Impact of Revised Wage Code on Gratuity Liabilities

There have been several discussions around the Revised Wage Code, which has perplexed several organisations and
made them a bit uncertain about various liabilities. Here are some key highlights and how they impact us. We see
that Gratuity will be one of the most important liability and will see a huge change and hence it’s essential to
understand that better.

The Code

It regulates: (i) Wages, (ii) Industrial Relations, (iii) Social Security, and (iv) Occupational Safety, Health and Working
Conditions
• While the Code on Wages, 2019 was passed by the Parliament, Bills on the other three areas were
referred to the Standing Committee on Labour
• The Standing Committee has submitted its report on all three Bills. The government replaced these Bills
with new ones on September 19, 2020.

Revised Definition of Wages (As per Draft Code)

Revised definition of wages states all remuneration whether by way of salaries, allowances or otherwise,
expressed in terms of money or capable of being so expressed which, would if the terms of employment, express
or implied, were fulfilled, be payable to a person employed in respect of his employment or of work done in such
employment. Wages include—
a) Basic pay
b) Dearness allowance; and
c) Retaining allowance, if any

The Code on Wages 2019 excludes bonuses, pension and PF contributions, conveyance allowance, HRA or housing
benefits, overtime, gratuity, commission, retrenchment compensation and such other things. It mandates that basic
pay will have to make up 50% of employees' CTC. Allowances to employees, like leave travel, house rent, overtime
and conveyance, will have to be limited to the remaining 50% of CTC. If any of these exemptions, in aggregate,
exceed 50% of the CTC, the extra amount will be deemed as remuneration and will be added to the wages.

New Wage Definition – Impact on Corporates

• The new definition of Wages may impact the costs of many organisations and take-home salaries for
employees
• The exclusion limit of 50% is aimed at ensuring that companies do not adopt compensation structures
which result in wages being reduced below 50% of the total remuneration.

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 • Several companies may have to re-design their compensation structures, with basic salary (and DA)
seeing an increased proportion in the total CTC / Compensation
• About a third of the Companies may have to materially increase basic salaries within the component
structures, which may impact take home salaries whilst also pushing up actuarial liabilities due to
change in underlying salary for Gratuity calculation.

An Actuarial Study* from valuation analysis in FY 20, shows that Basic salary to Gross Salary ratio of some of the
top listed Companies

5%
Less than35% % 15%
10%
35% -39%

40% -44%
20%
45% -49% 25%

50% -59%

25%
60% andAbove

***Source KPAC Actuarial Consultants (Actuary partners of Bajaj Allianz Life Insurance)

*Pie chart captures the split of Companies based on their Basic Salary (and DA) to Gross Compensation ratio

What is Gratuity

The payment of a gratuity to employees upon cessation of service is a statutory obligation imposed on employers
by the Payment of Gratuity Act, 1972 now merged to Social Security Code. In terms of the Act, gratuity is payable to
an employee on the termination of her/his employment after she/he has rendered continuous service for not less
than 5 years (a) on his superannuation or (b) on his retirement or resignation or (c) on his death or disablement due
to accident or disease (completion of 5 years is not, however, necessary for payment of gratuity in case of death or
disablement). The gratuity is to be calculated at the rate of 15/26th of a month’s wages for every completed year of
service or part thereof in excess of six months.

Nature of the Liability:

The amount of gratuity payable depends upon the terminal salary of the employee and the number of years of
service completed by him. Since the liability keeps on increasing with the completion of every year of service and
with the grant of every increase in salary, sound financial principles demand that necessary funds are set apart in
advance.

The valuation of liability is calculated by an independent actuary through assessment of salary data, proposed
wage increase (salary escalation), possible attrition and tenure of services.

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GRATUITY ACTUARIAL LIABILITY

• The “applicable wages” considered in gratuity calculation is expected to increase and may result in a
one-off increase in gratuity liability
• The one-off increase in liability shall be charged to Income Statement or Other Comprehensive Income
(OCI)depending upon the applicable accounting standard
• The extent of this one-off increase in liability will depend on the extent to which there is a need to re-
design the compensation structure

Higher than expected increase in salary (vis-à-vis the assumed salary growth rate) will result in actuarial loss
(experience loss) and an increase in the liability, with the said increase being recognised in accordance with the
applicable Accounting Standards.

Current Methods of Gratuity Fund Management.

•Shown as Liability in Balance Sheet.

•P & L Shows inflated figures.
•Paid from Companies cash as and when Liability Arises.
Pay As You Go
•Not a prudent Practice of Liability Management and can impact adversely in large attrition if liabilities are not funded
rightly.

•Can be Managed as per pattern suggested in Rule 67 (2)

Managing •Requires Day to day Monitoring and Stringent pattern does not give room for higher yield
Funds by Self •Involves exclusive manpower and has a higher admin cost & time.

•Funding with insurers help with considerably better returns without any risk.
•Income tax advantages accrue to the employer when funded with an insurer. The initial & annual contributions made
Outsourced to by the employer are allowed as deduction in full in computation of business income.
Insurer •Subject Matter expertise.

Disadvantages of following a Pay-as-you-Go method of Gratuity Payments

A. The P&L Account of the company reflects an inflated picture of the Profits/Losses of the company. In years
where there are no or minimal gratuity payments sue to death/resignation/termination etc. the profits are
overstated whereas in years where the payout is high, the same is understated.
B. Funds are not earmarked for the purpose of gratuity payouts, thereby, putting strain on the company
funds incase of winding up/dissolution of the company or incase there are several separations in any
particular year(s), as gratuity is a statutorily payable to the employees.

Considering the impact on liability It is thus recommended to

• Invest your funds so that your liabilities are appropriately provisioned. It is however important to decipher
the provisions once notified. Final shape of the code will give a clearer picture.
• It is certain that most employee benefit liabilities will see a massive change.
• Companies who are yet to fund its liability will see lot of strain in balance sheet and hence funding would
become a necessity than choice to ensure a healthy balance sheet in years to come.

Please feel free to write to me Rahul.chaurasia@bajajallianz.co.in for any queries