RESOURCE GUIDEApplies to: IndiaAuraOS

KB-025

India's Four Labour Codes: What Changes in Wage Definition, and What Your HRMS Must Recalculate

The unified definition of wages, the 50 per cent rule, and a worked example showing one salary structure with every downstream liability recalculated.

Author:Bosco Sabu John

Updated 14 August 2026

10 min read

India labour codes wage definition: what your HRMS must recalculate

All four Labour Codes took effect on 21 November 2025. The Code on Wages defines wages as basic pay, dearness allowance and retaining allowance, and adds back any excluded allowances beyond half of total remuneration. That single definition drives gratuity, provident fund, ESI, bonus and overtime.

This is for the payroll lead, HR controller or finance business partner who has to configure a system against the new definition and defend the numbers afterwards. It covers what is in force, the mechanics of the definition, a worked example with each downstream liability recalculated, and the remediation sequence to run inside an HRMS.

What is actually in force, and what is not

Given the deferral history, status matters more than summary. The Ministry of Labour and Employment brought all four Codes into effect on 21 November 2025, consolidating 29 labour laws: the Code on Wages, 2019, the Industrial Relations Code, 2020, the Code on Social Security, 2020, and the OSH&WC Code, 2020. These are commenced law.

Rules are a separate layer. Draft central rules under all four Codes were published on 1 January 2026 with 45 days for objections, and the Code on Wages (Central) Rules, 2026 were notified on 8 May 2026. [NEEDS SOURCE: e-Gazette confirmation of the notification numbers and dates for the four Central Rules, 2026.]

Schemes are a third layer. The Employees' Provident Fund Scheme, 2026 was published in the Gazette on 29 June 2026, replacing the 1952 Scheme, with mandatory contribution of 12 per cent of wages each from employee and employer, and the existing 10 per cent rate continuing for establishments notified by the central government.

State rules determine what most employers actually file. Maharashtra published its Code on Wages and Industrial Relations Code Rules in the state gazette dated 28 April 2026, consultation closing 12 June 2026, with nine further draft rules out for review. Other states are at different points. [NEEDS SOURCE: a state-by-state position on final rules notified under each Code as at August 2026.]

The practical reading: substantive obligations bind now, procedural detail depends on the state, and a national payroll configuration cannot be uniform until those rules settle.

The unified definition of wages, and the 50 per cent rule

Section 2(y) does three things in sequence, and the sequence is what payroll teams get wrong.

First, it includes. Wages means all remuneration capable of being expressed in money, and includes basic pay, dearness allowance and retaining allowance if any.

Second, it excludes a closed list: bonus not forming part of the terms of employment; the value of house accommodation; employer contributions to provident fund or pension; conveyance allowance and the value of any travelling concession; sums paid to defray special expenses; house rent allowance; remuneration payable under an award, settlement or court order; overtime allowance; commission; gratuity; and retrenchment compensation.

The list is closed, so an allowance matching none of those heads is not excluded merely because it is called an allowance. A residual "special allowance" or "flexible benefit" line that exists only to balance a cost-to-company figure falls inside wages in full. [NEEDS SOURCE: any official clarification on the treatment of residual special allowances under section 2(y).]

Third, it adds back. Under the first proviso, if payments under clauses (a) to (i) exceed one-half of all remuneration, the excess is deemed remuneration and added to wages. Gratuity and retrenchment compensation sit outside that test. A second proviso treats remuneration in kind up to 15 per cent of total wages payable as part of wages.

The calculation is therefore not "basic plus DA". It is statutory inclusions, plus every component with no matching exclusion, plus the excess of excluded components over half of total remuneration.

Element by element

Element	Old basis (common practice)	New basis under section 2(y)	Downstream effect
Basic pay	Wage base for PF and gratuity	Wages	Unchanged as an input, no longer the whole base
Dearness and retaining allowance	Inconsistently applied	Wages	Must appear in every statutory base
House rent allowance	Excluded	Excluded head (f), counts in the 50 per cent test	Large HRA pushes the excluded total past half and triggers add-back
Conveyance allowance, travelling concession, special expenses	Excluded	Excluded heads (d) and (e), count in the test	Same
Commission	Excluded	Excluded head (i), counts in the test	Variable pay moves the add-back month to month
Overtime allowance	Excluded	Excluded head (h), counts in the test	Excluded from wages but computed at twice the wage rate
Residual special or flexi allowance	Treated as excluded in practice	No matching exclusion, so wages	Often the single largest increase
Remuneration in kind	Ignored	Wages up to 15 per cent of total wages payable	Housing, meals and transport in kind need valuing
Gratuity and retrenchment compensation	Excluded	Excluded heads, outside the 50 per cent test	Neutral in the test, but gratuity's own base changes

A worked example

Two employees on the same allowance philosophy, one senior and one junior, monthly figures in rupees.

Component	Employee A	Employee B
Basic pay (wages)	25,000	10,000
House rent allowance (excluded)	30,000	6,000
Conveyance allowance (excluded)	8,000	3,000
Leave travel concession (excluded)	5,000	nil
Special expenses reimbursement (excluded)	12,000	2,000
Commission (excluded)	15,000	nil
Special allowance (no matching exclusion)	5,000	9,000
Gross	100,000	30,000

For A, excluded heads (a) to (i) total 70,000 against a one-half threshold of 50,000, so 20,000 is added back. Wages become 25,000 plus 5,000 plus 20,000 = 50,000, against an old base of 25,000. For B, excluded heads total 11,000, below the 15,000 threshold, so no add-back applies and wages become 10,000 plus 9,000 = 19,000, against an old base of 10,000.

Each downstream liability, on verified rates:

Provident fund. The EPF Scheme, 2026 sets 12 per cent each from employee and employer. Employee A's basic of 25,000 already exceeded the statutory wage ceiling of Rs 15,000 per month, so an employer restricting contributions to the ceiling sees no change: 1,800 before and after. For B the effect is real: the old base of 10,000 produced 1,200 per month, and new wages of 19,000 exceed the ceiling, so contribution moves to 1,800, up 600 per month or 7,200 a year per head. The population that matters is everyone whose old basic sat below Rs 15,000 and whose redefined wages sit above it. On 6 January 2026 the Supreme Court directed the central government and EPFO to decide within four months on revising that ceiling, unchanged for eleven years. [NEEDS SOURCE: the outcome of that direction and any revised ceiling as at August 2026.] [NEEDS SOURCE: reports that contributions above Rs 1,800 per month are now voluntary; no primary notification retrieved.]

Gratuity. Fifteen days' wages per completed year of service. On the conventional 15/26 formula, A's annual accrual moves from roughly 14,400 to 28,800 and B's from 5,800 to 11,000, and the actuarial liability moves with it. Gratuity is payable within 30 days of becoming due. The maximum was set at Rs 20 lakh by notification S.O. 1420(E) dated 29 March 2018 under the Payment of Gratuity Act, 1972. [NEEDS SOURCE: whether Rs 20 lakh has been re-notified under section 53 of the Code on Social Security, and the divisor prescribed in the Social Security (Central) Rules, 2026.]

ESI. Contribution is 0.75 per cent of wages from the employee and 3.25 per cent from the employer, with a coverage ceiling of Rs 21,000 per month (Rs 25,000 for persons with disability). B's gross of 30,000 sat above that ceiling, but redefined wages of 19,000 sit below it. If the ceiling is tested against Code-defined wages, B moves into coverage: 617.50 employer and 142.50 employee per month. This is the sharpest and least discussed exposure in the exercise. [NEEDS SOURCE: confirmation that the ESI ceiling is tested against wages as defined in the Code on Social Security, and whether Rs 21,000 has been re-notified.]

Bonus, overtime and leave encashment. Bonus is a minimum 8.33 per cent and maximum 20 per cent of wages for employees with at least 30 days worked in the accounting year who draw wages up to a limit set by the appropriate government, so B's minimum annual bonus computes to roughly 19,000. Overtime is not less than twice the normal rate of wages: B's hourly rate moves from roughly 48 to 91, and the overtime hour from 96 to 183, which for a plant running regular overtime is the fastest-moving line. Leave encashment follows wages, so A carrying 30 days on separation moves from roughly 28,800 to 57,700. [NEEDS SOURCE: the bonus eligibility and calculation ceilings notified under section 26 of the Code on Wages, and the leave accrual and encashment provisions under the OSH&WC Code.]

Payment timelines, settlement and records

Section 17 fixes the wage period: daily wages at the end of the day, weekly on the last working day of the week, fortnightly before the end of the second day after the fortnight ends, and monthly before the expiry of the seventh day of the succeeding month. For IT and ITES workers the government has stated that salary release is mandatory by the seventh of every month.

Full and final settlement is the change most likely to break an existing process. Where an employee is removed, dismissed, retrenched or resigns, wages must be paid within two working days. Most settlement workflows assume 30 to 45 days for clearance, asset recovery and manager sign-off, and two working days does not accommodate a serial approval chain.

Deductions are capped at 50 per cent of wages in a wage period. Records consolidate to an attendance register cum muster roll, a wage register, an overtime register and a register of fines and deductions, held physically or electronically, preserved for five years, with wage slips issued on or before payment. The OSH&WC Code adds a register of employees and of dangerous occurrences, with an annual return filed electronically. The Ministry's framing is that 31 returns collapse to one, 181 forms to 73 and 84 registers to 8. Registration is due within 60 days of an establishment coming into existence.

An HRMS remediation procedure

Export the salary component master: every earning head across every entity, grade and location, with its tax treatment and current statutory flags.
Map each head to a section 2(y) clause. Inclusion, one of the eleven exclusions, or unmapped. Record the clause letter against each head; that mapping is the audit trail.
Escalate the unmapped heads. Anything not tied to a named exclusion is wages. Residual special allowances, flexi baskets and balancing figures land here and carry the largest value.
Value remuneration in kind. Accommodation, meals, transport, anything provided rather than paid, capped at 15 per cent of total wages payable.
Build the 50 per cent test at employee-month level, not grade level. Commission, incentive and reimbursement components vary monthly, so the add-back appears in some months and not others. A test on annual averages will be wrong for exactly the employees who matter.
Compute the wage figure per employee per month and store it as a first-class field that every downstream calculation reads from.
Identify the crossing populations: old basic below the EPF ceiling with new wages above it; gross above the ESI ceiling with new wages below it; anyone crossing the bonus eligibility limit. These three lists drive the cost impact.
Rebuild the statutory bases. Point PF, ESI, gratuity accrual, bonus, overtime and leave encashment at the new field rather than basic pay, verifying each independently. Long-lived configurations often hold hard-coded bases in more than one place.
Rerun the gratuity actuarial valuation and give finance the revised provision before the next reporting date.
Reconfigure settlement to two working days. Run asset recovery, notice recovery and manager clearance in parallel with the calculation rather than ahead of it, and agree in advance what happens when a recovery is unresolved at the deadline.
Rebuild registers and the wage slip to the consolidated set, with five-year retention.
Run three parallel payroll cycles, reconciled per employee, explaining every variance above a set threshold in writing. Do not go live on a single test cycle.

Modelling the cost impact before it lands

Model on live payroll data, not grade averages, because exposure concentrates in a minority of employees. Build four numbers: the increase in employer PF for the crossing population, the increase in annual gratuity accrual across the whole population, the new ESI liability for anyone pulled into coverage, and the increase in overtime cost for shift populations. Then rerun with the EPF ceiling revised upward, since that decision is live.

The restructuring temptation is to raise HRA and cut basic. It does not work: the 50 per cent proviso is the backstop, and pushing value into excluded heads simply increases the add-back. The only structures that reduce the wage figure reduce total remuneration.

Where teams get this wrong

The commonest error is testing the 50 per cent rule against annualised figures. Commission and reimbursement components spike in particular months and the add-back is a monthly test. Annual averaging hides the months where excluded heads breach the threshold, and those are the months an inspector samples.

The second is assuming a component is excluded because it always has been. The list is closed. A "site allowance" or "shift allowance" has no listed head to fall under unless it genuinely defrays special expenses, and calling a balancing figure a reimbursement without an expense behind it is not a defence.

The third is treating the EPF ceiling as making the change irrelevant. It does for employees whose basic already exceeded Rs 15,000, and the opposite for lower-paid employees whose redefined wage crosses it. In a wide pay range, the cost impact sits at the bottom, not the top.

The fourth is the settlement deadline. Two working days is the statutory position, and no workflow routing through three approvers and an asset-recovery queue will meet it.

What to automate, and what not to

Automate the arithmetic and the audit trail: component-to-clause mapping, the monthly 50 per cent test, the derived wage field, its propagation into six statutory calculations, parallel-run reconciliation, and register retention. This is deterministic work at volume, and where spreadsheets produce numbers nobody can reproduce twelve months later.

Do not automate the classification decision. Whether an allowance genuinely defrays special expenses, whether a variable payment is commission or incentive, whether a benefit in kind has been valued reasonably: these need a named owner and a written rationale, because they will be tested. And while state rules and several ceilings remain open, a system should record and flag the assumption it applies rather than bury it in configuration.

Where a system helps

The workflow worth systematising is the chain from component master to statutory base: each earning head mapped to a clause of section 2(y), a wage figure derived per employee per month, and every downstream calculation reading from that one field rather than its own copy of basic pay. The second half is the parallel run, holding old and new configurations against the same input data and reconciling per employee.

KreupAI's AuraOS handles component mapping and derived statutory bases in that structure, including parallel-run reconciliation before cutover. If you are planning the remediation, the HCM workflow is where to start.

FAQ

Are the Labour Codes actually in force, or still deferred? In force. All four became effective on 21 November 2025. What remains uneven is the rules layer: central rules were notified in 2026, and state rules are at different stages, with Maharashtra publishing its Code on Wages and Industrial Relations rules in the state gazette on 28 April 2026.

Can I keep basic pay at 30 per cent and avoid the change? No. The proviso to section 2(y) adds back excluded payments above one-half of total remuneration, so a low basic paired with large allowances produces an add-back rather than a lower wage figure.

Does the new definition increase provident fund for everyone? No. Contributions are computed against a statutory wage ceiling of Rs 15,000 per month, so employees whose basic already exceeded it see no change. The increase falls on those whose old basic sat below the ceiling and whose redefined wages sit above it.

How quickly must a final settlement be paid now? Within two working days of removal, dismissal, retrenchment or resignation, under section 17. That is a change from the 30 to 45 day cycle most settlement processes assume.

Related reading: KB-005 [ASSIGN: title].