazette Notification S.O. 2702(E) of 29 May 2026.
How the revised Section 2(y) definition interacts with that ceiling is not resolved. The Ministry’s March 2026 FAQs address the wage definition and gratuity without reconciling either against the ceiling, and we have seen conflicting readings among practitioners — some treating the position as unchanged, others reading the Employees’ Provident Fund Scheme, 2026 as adopting the Code’s wage definition as the contribution base.
What that means depends on where you start. If you already contribute on actual wages rather than the ceiling, your base rises with the corrected classification. If you contribute at the ceiling, the position is genuinely unclear, and you should confirm it with your PF consultant before changing anything. Anyone presenting this as settled is going further than the source material supports.
Background: how PF contributions are calculated and ESI contribution rules and limits.
Overtime, hours and leave
Overtime is payable at twice the normal rate beyond eight hours in a day or forty-eight in a week (Sl. No. 24). The FAQ frames the daily trigger with “as daily wager” wording, so if you run shift patterns, check applicability rather than assuming the flat rule reaches you. Overtime allowance is also caught by the 50% test as clause (h), which means that for workforces with heavy overtime the wage base can move month to month (Sl. No. 1 and 8).
On leave, carry-forward is capped at 30 days into the following calendar year (Sl. No. 21), and there is no prescribed maximum on encashment — leave beyond 30 days that was applied for and not granted may be encashed at year end (Sl. No. 26).
Who the leave provisions cover is widely misreported, and getting it wrong has consequences. Under Section 2(zzl) of the OSH & WC Code, “worker” covers anyone doing manual, unskilled, skilled, technical, operational or clerical work, with no wage ceiling attached at all. The ₹18,000 per month figure applies only to the carve-out for persons employed in a supervisory capacity. Persons in a managerial or administrative capacity fall outside the definition at any wage.
The practical consequence is that a technician or clerical employee earning ₹40,000 remains a worker and remains covered. Applying ₹18,000 as a universal cut-off — a common simplification — risks under-delivering statutory leave to employees who are entitled to it. If you are reviewing policy, Kredily’s leave management overview covers the mechanics separately.
Your state matters, and national coverage will not tell you how
Labour is a concurrent subject. States notify their own rules on their own timelines, and several statutory obligations were already state-specific before the codes — professional tax rates and filing cycles differ by state, and labour welfare fund rules differ again.
The practical implication is that a compliance position built entirely from national coverage, including this page, will be incomplete. Check your own state’s labour department directly, and if you employ across state lines, check each one. For the pieces that were already state-specific, see professional tax slabs by state and, as an illustration of how much LWF varies, labour welfare fund rules in Karnataka.
What to do
These are starting steps, not sign-off. Confirm with your auditor, actuary or counsel before changing any booked provision, payroll structure or employee classification.
- Classify your components against the eleven exclusions, band by band. This is the step that matters most and the one being skipped in favour of the 50% shorthand.
- Recompute wages with special allowance included, subject to the caution above on clause (e).
- Then run the 50% test. Sum clauses (a)–(i) and compare against half of remuneration. Often it will not trigger.
- Model what the corrected wage base does to your gratuity provision, and review that model — including the wage-base classification itself and your position on pre-21-November service — with your auditor or actuary before restating anything.
- List every fixed-term employee past twelve months and get a legal view on whether renewals aggregate.
- Confirm your PF position with your consultant.
- Review contractor agreements for the gratuity obligation and your residual exposure.
- Check your leave policy against the correct worker definition rather than the ₹18,000 shorthand.
- Check your state’s rules, and every state you employ in.
One thing this page cannot do is aggregate exposure across your headcount. Steps 1 to 4 give you the per-employee arithmetic; converting that into a provision across bands and tenures is a modelling exercise, and for balance-sheet purposes your auditor or actuary will want to own the assumptions.
What is still unsettled
This list is not exhaustive, and our reading of special allowance against clause (e) carries the same order of uncertainty as everything on it.
The EPF ceiling interaction with the revised wage definition remains open, as does the aggregation of service across renewed fixed-term contracts for the one-year gratuity threshold, and the extent of any principal-employer liability for a defaulting contractor’s gratuity. The treatment of a CTC-level gratuity provisioning line under Section 2(y) is not addressed by the statute at all, and nor is whether “all remuneration” in the 50% test means full CTC or only remuneration payable to the employee. State rules are their own category, still landing.
Where the source material does not answer a question, this page does not answer it either.
Frequently asked questions
What are the four new labour codes?
The Code on Wages 2019, Industrial Relations Code 2020, Code on Social Security 2020, and the Occupational Safety, Health and Working Conditions Code 2020. They consolidate 29 central labour laws and all four came into force on 21 November 2025.
What is the new basic salary rule in 2026?
There is no rule requiring basic salary to be 50%. Wages are defined inclusively: everything you pay is wages unless it falls within eleven listed exclusions. Separately, if excluded components under clauses (a) to (i) exceed half of total remuneration, the excess is added back. For many Indian structures the second rule does not trigger, and the first is what changes the numbers.
Is the new labour code applicable from April 2026?
No. The codes came into force on 21 November 2025. April 2026 relates to Central Rules, which are implementation detail. The revised wage definition and its effect on gratuity have been binding since November 2025.
What changes are there in the new labour code?
For payroll: the definition of wages, and through it gratuity and potentially provident fund. Beyond payroll, the Industrial Relations Code changes rules on unions, standing orders and retrenchment, and the OSH Code covers working hours, leave, safety and contract labour. This page covers the payroll changes.
Is special allowance included in wages under the new labour codes?
On our reading, yes in the ordinary case. Section 2(y) lists eleven excluded components and a generic special allowance is not among them; clause (e) covers reimbursement of employment-related expense rather than acting as a catch-all. This is an interpretation of a recently commenced provision with no case law behind it — if your special allowance has genuine reimbursement characteristics, take advice.
How much does gratuity liability increase?
It depends how much of CTC sat outside basic and DA in components that are not actually excluded. On worked example 1 above, gratuity accrual rises 173%. A structure already computing gratuity on total non-excluded remuneration sees no change.
Does this reduce take-home pay?
Not by itself. Restructuring to raise basic increases PF deductions, reducing net pay while increasing retirement savings. The gratuity effect is an employer provisioning question and does not touch the payslip. See how CTC translates into take-home pay.