Gratuity, Provident Fund contribution may rise under new code

Cost to company (CTC) contains all monetary and non-monetary amounts spent on an employee.

The Code on Social Security, 2020 (“Code”) has done away with the five (5) year requirement for gratuity. Section 54 of the Code, Gratuity has been made pro rata for fixed term contract staff. Along with this, the Code’s definition of wages as per Section 2 (88), for the purpose of gratuity calculation will raise the quantum of gratuity. The definition of wages in the Code now includes basic wages and dearness allowance. So, when the gratuity is calculated in the new definition of wages, the financial liability of employers would pay out gratuity for higher wage contract workers. According to the Code, wages for the purpose of calculation of gratuity and provident fund contributions will have to be at least fifty per cent (50%) of employees’ total pay. To comply with this rule, employers will have to increase the basic pay component of salaries, leading to a proportional increase in gratuity payments and employees’ contribution to the provident fund.

The new rules may result in the restructuring of salaries for employees whose employers are contributing to the provident fund (“PF”) based on actual salary. Currently, it is voluntary on part of the employer and employee to make PF contributions on actual wages in case the monthly salary of the employee is over fifteen thousand rupees (INR 15,000). The employer and employee PF contribution can be limited to twelve per cent (12%) of fifteen thousand rupees (INR 15,000). In such cases, PF contribution may not be impacted.

If the employer/employee has currently opted to pay PF on the full basic salary instead of fifteen thousand rupees (INR 15,000) per month, then restricting this back to fifteen thousand rupees (INR 15,000) per month (or the new wage limit, if applicable) may need a joint declaration with the employee. However, most companies in the formal sector are already abiding by this rule related to PF contribution.

Gratuity cannot be calculated on basic wages and dearness allowance that are less than fifty per cent (50%) of CTC. Most firms currently have basic wages and dearness allowance at thirty to forty per cent (30%-40%) of CTC. As a result, employees would get higher gratuity payments and employers’ contribution to their retirement corpus would rise, but they would get a cut in their take-home pays once the government notifies draft rules under the Code.

According to Section 2 (88) of the Code, wages for the purpose of calculation of gratuity and PF contributions will have to be at least fifty per cent (50%) of employees’ total pay. To comply with this, employers will have to increase the basic pay component of salaries, leading to a proportional increase in gratuity payments and employees’ contribution to the PF.

The Code may result in the restructuring of salaries for employees whose employers are contributing to the PF based on actual salary. Currently, it is voluntary on part of the employer and employee to make PF contributions on actual wages in case the monthly salary of the employee is over fifteen thousand rupees (Rs. 15,000). The employer and employee PF contribution can be limited to twelve per cent (12%) of fifteen thousand rupees (Rs. 15,000). In such cases, PF contribution may not be impacted.