Background

On November 21, 2025, the Government of India brought into force the 4 Labour Codes[1]. Among the most consequential amendments is the standardized definition of “wages” under the Code on Wages, 2019. The new definition of “wages” covers all remuneration paid to an employee in respect of their employment, except for a specified list of exclusions (such as house rent allowance, bonus, pension/provident fund contributions, conveyance allowance, gratuity, etc.). Further, if the cumulative value of those specified exclusions exceeds 50% of the total remuneration, the excess amount will be deemed as ‘remuneration’ and added back to the “wages” for calculation purposes.

The intention of legislature, while drafting the definition of ”wages” seems to eliminate the practices of undervaluing the contributions to social security, specifically inflating allowances while suppressing the basic pay component in the cost-to-company (CTC) structure of an employee. Notably, this change codifies the “universality” principle laid down by the Supreme Court in Regional Provident Fund Commissioner v. Vivekananda Vidyamandir [2]. In that ruling, the Court held that any allowance that is universally, necessarily and ordinarily paid to all employees effectively forms part of basic wages for must be included for calculating Provident Fund (PF) contributions.

Tax Implications

Employee

The expanded wage base will potentially increase contributions to be made under the social security framework leading to a reduced take-home salary for employees. While this lower in-hand pay is a challenge, it is offset by opportunities for enhanced retirement savings and potentially lower annual income tax liability due to larger tax-deductible contributions under old tax regime.

Employer

It is a common practice among the employers to negotiate compensation on a CTC basis which means the social security contributions made by the employer are factored into the total remuneration packages. Accordingly, a higher wage base will increase the contributions to be made by the employer and consequently, CTC of the employee (unless restructured by the employer).

Transfer Pricing (TP)

The employee costs form a significant component of the operating costs of Indian entities of MNCs, especially captive units such as information technology, contract research & development, marketing entities, etc. The higher contributions to be made by the employer will have to be factored in the operating cost base for TP purposes. Such increase in the operating costs will have impact on the arm's length pricing (ALP) of intra-group services and necessitating updates to TP working, documentation and benchmarking analysis.

Secondment

Generally, in a secondment arrangement for an expat working in India, the foreign entity pays the offshore component of the remuneration (including offshore social security contribution) while the Indian entity makes payment of the onshore component. Following the implementation of the Labour Codes and the adoption of the revised definition of “wages”, the salary components may require revision, thereby impacting ALP of such secondment arrangement. Consequently, the documentation and working for TP purposes need to be updated.

General Anti-Avoidance Rule (GAAR)

In case salary components are aggressively restructured with a view to reduce the increased costs / tax liability, there is an exposure that such restructuring could be scrutinized by the tax authorities under GAAR if the arrangement is deemed to lack commercial substance and its main purpose is to obtain a tax benefit and consequently may be classified as an Impermissible Avoidance Arrangement. In such cases, the authorities have the power to disregard the arrangement entirely to deny the intended tax benefits.

Conclusion

The new definition of 'wages' under the Labour Codes is a watershed reform designed to enhance social security for India's workforce and curb wage-structuring practices that diluted statutory benefits. While it promises long-term advantages for the employees in the form of a larger retirement corpus, the transition is fraught with challenges. Employers face immediate financial pressure from increased costs and employees, in turn, will have to adjust to lower take-home pay. By treating the new wage definition as a comprehensive business restructuring challenge rather than a simple payroll update, MNCs can build a resilient and defensible tax position that withstands scrutiny from tax perspective in India.

Reference

  1. Code on Wages, 2019, the Industrial Relations Code, 2020 , the Occupational Safety, Health and Working Conditions Code, 2020 , and the Code on Social Security, 2020 (collectively, the “Labour Codes”).
  2. Regional Provident Fund Commissioner v. Vivekananda Vidyamandir, Civil Appeal No. 6221 of 2011, before the Hon’ble Supreme Court of India.

Author:

Gyanendra Kumar Mishra, Partner

Disclaimer

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.