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Income Tax Under the New Code on Wages: Challenges and Solutions

By greytHR
4 minute read
April 08, 2022

What is the definition of wages as per the new labour codes? What is covered? What is excluded? What is the taxation impact of the new code? What are the uncertainties?

Aparna Surabhi, CFO, Caliber Technologies, Ramesh Padmanabhan, GM ‒ Labour Law & Compliance, Team Lease and Anurag Jain, Co-founder, ByTheBook joined us at our Parichay webinar series to answer these questions and give us a better understanding of the tax implications of the new Code. Here are the highlights.

Wages Defined

  • Several laws have been subsumed into 4 broad labour codes: The Code on Wages, the Code on Social Security, the Industrial Relations Code, and the Occupational, Safety, Health and Working Condition Code.

  • Every establishment in the country will be covered under the new Code

  • Central legislation had different definitions and interpretations of the term wages. The new labour codes aim to create a single definition of wages that everyone understands.

  • The new definition includes all the salary components that can be expressed in terms of money (i.e., Basic pay + DA + retaining allowance)

  • The legislation has carved off the below exclusions to a limit of 50% of the total remuneration (excluding gratuity and retrenchment compensation).

  • Statutory bonus, accommodation by the employer, employer’s contribution to pension/provident fund, conveyance allowance, HRA, remuneration under any award or settlement, OT allowance, commission, gratuity on termination, etc.

  • Retrenchment compensation or other benefits paid on retirement are excluded.

  • When remuneration is paid in kind, only its value of up to 15% of the total wages is considered. The balance is excluded.

  • As per the OSH Code, employees (earning more than INR 18,000) in the supervisory, managerial, or administrative capacity are excluded from the definition of worker.

Wage Calculation: An Illustration

An employee’s total remuneration is 40,000. His specific exclusions add up to 22,000 (2,000 more than the permitted 50% of the total). The new wage definition adds the extra amount back to the remuneration/wages.

Gratuity

  • If gratuity is part of the CTC, then the employee’s take-home salary will change. If it’s paid in addition to the CTC, the organisation has to increase that outflow because of the wider definition of wages.
  • If the restructuring is done by including gratuity in an employee’s CTC, there is no impact on the employer’s overall cash outflow.

Leave

  • Encashment of accumulated leave (more than 30 days) will be paid on the basis of the wage component. Hence, the revised wage definition increases the cash outflow in this case.
  • Until now, unavailed leaves could be carried forward to the next year and encashed during exit. As per the amended law, these earned leaves can be encashed during every year-end.

Provident Fund

  • The Code is likely to impact only those employees (drawing less than 15,000) who are mandatorily required to contribute to Provident Fund.
  • Employees crossing the aforesaid salary threshold can contribute voluntarily to PF. Their organisation could give the option to contribute 12% of the newly defined wage or 12% of 15,000.

Overtime

  • Overtime implies twice the amount of normal wages. Therefore, the wider definition of wages will impact this component too.
  • The Code has an anomaly in the coverage of overtime. So, it is possible that employees with high pay might claim overtime, and this could lead to a higher cash outflow for organisations.

Example: During the peak filing season, busy employees of a CA firm are likely to put in a lot of overtime.

Bonus

The Payment of Bonus Act increased the bonus threshold to INR 21,000 to cover more employees. In the proposed changes, the bonus threshold will be declared separately by the respective states and union territories.

Tax Liabilities

If the CTC model is followed, and no additional amount is paid, there is no impact on the profits or the tax liability of the organisation.

If a voluntary PF contribution is made after restructuring, the employer’s contribution will increase and the employees’ take-home salary will reduce. In case the employee opts for the new regime (with permissible deductions), there may not be an impact on the tax paid.

If the employer’s contribution to PF is higher than the gross (in the gross salary model), it would lead to an increase in the outflow of the employer’s contribution. This will also decrease the profits and increase the tax liability of the organisation.

Uncertainties

If an organisation wants to handle compliance in a hassle-free manner, they need to invest in the right technology.

The threshold of certain allowance/benefits (like ESI) has not been notified. This could lead to a legal void.

A shop or commercial establishment with 10 or more employees will come under the ambit of the OSH Code. Earlier, these entities were regulated at the state level. The new code has not clarified the impact on organisations with less than 10 employees.

Some ambiguities still exist in terms of how performance pay, incentives and commissions are treated.

Included in wages, retaining allowances are payable to an employee of a factory or another establishment during a period when it is not working. This usually applies to seasonal industries where employee retention is a challenge.

Concluding Notes

The government was expected to put all these labour codes into effect on October 1, 2021. But the pandemic seems to have played spoilsport. They are now likely to implement the same in the upcoming fiscal year. Alternatively, the codes could be enacted on a staggered basis.

Despite all the uncertainties, two facts come to the fore: The changes made by the new Code are likely to impact the profitability of organisations. Also, the technology companies have to be well-prepared to accurately feed all these components and exclusions into their systems.

Watch the recording of the entire webinar.

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