Government should scrap the retrospective clause on gratuity payments in labour codes
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Government should scrap the retrospective clause on gratuity payments in labour codes


The definition of wages in the labour codes, on the basis of which gratuity and leave encashment are paid, is wider than what companies have considered while providing for them in their books of accounts.

When the retrospective income tax law was scrapped in August 2021, the decision showed the government’s commitment to providing a stable investment regime and consistency of policy.

It’s now time to show the same commitment to both the investor community and industry. Through a change in the gratuity provision in the new Code on Social Security, 2020, the industry is likely to face a huge retrospective cost impact.

The code was notified on September 29, 2020, and is likely to come into force soon.


What is gratuity?

Gratuity is a lump sum paid to an employee on the termination of employment. Gratuity is regulated by the Payment of Gratuity Act, 1972, and is payable only if the employee completes five years of service before termination, except on account of death or disability of the employee. Once the new labour codes are enforced, gratuity will be regulated as per the Code on Social Security.


What is the retrospective impact?

Under both the current law and the new labour code, an employer is required to pay gratuity to an employee at the rate of 15 days’ wages, based on the rate of wages last drawn by the employee. Also, under both laws, it is clarified that 15 days’ wages will be calculated by dividing the monthly rate of wages last drawn by the employee by 26 and multiplying the quotient by 15.

Gratuity = (Last drawn wage/26 x 15) x years of service

However, there is a difference in how the term wages is defined under both laws. Under the Payment of Gratuity Act, wages cover basic salary and dearness allowance. In most private companies, under the cost to company (CTC) model, dearness allowance is not paid. Hence, gratuity is calculated on the basis of the employee’s last drawn basic salary.

Under the Code on Social Security, wages have an exhaustive definition and cover all remuneration payable to an employed person, with a specified list of exclusions and a cap of 50 percent of total remuneration on such exclusions.

For most companies, wages under the labour code will be much broader than the basic salary and this will result in a retrospective cost impact.


Policy objective

The objective of the labour codes is to facilitate implementation and remove a multiplicity of definitions without comprising the basic concepts of welfare and benefits to workers. Also, the aim is to ensure transparency and accountability and to facilitate ease of compliance.

A common definition of wages for the calculation of all employee benefits covered under the labour codes is a very positive step taken by the government, which will facilitate compliance and ease the administrative burden of employers.

One hopes that given the policy objective of the labour codes and the government’s promise to do away with retrospective laws that adversely affect the investment climate in India, the retrospective impact of both gratuity and leave encashment under the labour codes will also be taken away.

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