The Code on Social Security aims to amend and consolidate the laws relating to social security benefits for employees in India. The code has been passed by both houses of the parliament and has received the President’s assent. It was expected to become effective starting 1st April 2021. However, the implementation of the code has been temporarily postponed to a future date.
Based on the codifications which were supposed to be made effective on 1st April 2021, we see three major changes that companies will face while paying and provisioning for gratuity. These three changes and our assessment of the likely impact of these changes are explained below.
Definition of “Wages”
Change
Gratuity is currently calculated on the Basic Salary plus Dearness Allowance (if any). Under the new code, the wages for calculating gratuity will include all remuneration except the components listed below:
- Bonus payable under law
- Value of any house accommodation or the supply of light, water, medical attendance or any amenity or service excluded from computation of wages by special government order
- Any contribution made to a pension fund or provident fund and any interest which may accrue on the same
- Any conveyance allowance or value of travel concession
- Any sum paid for defray of expenses
- House rent allowance
- Remuneration paid under any award or settlement
- Any overtime allowance
- Any commission payable to the employee
- Any gratuity paid on termination
- Any retrenchment benefit or retirement benefit or ex-gratia paid on termination
Additionally, if the components 1 to 9 listed above account for more than 50% of the employee’s total remuneration, then the portion which exceeds 50% of total remuneration will be deemed as “wages” for the purposes of calculating gratuity.
Impact
The impact can be substantial for employers who currently have a compensation structure where Basic Salary plus Dearness Allowance is substantially below 50% of employee’s total remuneration. The increase in liability will be lower for companies who have a gratuity policy where the gratuity payment is restricted to the ceiling of INR 2 million as against those where no such monetary ceiling is applied.
In effect, the “wages” which will be used to calculate gratuity will be the greater of:
- the total remuneration minus the sum of the components 1 to 9
- 50% of the total remuneration
Hence, the “wages’ that will now be used for the calculation of gratuity will effectively be a minimum of 50% of the total remuneration of the employee.
Fixed-Term Contract Employees
Change
The vesting criteria of completing 5 years of service to be eligible for gratuity will no longer be applicable to fixed-term contract employees. There is no change in the vesting condition of 5 years for full-time employees. Under the proposed code on social security, fixed-term contract employees will be entitled to gratuity on the basis of their proportionate service with the company regardless of the number of years of service they have put in.
Impact
As a result of this change, companies having a large proportion of fixed-term contract employees will now see an increase in their gratuity liability provision in order to allow for the gratuity becoming payable to these employees. Even if the fixed-term contract employees have been employed through a third party contractor under a “cost-plus” model, the cost of this increase is likely to be passed on by the third party contractor to the company, thereby increasing the indirect cost for the company.
Mandatory Funding of Gratuity Benefits
Change
From a date to be specified by the government in the future, it shall be mandatory for all entities (except those belonging to or being under the control of the Government), to obtain insurance i.e. set up a gratuity fund with LIC or another approved insurer, for the liability for payment of gratuity to their employees.
This requirement will not be imposed on:
- entities that already have an approved self-managed gratuity fund
- entities that employ more than 500 individuals and establish an approved self-managed gratuity fund in the future
Impact
There will be no implication of this change for entities who have already funded their gratuity liability. However, entities having an unfunded gratuity will need to start funding this liability externally.
This provision can result in an opportunity cost to the company as they would have to inject cash into the gratuity fund to finance the liabilities, which could have been used elsewhere in their business. For companies that have a very high cost of borrowing and have unfunded gratuity liabilities, we expect to see a negative impact on their P&L account.
If you have any further questions on the above implications of the Code of Social Security, please feel free to reach out to us through our Contact Us Page.
Disclaimer: Please note that the above content is only for informational purposes and is based on our understanding of the subject. It should not be relied upon or constructed as a legal opinion or advice regarding any specific issue or factual circumstance.