Labour Law Reforms

Labour Law Reforms

1. The Most Important Change: Standardised Definition of Wages

Under the new Labour Codes, “wages” must be at least 50% of total remuneration. This applies uniformly across social security and employment benefits, including:

• Gratuity
• Provident Fund
• ESI
• Overtime
• Leave encashment

Certain components such as HRA and several allowances (approximately 12–13 items) are specifically excluded from wages.

If an organisation structures compensation such that wages are less than 50% (for example, 40%), the law deems wages to be 50% for statutory calculations, even if contractual wages are lower.

This deeming provision automatically increases the base for statutory contributions and employee benefit calculations leading to higher employer costs regardless of pay structure design.

2. Dual Impact on Gratuity: Permanent and Fixed-Term Employees

Permanent Employees

The gratuity formula itself remains unchanged 15 days’ salary for each completed year of service (based on 26 days). However, the “last drawn salary” now reflects the revised wage definition.

Since wages must now be at least 50% of total remuneration, the base used for gratuity calculations will increase for most organisations. As a result:

• Gratuity obligations will increase materially.
• Organisations without the ₹20 lakh gratuity cap may see a sharper impact.

Fixed-Term Employees

Earlier, gratuity was payable only after five years of continuous service. Under the new codes, fixed-term employees become eligible for gratuity after just one year of service.

This significantly expands the population eligible for gratuity and increases long-term benefit obligations especially in sectors such as retail, FMCG, logistics, and manufacturing where fixed-term contracts are widely used.

3. Leave Liabilities Will Also Increase

The expanded wage base also impacts:

• Accrued leave balances
• Leave encashment provisions

Since leave benefits are calculated on wages, higher wage definitions directly increase leave provisions and ongoing employee benefit costs.

4. Accounting Classification: These Are Plan Amendments

From an accounting standpoint, the increase in gratuity and leave liabilities arises due to a change in law affecting benefit plans. This qualifies as a plan amendment under:

• Ind AS 19, and
• AS 15 (Indian GAAP)

The resulting increase is treated as past service cost, representing the change in present value of obligations relating to prior employee service.

This applies even though the change is mandated by law and not voluntarily introduced by the employer.

5. P&L Impact: Ind AS vs Indian GAAP

Under Ind AS

• Entire past service cost must be recognised immediately in the Profit & Loss Statement.
• No deferral is permitted.

Under Indian GAAP (AS 15)

• Vested gratuity cost: Immediate P&L recognition.
• Unvested gratuity cost: May be amortised over the remaining vesting period.
• Leave liability: Immediate P&L recognition (no deferral permitted).

This means most organisations will experience a one-time P&L impact upon implementation.

6. Timing: Impact Must Be Recognised in Interim Financials

Once the Labour Codes become effective, the increased liability must be recognised immediately including in interim financial statements.

Entities cannot defer recognition until year-end merely because detailed rules are still evolving.

For earlier reporting periods (e.g., September financials approved after notification), the impact is treated as a non-adjusting event, but mandatory disclosures must be provided explaining the expected financial impact.

7. Can the Impact Be Presented as an Exceptional Item?

There is no formal definition of “exceptional item” under Ind AS or Schedule III. However, guidance suggests that an item may be separately presented if it is:

• Material in magnitude, and
• Non-recurring in nature

Since the Labour Codes represent a one-time structural change, many entities may evaluate classification as exceptional subject to materiality and professional judgment. Detailed disclosures remain mandatory irrespective of classification.

8. Tax Implications and Deferred Tax

From a tax perspective:

• Gratuity and leave provisions are generally deductible only on actual payment, unless contributed to an approved gratuity fund.
• Accounting expense may arise immediately, while tax deduction may arise later.

This timing difference may create a Deferred Tax Asset (DTA), subject to prudence and future taxable income availability.

9. Salary Restructuring Does Not Avoid Accounting Impact

salary restructuring to comply with the 50% wage requirement is also treated as a plan amendment.

Only genuine actuarial changes (e.g., normal salary escalation) may flow through OCI. The remaining impact must be recognised through P&L as past service cost.

Organisations must carefully segregate restructuring impact from actuarial changes.

10. Practical Implementation Priorities

To ensure smooth implementation:

• Engage early with actuaries and auditors.
• Update valuation models, benefit formulas, and employee population data.
• Clearly document wage definitions, assumptions, and judgments.
• Strengthen audit trail and governance documentation.
• Proactively communicate expected financial impacts to investors and stakeholders.