How Do New Labour Codes 2026 Affect Payroll in India?
India consolidated 29 labour laws into four codes. The deadline passed on April 1. Now comes the hard part, every salary structure in the country may need to change.
On the morning of 21 November 2025, an announcement from the Ministry of Labour and Employment changed the legal landscape of employment for every employer in India. The government had formally enacted all four Labour Codes, merging 29 different central labour laws, some of them from the 1940s – into one national framework. The central government fixed April 1, 2026, as the date for full operational parity across sectors and states. That date has now come and gone.
For most employees, the change will first show up not in a circular or a government gazette but in their payslip, in the form of a lower monthly take-home and a higher long-term retirement corpus.
For employers, it arrives as a compliance restructuring exercise with financial consequences that KPMG India estimates could raise statutory costs by 5 to 15% for organisations that ran aggressive allowance-heavy pay structures under the old framework.
India’s payroll automation, to put it plainly, has entered a new era.
Four Labour Codes That Change Everything
The four codes,
- The Code on Wages (2019)
- The Industrial Relations Code (2020)
- The Code on Social Security (2020)
- The Health and Working Conditions Code, occupational safety (2020)
Implications for workforce management vary from each other. However, with regard to payroll, the most important rule, although concise, has far-reaching implications: basic salary should make up at least 50% of the Cost to Company (CTC) of the employee.
This single rule dismantles a compensation strategy that Indian employers have followed for decades. For years, the salary structure was built on a low basic pay (generally 30 to 40 % of CTC) with the rest being allowances like House Rent Allowance, Leave Travel Allowance, special allowances, conveyance, etc. Provident Fund contributions and gratuity are calculated on the basic wage, so lower basic pay meant lower statutory outflows and a higher monthly in-hand salary for the employee. It wasn’t anything illegal. That was simply how things were done for most HR departments.
The new Code on Wages defines ‘wages’ as basic pay along with Dearness Allowance plus Retaining Allowance. If all exclusions from this definition, i.e., HRA, Conveyance, Overtake, Bonuses & Employer PF contributions in aggregate exceed 50% of total remuneration, then the excess is automatically added back to the wage base for all statutory calculations. You can’t get around it. The restructuring is a must.
In an interaction with Business Standard in April 2026, Niyati Shah, a CA and the vertical head for personal tax at 1 Finance, said, “In the past, for an employee with a CTC of ₹12 lakhs, we have seen salary structures where the basic was around 30-35%. But now, it needs to increase somewhere around ₹6 lakhs, indicating that the allowance portion will reduce, whilst the portion of PF, gratuity, and bonus will increase.”
How PF, Gratuity and ESI Calculations Are Shifting?
The downstream effect of the 50% rule flows through every statutory deduction line.
Provident Fund contributions remain at 12% from the employee and 12% from the employer, the rate has not changed. But the base on which that 12% is applied has expanded for a large share of the workforce. The mandatory PF wage ceiling will remain ₹15,000 per month. Moreover, employees who are already above that ceiling may see limited impact in PF specifically. But for those under it, the change is real.
Gratuity, perhaps more than any other statutory payment, is where employees stand to gain substantially. The wage base is now closer to 50% of CTC, so exit payments for employees who have been with the company for a long time will be much higher. The Code on Social Security also changes the structure of the growing contract workforce. Fixed-term employees can now get pro-rata gratuity after just one year of continuous service, down from the previous five-year limit. Lawyers have been careful to make it clear that this one-year rule only applies to employees with fixed terms. The five-year qualifying period is still in place for permanent employees.
Coverage under ESI has been increased. The maximum wage limit for ESI has gone up from ₹15,000 to ₹21,000. This means that employees who weren’t covered by social security before are now required to be.
The new wage definition changes how leave encashment, overtime, and the statutory bonus are all calculated. For workers who are eligible for overtime, a higher base means that they will get more money for overtime. The legal minimum bonus calculation now uses a larger wage figure for the annual bonus cycle.
The estimated drop in salary for all employees will be between 2 and 5% for those who had their basic salary below the 50% level. The compromise here is a much bigger pension kitty at the end of the road; however, this must be explained and not assumed.
Old Framework vs New Regime: A Structural Comparison
| Parameter | Earlier Framework | New Labour Codes 2026 |
| Basic Pay as % of CTC | 30–40% (common practice) | Minimum 50% mandatory |
| PF Contribution Rate | 12% each | Unchanged — on higher base |
| PF Wage Ceiling | ₹15,000/month | ₹15,000/month (unchanged) |
| ESI Wage Ceiling | ₹15,000/month | ₹21,000/month |
| Gratuity Eligibility (Fixed-Term) | 5 Years | 1 Year |
| Full & Final Settlement | 30–45 days (typical practice) | Within 2 working days |
| 4-Day Work Week | Not permitted | Permitted (48 hrs/week cap) |
| Women Working Night Shifts | Restricted | Permitted with consent |
| Layoff Without Prior Permission | Up to 100 employees | Up to 300 employees |
| Central Laws Governing Labour | 29 | 4 |
You Now Have 48 Hours to Settle an Outgoing Employee’s Dues
Beyond the wage restructuring, one operational change is forcing companies to rethink their back-office processes entirely. Under the new codes, employers must complete full and final settlement of all dues, pending wages, leave encashment, and statutory contributions within two working days of an employee’s exit, regardless of whether the separation is by resignation, dismissal, or retirement.
The former practice of taking 30 to 45 days for F&F transactions was an unwritten norm followed by most organisations. The two-working-day policy represents an entirely new standard, which means attendance details, leave balances, amounts to be refunded, and deductions should all be processed on a real-time basis. For companies using spreadsheets or legacy systems in which HR and finance data exist separately and are not integrated into the payroll system, this deadline is operationally unachievable without a structural change in how payroll is run.
The new Income Tax Act 2025 that also came into effect on 1st April 2026 adds another element of urgency. All F&F calculations should be included in the TDS calculations and Form 24Q in a new format. The updated form 16 has to be distributed among all employees by 15th June 2026.
A Structural Shift in Payroll Operations
In effect, the new labor codes coupled with the Income Tax Act 2025 now require continuous technology-driven payroll compliance as the benchmark for all employers in India, not just an ideal, not just best practices for corporations, but rather a benchmark.
Businesses that have not yet updated their salary structures to meet the 50% minimum wage floor, reviewed their PF and gratuity obligations and redesigned their payroll system to ensure compliant TDS computation and mandatory statutory filings have compliance risks on their hands. As compliance experts will tell you, misimplementation can lead to retrospective PF liabilities, inadequate gratuity and penalisation.
This is the environment in which platforms like TankhaPay, India’s all-in-one HRMS and payroll solution with more than 26 years of experience in complying with the law, have become useful instead of just convenient. It meets the compliance architecture that the new codes require by having all of its PF, ESI, TDS, PT, and LWF calculations done automatically in one system, real-time attendance integration, and automated F&F settlement workflows. The move to the new framework is just a system update for more than 1,000 businesses and 1.5 million workers in India who are already using the platform.
Who Gains and Who Bears the Cost
Not all those who have benefited from this reform have benefited equally. Indeed, the reform has not been neutral in its allocation of gains. Those employees on fixed-term or contractual agreements, a group that has often found itself outside most legal guarantees for workers, would be the immediate beneficiaries of the reform.
For permanent employees with long tenure at organisations, the expanded gratuity base means substantially higher payouts at the time of exit. For employees already in a 50% basic structure, the practical change is limited.
Employers who run lean on basic pay and heavy on allowances face the starkest transition. For them, the reform is simultaneously a compliance mandate, a cost restructuring exercise, and a workforce communication challenge. Amrita Tonk, Partner at CMS INDUSLAW, has noted that the new code “dismantles allowance-heavy pay structures” and leaves employers with significantly less room to manoeuvre on salary design.
The broader intent, however, is not punitive. The Institute of South Asian Studies at India’s National University of Singapore has said that the success of these codes will not be based on how well they are written but on what they do on factory floors, in offices, and on digital platforms. They need to really find a balance between giving employers flexibility and protecting workers, and they need to make gig and informal work more formal without stifling the growth that provides jobs.
That test is now underway.
For more information, the Ministry of Labour and Employment in India posts updated FAQs and state-specific implementation timelines at labour.gov.in. And employers are advised to consult a qualified compliance professional for restructuring their business in a way that works for them.
