Gratuity Compliance After Labour Code Reforms: A Guide for HR and Finance Teams

Gratuity Compliance After Labour Code Reforms: A Guide for HR and Finance Teams

Jul 02, 2026

Gratuity compliance in India changed permanently on 21 November 2025. The Government of India notified all four Labour Codes into force, including the Code on Social Security, 2020, replacing laws that had governed the workplace for over five decades. Every HR manager and every finance head in a covered establishment now operates under a fundamentally different legal framework. Two changes stand out: the wage definition rule, which demands that basic pay form at least 50% of total CTC, and the revised eligibility rule, which extends gratuity rights to fixed-term employees after just 1 year of continuous service.

Key Changes at a Glance

What Does the 50% Wage Rule Mean for Your Payroll Structure?

For years, many employers structured salaries so that basic pay stayed well below 50% of total CTC. Allowances – house rent allowance, special allowance, travel allowance – filled the rest. The arrangement kept statutory contributions like Provident Fund and gratuity provisions low. Under the new Labour Code, this changes. The basic wage component must now equal at least 50% of the total cost to the company.

Actuarial data suggests that companies with allowance-heavy pay structures could see their total gratuity liability rise by 25% to 50% as a direct result. If your payroll audit has not happened yet, the time to act is now.

How Does Fixed-Term Employee Eligibility Work Under the New Code?

This is where many HR teams face real difficulty. Under the Payment of Gratuity Act 1972, a fixed-term contract worker almost never reached the 5-year threshold. Projects ended. Contracts lapsed. Workers moved on without receiving anything. The new Code on Social Security changes this in a meaningful way.

Fixed-term employees – those employed on a written contract for a specified period – are now eligible for pro-rata gratuity payment after completing just 1 year of continuous service. Contractual workers engaged through a third-party contractor, however, do not fall within this provision. The distinction matters, and misclassification creates real compliance risk.

• Fixed-term employees on direct company contracts: eligible after 1 year
• Permanent employees: eligibility remains at 5 years
• Third-party contractual workers: not covered under this revision
• Death or permanent disablement: payable irrespective of service duration under both old and new rules

How Should Finance Teams Account for the Liability Increase in Financial Statements?

This is where compliance leaves the HR desk and sits squarely in the finance function. The Labour Code changes constitute a plan amendment under accounting standards. That means the additional liability does not get spread forward quietly – it must be recognised immediately as Past Service Cost.

Companies preparing financial statements for the year ending 31 March 2026 cannot defer this recognition. The actuarial valuation must use the restructured salary reflecting the new 50% wage definition – alongside actual current salary data – to give auditors two clear sets of numbers.

What Steps Should HR and Finance Teams Take Immediately?

The question is not whether to act. The question is where to start. Below is a structured sequence that organisations can follow to achieve full statutory compliance without disrupting day-to-day operations.

• Audit your payroll structure and verify that basic pay meets the 50% of CTC requirement for every employee grade
• Identify all fixed-term employees on direct company contracts and include them in your gratuity data set
• Commission an updated actuarial valuation using both old and new salary structures so that Past Service Cost is accurately quantified
• Ensure your actuarial report explicitly sets out the financial effect of each regulatory change as a separate line item
• Coordinate with your statutory auditor to confirm the accounting treatment under the applicable standard – Ind AS 19 or AS 15

How Does the Gratuity Calculation Formula Work Under the New Labour Codes?

The calculation formula itself has not changed. What has changed is the wage base applied to it. Under both the old and new framework, gratuity is calculated as:

Gratuity Amount = (Last Drawn Wages × 15 × Number of Completed Years of Service) ÷ 26

The key difference is that “Last Drawn Wages” now refers to the wage as defined under the Code on Wages – basic pay plus Dearness Allowance, which must together represent at least 50% of total CTC. For an employee whose basic pay was artificially kept low, the effect on the final payout is substantial. Employees could receive 40% to 70% higher gratuity payments compared to what the old framework would have produced.

Illustrative Impact of 50% Wage Rule on Gratuity Liability

Note: Figures are illustrative, calculated on the formula basis assuming 26 working days per month. Actual values depend on employee-specific data and actuarial assumptions.

If your organisation has not yet commissioned a revised actuarial valuation of gratuity under the new Labour Codes, the financial reporting deadline for 31 March 2026 is close. Mithras Consultants provides independent, certified actuarial valuations with draft reports typically ready within 2 working days of receiving your employee data. Reach out to our team or call +91-9212375418 to discuss your organisation’s requirements.

Frequently Asked Questions

1. Are all companies required to comply with the new Labour Code gratuity rules?

Yes. The Code on Social Security, 2020 became effective 21 November 2025 and applies to all covered establishments across India, independent of pending state-level rules.

2. Do fixed-term employees hired before 21 November 2025 qualify under the new eligibility rule?

The new rules apply prospectively from 21 November 2025. Service completed before that date does not count under the 1-year fixed-term provision.

3. Is it mandatory to commission a fresh actuarial valuation for the March 2026 financial year?

Yes. Any valuation with a measurement date on or after 21 November 2025 must incorporate the revised wage definition and expanded eligibility criteria under the new Codes.

4. What data does an actuary need to compute the revised gratuity liability?

Actuaries typically require employee-level data including Date of Birth, Date of Joining, current salary, and restructured salary under the new 50% wage definition, alongside benefit structure details.

5. Does the new Labour Code affect the tax-exempt ceiling for gratuity receipts?

No. The tax-exempt ceiling of Rs. 20,00,000 for private-sector employees under Section 10(10) of the Income Tax Act remains unchanged as of the current notified provisions.