Introduction to India’s New Labour Codes

India’s labour landscape has undergone its most significant transformation since Independence with the implementation of four comprehensive Labour Codes effective November 21, 2025. This historic reform consolidates 29 separate labour laws into a unified, modern framework designed to address the needs of India’s rapidly evolving workforce.

The updated regulations represent a pivotal shift in how gratuity—a crucial retirement benefit—is calculated and distributed, impacting approximately 16 crore workers who have joined the formal workforce in recent years. For millions of employees across sectors, these changes translate to potentially higher gratuity payouts and expanded eligibility, particularly for fixed-term contractual workers who form an increasing portion of India’s employment ecosystem.

At the heart of these transformations lies a fundamental redefinition of “wages” that ripples across multiple statutory benefits, with gratuity calculations experiencing some of the most noticeable changes. As Vinay Joy, Partner at Khaitan & Co., notes, “In practical terms, this will prompt many employers to rebalance compensation structures toward a higher basic component, thereby increasing long-term statutory contributions.”

Key Changes to Gratuity Rules Under New Labour Codes

Reduction in Eligibility Period for Fixed-Term Employees

One of the most significant changes introduced by the Code on Social Security 2020 is the dramatic reduction in the eligibility period for fixed-term employees. Previously, all employees—regardless of employment type—required five years of continuous service to qualify for gratuity benefits. Under the new rules, fixed-term employees become eligible after just one year of continuous service.

This transformation represents a substantial expansion of social security coverage for India’s growing contractual workforce. Fixed-term employees—defined as workers hired for specific projects or roles with predetermined end dates—are common in sectors like IT, manufacturing, media, startups, and project-driven industries. Under the previous regime, these employees often couldn’t qualify for gratuity since their contracts typically ended before completing five years of service. Now, they’ll receive pro-rata gratuity benefits based on their service period, even for contracts lasting just one to two years.

It’s important to note that the five-year requirement remains unchanged for permanent employees. The only exceptions to the five-year rule for permanent employees continue to be cases involving death or disability. This differentiated approach acknowledges the distinct nature of fixed-term employment while maintaining the existing framework for permanent staff.

Expanded Definition of “Wages”

The Labour Codes introduce a uniform definition of “wages” across all four codes, fundamentally altering how gratuity and other statutory benefits are calculated. Under the previous regime, gratuity was calculated primarily based on basic salary plus dearness allowance. The new definition significantly expands this computation base.

The revised approach mandates that “wages” must constitute at least 50% of total remuneration. If the sum of specifically excluded components (such as house rent allowance, overtime, bonus, and special allowances) exceeds 50% of total compensation, the excess amount must be “added back” to the wage base for gratuity calculations.

This redefinition aims to prevent the practice of structuring compensation packages with disproportionately low basic salaries to minimize statutory payouts. As Divya Baweja, Partner at Deloitte India, explains, “Hence, only increasing the basic salary to 50% will not be compliance enough under the codes. The employees will be eligible to receive gratuity at revised wages, where ‘wage’ needs to be calculated as per the Codes.”

Understanding the New Gratuity Calculation

The Gratuity Formula

Despite the significant changes to eligibility and wage definition, the fundamental gratuity calculation formula remains unchanged under the new Labour Codes. The formula is:

Where:

• Last Drawn Wages: Now calculated based on the expanded definition of wages, including the add-back of excess allowances beyond 50% of total remuneration
• 15/26: Represents 15 days of wages out of 26 working days in a month (approximately 57.7% of monthly wages for each year of service)
• Completed Years of Service: For service periods exceeding 6 months, the figure is rounded up to the next full year

The statutory maximum gratuity payout remains capped at ₹20 lakh (₹2,000,000), which was increased from ₹10 lakh in 2018. Additionally, gratuity continues to be fully tax-free up to this ₹20 lakh limit for private sector employees.

Impact of the 50% Wage Rule: Practical Examples

The implementation of the 50% wage rule significantly alters gratuity outcomes, particularly for employees with compensation structures that previously featured basic salaries below 50% of total CTC. Consider these practical illustrations:

These examples demonstrate the compound impact of both regulatory changes—the expanded wage definition increases the calculation base, while the reduced eligibility period brings more employees into the gratuity framework.

Interactive Gratuity Calculator and Visualizations

Gratuity Comparison Across Income Levels

The table below illustrates how gratuity payouts change under the new rules for common CTC levels, assuming 10 years of service and standard salary structures:

Source: Based on calculations from Shardul Amarchand Mangaldas & Co. and Deloitte India

Implications for Employers and Organizations

Financial and Accounting Impact

The new gratuity rules present significant financial implications for employers across India. According to actuarial estimates, most Indian companies will see their gratuity liabilities increase by 25-50% due to the combined effect of the expanded wage definition and inclusion of fixed-term employees.

From an accounting perspective, companies must recognize this increased liability immediately under accounting standards:

• Ind AS 19 companies: Must recognize the entire gratuity liability increase immediately in the Profit & Loss statement as Past Service Cost
• AS 15 companies: Split the Past Service Cost between vested employees (recognized immediately) and unvested employees (amortized over average remaining period until vesting)

Compliance and Strategic Considerations

The new framework requires organizations to undertake several strategic actions:

Atul Gupta, Partner at Trilegal, emphasizes the urgency of compliance: “Organisations will need to take immediate cognisance of the substantive provisions that have come into force today, even while they wait for rules to be formalised.”

Employee Strategies and Considerations

For Fixed-Term Employees

The new gratuity rules fundamentally transform the value proposition for fixed-term employment. If you’re a fixed-term employee:

• Document Contract Periods: Maintain clear records of all fixed-term contracts, as even single-year engagements now generate gratuity benefits
• Understand Pro-Rata Calculations: Recognize that gratuity will be calculated based on your actual service period, with partial years exceeding 6 months rounding up to the next full year
• Negotiate Compensation Structure: When discussing new contracts, be aware that a higher basic salary component (up to 50% of CTC) will directly increase your gratuity accruals
• Verify Payout Timing: Ensure employers process gratuity payments within 30 days of contract completion, as mandated by law

For Permanent Employees

While permanent employees don’t benefit from the reduced eligibility period, the expanded wage definition still enhances their gratuity outcomes:

• Review Your Salary Structure: Analyze your current compensation breakdown to understand how the 50% wage rule affects your gratuity calculation base
• Long-Term Planning: Recognize that the increased gratuity base creates a more substantial retirement benefit than under previous rules
• Career Transition Considerations: When considering job changes, factor in the impact on gratuity accruals, particularly if moving between organizations resets your service period

For All Employees

• Tax Planning: Remember that gratuity remains tax-free up to ₹20 lakh, providing a significant tax-efficient component to your retirement planning
• Documentation: Maintain complete employment records, including appointment letters, salary revisions, and service certificates
• HR Engagement: Proactively consult with your HR department to understand how your organization is implementing the new wage calculation methodology

Implementation Challenges and Future Outlook

Transition Period Uncertainties

Despite the clear effective date of November 21, 2025, several implementation aspects remain uncertain. One significant question involves how gratuity will be calculated for employees whose service spans both the old and new regimes.

According to legal experts, “Given that the labour codes have been enforced with prospective effect, it remains to be seen whether the benefit calculations under the Codes will be bifurcated into the benefits accrued for the period prior to November 21, 2025 and after.” This means employees with long tenures might see hybrid calculations—part under the old rules, part under the new—until regulatory clarity emerges.

State-Level Variations

While the Labour Codes provide a national framework, individual states retain flexibility in formulating specific rules within this structure. This could lead to variations in implementation across different jurisdictions. Employers operating in multiple states must monitor these regional differences to ensure comprehensive compliance.

Long-Term Evolution

Most experts view the Labour Codes as a positive step toward modernizing India’s employment framework. Rahul Ahluwalia of the Foundation for Economic Development notes that the “reduced compliance burden is particularly significant for manufacturers,” though he cautions that the “services sector will now be affected by a lot of the rigid laws that used to cover only factories earlier.”

The true test will lie in implementation, especially as states begin issuing their final rules and adapting them to their local workforce structures. As Sudhakar Sethuraman of Deloitte India observes, “The codes bring greater uniformity to wage structures and key employment-related provisions. The compliance framework is aimed at being simpler, consistent and easier for stakeholders to navigate.”

Conclusion: Navigating the New Gratuity Landscape

India’s new gratuity rules represent a significant step toward expanding social security coverage and creating a more equitable compensation framework. The changes deliver tangible benefits to employees—particularly fixed-term workers—while presenting organizations with both compliance challenges and opportunities to redesign their compensation strategies.

As India’s workforce continues to evolve with increasing numbers of fixed-term, contractual, and gig workers, these regulatory changes create a more inclusive social security framework. While implementation challenges remain during the transition period, the overall direction aligns with global trends toward portable benefits and comprehensive worker protections.

The successful adoption of these reforms will depend on collaborative efforts between employers, employees, and regulatory authorities to build a gratuity system that balances worker security with organizational sustainability in India’s dynamic employment landscape.