India’s wage and compensation landscape is entering a new and progressive phase. The implementation of the four labour codes, effective 21 November 2025, together with the new Income‑tax Act and Rules coming into force from 1 April 2026, marks a coordinated effort to modernise how salaries, benefits and social security are governed.At the heart of this transition is a unified definition of “wages” under the labour codes – a seemingly simple reform that brings consistency and transparency to pay structures that have evolved over decades. This shift is expected to strengthen the link between earnings, statutory benefits and long‑term social security. At the same time, the proposed revisions to income‑tax exemption limits are expected to enable employees to claim higher tax exemptions on select allowances and benefits, improving the overall treatment of compensation.In this environment, employers must carefully balance the wage definition under the labour codes with the revised income‑tax rules while evaluating the impact on compensation arrangements. Different components of pay now need to be reviewed through both statutory and tax lenses, requiring organisations to reassess implications on costs, benefits and competitiveness.
How salary structures traditionally worked
To understand the magnitude of the change, it is useful to revisit how salaries have typically been paid in India. Most organisations follow a Cost‑to‑Company (CTC) model, under which total compensation is split across multiple components. These usually include basic salary, allowances such as house rent allowance (HRA), special allowance, conveyance allowance, and employer contributions to provident fund and other benefits.Over time, many employers adopted compensation models where a portion of the CTC was paid as basic salary, with the balance distributed through allowances and reimbursements. This approach served two broad purposes. First, it limited the base on which statutory contributions such as provident fund and gratuity were calculated. Second, it often enhanced short‑term take‑home pay for employees, particularly where certain allowances or reimbursements enjoyed tax exemptions.
Labour codes and the new definition of wages
The labour codes seek to replace this variability with greater uniformity. Under the new framework, the definition of wages has been standardised across all four codes, creating a single reference point for calculating statutory benefits.Wages broadly include all remuneration payable for employment, subject to specific exclusions such as house rent allowance, conveyance allowance, statutory bonus, commission, specified reimbursements, and retirement benefits. Any salary component that does not fall within the prescribed exclusions may be treated as wages.A key feature of the framework is the introduction of a structural threshold. Excluded components cannot exceed 50% of total remuneration. Where this limit is breached, the excess is automatically included within wages. This effectively establishes a minimum level for wage‑linked components such as basic salary, dearness allowance and other included elements.The intent is to curb excessive fragmentation of pay and ensure that social security contributions are calculated on a more representative earnings base.It is also important to address a common misconception. Even organisations where basic salary is set at 50% of gross remuneration may be impacted. Where components such as special allowance form part of the overall pay arrangement, they may still be required to be included within wages, depending on how total remuneration is configured.
Inter‑play with the new income‑tax rules
On 7 February 2026, the draft Income‑tax Rules, 2026 were released for public consultation, signalling important changes in the tax treatment of certain allowances and benefits.As per the proposed rules, where an employee owns and uses a motor car for both official and personal purposes, the tax‑exempt limit for running and maintenance expenses borne by the employer has been increased to Rs 5,000 per month (plus Rs 3,000 per month for a chauffeur, if provided), from the current limits of Rs 1,800 and Rs 900 respectively. Higher limits apply for cars with larger engine capacity. Corresponding increases have been made to taxable perquisite values where cars are owned or hired by employers.The exemption limit for free food and non‑alcoholic beverages provided during working hours—whether at office premises or through paid vouchers—has been enhanced to Rs 200 per meal, up from Rs 50.The list of cities eligible for a 50% HRA exemption under the old tax regime has been expanded beyond the four metros to include Bengaluru, Hyderabad, Pune and Ahmedabad.
The exemption limit for Children Education Allowance under the old tax regime has been increased to Rs 3,000 per month per child (from Rs 100), subject to a maximum of two children.The interaction between the labour codes and the income‑tax framework also needs to be viewed in the context of the old and new tax regimes. For instance, HRA is specifically excluded from the definition of wages under the labour codes. From a tax perspective, HRA may be partially exempt under the old tax regime, subject to prescribed conditions, while remaining fully taxable under the new tax regime. Similarly, the revised income‑tax rules provide for a higher tax‑exempt ceiling for free food and non‑alcoholic beverages, including meal vouchers, while the draft central rules under the labour codes propose to exclude meal vouchers from the definition of wages. These examples illustrate that the tax treatment of a component and its treatment under labour codes can differ, and that both frameworks operate independently, though in parallel.
Impact on gratuity and provident fund contributions
The revised definition of wages has important implications for social security. Benefits such as gratuity and leave encashment will now be calculated based on the new wage definition, which could increase employer outgo where the wage base expands.Provident Fund contributions, however, remain unchanged for now. Provident Fund contributions may continue to be calculated on the statutory wage ceiling of Rs 15,000 per month, or such revised ceiling as may be notified under the EPF Scheme. Employers and employees may continue contributing at 12% of basic salary where basic salary exceeds the ceiling, even if wages under the labour codes are higher. This ensures continuity and avoids an automatic reduction in take‑home pay solely due to the new wage definition.
Managing the transition
From a compliance perspective, the introduction of a uniform wage definition reduces ambiguity and interpretational disputes, particularly for organisations operating across multiple states. At the same time, employers will need to evaluate the financial implications arising from higher wage‑linked statutory benefits and ensure that systems, payroll processes and HR platforms are aligned with the new framework.An important safeguard during this transition is provided under Section 124 of the Code on Social Security. This provision prohibits employers from reducing an employee’s wages or benefits solely on account of increased statutory contribution requirements.For employees, the changes bring greater clarity on how different elements of pay are treated for statutory benefits and tax purposes, reinforcing transparency around earnings and long‑term social security coverage.Looking aheadAs central and state governments finalise supporting rules and enforcement gathers pace, the practical impact of the labour codes will become clearer. In the near term, proactive planning will be critical to managing the transition smoothly.Over the longer term, India’s new wage framework represents a structural shift toward greater consistency, predictability and alignment between labour and tax laws. By strengthening the link between earnings and social security while allowing appropriate tax relief on select benefits, the reforms mark a significant step in the evolution of India’s world of work.(Puneet Gupta is Partner, People Advisory Services Tax at EY India)
