How the New Compensation Rules Will Impact Salaries

The Re-Beginnan | Vol.2 | Issue 30

What’s the Deal?

As per the Code on Wages Bill 2019, new compensation rules are set to be implemented from the upcoming financial year starting 1st April 2021. As per the new rules, the allowance component under salary and compensation for an individual cannot exceed 50 percent and thus will result in the basic salary component being 50 percent or more. Currently, many private sector companies tend to keep the basic salary at less than 50 percent of the total compensation, resulting in a higher allowance component.

Complying to this, provident fund (PF) contributions, gratuity payments, and take-home salaries are set to be impacted.

What is the Code on Wages Bill 2019?

The Code on Wages bill 2019 was approved by the Parliament last year and aims at revising and consolidating the laws relating to wages, bonuses, and related matters. The Code on Wages Bill 2019 includes four labor laws — Minimum Wages Act, Payment of Wages Act, Payment of Bonus Act, and Equal Remuneration Act.

This year, the Parliament passed three labor codes on industrial relations, social security, and occupational safety. With these three bills, 29 central labor laws have been merged into four broad codes under labor reforms to improve ease of doing business and providing universal social security to workers. The new compensation rule on the mix of salary components is part of the 2019 code. The final rules will be notified by the government after considering public comments.

Overall Impact of the new Rule

The new rule is set to have an impact on the salaries & pay outs of several employees & employers in the country, respectively –

- Now, the employers will have to hike the basic salary to meet the 50 percent basic pay requirement.

- It will lead to an increase in provident fund (PF) contributions (from employer and employee) and gratuity payments that are calculated based on basic salary, which will increase. This will reduce the take-home salary of the employees.

- Also, due to basic pay being fully taxable, the income tax liability is set to increase, leading to a further reduction in take-home salary.

To simplify this, let’s take a Hypothetical Example.

Mr. A works at a private sector company and earns INR 15,000 per month (gross salary). The components are as follows:

As per the previous rules, Mr. A and his employer would contribute 12% of the basic salary i.e INR 600 as PF contribution. Assuming no professional tax, Mr. A has a net pay of INR 14,400. With the new rules, Mr. A’s basic salary in FY 2021 rose to INR 7,500 with a reduction in other allowances and bonuses. Now, Mr. A and his employer would be liable to pay 12% on INR 7,500 i.e INR 900 hence reducing the take-home salary to INR 14,100. Further, the gratuity paid by the employer at the end of the employee’s tenure would rise with the increase in basic salary.

It is worth noting that employees with salaries of over INR 15,000 would not see a change in take-home salary in regards to PF contribution as it is capped at INR 1800 per month (12% of INR 15000).

Closing Note…

The new rule is set to reduce employee take-home salaries and increase wage bills for employers. Even though this might lead to higher retirement savings, this leaves employees with lower disposable income and less freedom to plan personal investments. It is to be seen whether companies’ structure new salaries and remunerations by absorbing costs or passing them on to their employees.

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