Debunking four common myths about the Code on Wages, 2019: What HR leaders need to know

While the four Labour Codes have largely come into force in India since 21 November 2025, an unofficial fifth code remains firmly in active circulation: the code of misinformation. Alarmist newspaper headlines and unverified WhatsApp commentaries have provided fertile ground for this fifth code to flourish. 

Resultantly, HR professionals, who are at the forefront of navigating organizational transitions to the new legal framework, find themselves surrounded by confounding and often conflicting advice. 

As organizations undertake compliance gap assessments, the Code on Wages, 2019 (“Code”) has invariably emerged as the first point of focus among the four Labour Codes, owing to its broad applicability across various categories of establishments and employees. 

Against this backdrop, we have attempted to debunk four recurring myths about the Code by separating fact from fiction.

1. Myth: Basic salary must constitute at least 50% of the CTC under the Code

One of the most headline-grabbing interpretations following the enactment of the Code was that an employee’s basic salary cannot be less than 50% of the CTC. Unsurprisingly, this triggered a salary restructuring frenzy among organizations across the spectrum. 

In reality, however, neither does the Code mandate salary restructuring nor does it make any mention of the concept of CTC.  Instead, the Code defines “wages” broadly, bringing within its sweep various kinds of remuneration including basic pay, dearness allowance and retaining allowance. 

This is followed by a specific list of exclusions such as statutory bonuses, employer PF/pension contributions, house rent allowance, conveyance allowance, overtime allowance, commissions, certain employment-related expenses and the value of specified amenities. 

The definition then stipulates that if the aggregate value of these exclusions exceeds 50% of the total remuneration, the excess will be “deemed as remuneration” and be added back while calculating wages. 

Essentially, the 50% rule operates as a statutory deeming fiction for computing specific wage-linked entitlements (such as certain social security benefits and terminal payouts), rather than dictating the reshuffling of existing salary components. 

Nevertheless, many employers have restructured salaries, as a matter of administrative convenience and payroll simplification, to avoid the hassle of performing add-back calculations each time a wage-linked entitlement needs to be computed. 

However, in doing so, employers must be mindful of the critical but oft-neglected principle underlying section 124 of the Code on Social Security, 2020.  Section 124 prohibits an employer from reducing the wages or benefits of an employee merely on account of the employer’s liability to pay contributions or charges under the Code on Social Security, 2020. 

This anti-reduction intent is further amplified by the Ministry of Labour and Employment’s FAQs (dated 24 December 2025). The FAQs clarify the following objective of the revised wages definition: “allowances exceeding a fixed percentage…are added back to wages, increasing the base for PF, gratuity, and bonus… [to] strengthen social security of employees.” 

2. Myth: Any CTC component labelled variable pay will fall outside the wage reckoning 

“What’s in a name?” asked Shakespeare’s Juliet, and this question rings especially true in the context of variable pay. CTC components which are fixed in substance but are merely labelled as variable will not necessarily be exempted from the definition of wages. 

As a rule of thumb, variable pay by its very nature, should be contingent on the achievement of measurable performance criteria set out by the employer. 

Historically, courts in India have recognised a distinction between fixed wages and genuine incentive-based earnings. For instance, in Muir Mills Co. Ltd., Kanpur v. Its Workmen (AIR 1960 SC 985), the Supreme Court affirmed that production and incentive bonuses do not form part of basic wages since they vary based on the employee’s efficiency and diligence.

But what does the Code say about variable pay? 

Pertinently, while section 2(y) of the Code defines wages, it is silent on whether variable pay should be treated as an inclusion or an exclusion under the definition. 

This vacuum caused considerable uncertainty among employers while they were in the midst of assessing the financial impact of the new wages definition. 

However, on 30 December 2025, the Ministry of Labour and Employment issued FAQs clarifying that “performance based incentives, Employee Stock Option Plans (ESOPs), variable part of the component or reimbursement-based payments to the employee shall not be part of the wages.” 

This position was further reiterated in the Ministry’s FAQs issued on 16 March 2026 which affirmed that: “Annual performance-based incentives do not form a part of ‘wages’ for computation under the Labour Codes.”

Accordingly, there is a reasonable basis for treating bona fide performance-linked variable pay as falling outside the definition of wages under the Code. However, this should not be treated by employers as carte blanche to exclude a CTC component which is fixed in substance but variable in name from the wage reckoning. 

Additionally, there is an important caveat that bears mentioning: the Ministry’s FAQs constitute administrative guidance and do not amend the statutory definition of wages. Hence, the current practice of employers carving out genuine variable pay from the purview of the wages definition remains subject to future legislative and judicial clarifications. 

3. Myth: The whole full and final settlement must be cleared within two days of an employee’s exit

Since the enactment of the Code, numerous misconceptions have circulated around the timeline for full and final settlements. Section 17 of the Code merely stipulates that upon the termination or resignation of the employee from service, the “wages payable to him shall be paid within two working days of his removal, dismissal, retrenchment or, as the case may be, his resignation.” 

It becomes quite apparent on a plain reading of this provision that section 17 makes no mention of the concept of “full and final settlement”. 

What the section essentially requires is that those parts of the full and final settlement which constitute wages under the Code should be paid within the two working days’ timeline. The rest of the full and final settlement components are likely untouched by this timeline, subject to any specific laws or company policies governing their clearance. 

For instance, terminal gratuity payments will continue to follow their statutory settlement timeframe of 30 days. 

However, for leave encashment, the position is more nuanced and may require an examination of the applicable shops and establishments legislation, the Occupational Safety, Health and Working Conditions Code, 2020 and the relevant employment terms. 

Thankfully, some payroll software companies have retooled their salary processing models to enable employers to keep in sync with the revised wage settlement timelines prescribed by the Code.

4. Myth: There is a grace period for linking gratuity payments to the revised wages definition

As the definition of wages has expanded under the Code, the corresponding gratuity payout liabilities for many employers have soared too. In that regard, several industry representations were made before the government voicing concerns about increased costs arising from enhanced gratuity liabilities, but requests for a grace period were denied. 

The Ministry of Labour and Employment, in its 16 March 2026 FAQs, clarified that “Gratuity, based on revised definition of wages will be applicable w.e.f. 21.11.2025 i.e. date of implementation of the Codes”, thereby putting to rest any prospect of a grandfathering period. 

This clarification notwithstanding, many employers remain blissfully unaware that the clock for revised gratuity calculations has already started ticking and may, therefore, unwittingly expose themselves to penalties under the Labour Codes for shortfalls in gratuity payments. 

Conclusion: 

The four myths highlighted above represent only the tip of the misconceptions iceberg. Many others continue to proliferate, even months after the enactment of the Code. 

In fact, public commentary surrounding the new definition of wages can be likened to interpretations of the Mona Lisa: what is included and excluded has become the subject of great intrigue and fierce debate. And while the final compliance landscape will continue to evolve with the notification of state rules, it is crucial that HR teams have a firm grasp of the foundational concepts underlying the Code that have already crystallized. 

HR professionals should strike the delicate balance between securing employee interests and avoiding knee-jerk reactions that could set unsustainable precedents for the organization. 

In our experience, proactive HR leaders are taking several steps to perform this balancing act effectively. 

These steps include seeking professional advice on the cost implications and interpretational issues arising from the new definition of wages and undertaking corresponding revisions to employee documentation, including employment agreements and policies. 

To reduce operational headaches, HR teams are also digitizing their payroll systems to align with the revised wage payment timelines and processes under the Code. Additionally, employee town halls are being used as effective forums for explaining the impact of the Code on salaries and benefits, while internal FAQs are proving to be handy tools to address employee queries under the Code in a consistent way. 

Such measures enable HR teams to respond to persistent myths about the Code in a more sure-footed manner, while mitigating the legal and reputational risks associated with arbitrary or ad hoc decision-making.

About the author: Parinaz Madan is a Partner at Counsel & Co., where she leads the employment law practice. She completed her LL.B. from Government Law College, Mumbai and has qualified as a solicitor from the Bombay Incorporated Law Society. 

Disclaimer: This article is intended to provide general information and should not be substituted for context-specific professional legal advice. Neither the author nor Counsel & Co. shall be responsible for any loss whatsoever sustained by any person relying on this article.