Salary Structuring under Labour Codes: Why the 50% Wages Rule Alone Is Not Enough
Introduction
With the advent of the Labour Codes, salary structuring has become a critical compliance area for employers, particularly for HR and Payroll professionals. Much of the discussion has centred around the 50% wages criterion, which mandates that the excluded components of remuneration should not exceed 50% of total remuneration; failing which, the excess is deemed to be wages.
While organisations have largely realigned their salary structures to meet this numerical threshold, a significant compliance risk continues to be overlooked—the nature and character of allowances parked within the salary structure. Merely satisfying the 50% test does not automatically ensure compliance.
Understanding the Definition of “Wages” under the Code on Social Security
Section 2(88) of the Code on Social Security adopts a principle-based definition of wages. In simple terms:
- All remuneration paid to an employee is treated as wages
- Unless it is specifically excluded under the statute
The Code provides an exhaustive list of exclusions such as:
- House Rent Allowance
- Conveyance allowance
- Employer’s contribution to provident fund, pension, gratuity
- Overtime wages
- Statutory Bonus (as defined)
- Leave Travel Concession
- Employment Related Expenses (Uniform & Washing, Internet and Mobile, etc)
Any allowance not falling squarely within these exclusions risks being classified as wages.
The Common Pitfall: Residual or Miscellaneous Allowances
To achieve the 50% threshold, many organisations introduce heads such as:
- Special Allowance
- Miscellaneous Allowance
- Any Other Allowance
- Residual Allowance
While these heads may help achieve a mathematically compliant structure, they raise substantive legal concerns. Such allowances:
- Are not performance-linked
- Are paid uniformly month-on-month
- Do not correspond to any specific exclusion under the Code
As a result, these allowances do not enjoy statutory protection and are vulnerable to being reclassified as wages during inspection, assessment, or litigation.
Why This Matters: Impact on Statutory Contributions
If residual allowances are treated as wages, the implications are significant. The wage base for the following statutory benefits expands:
| Statutory Benefit | Impact of Reclassification |
| Provident Fund | Contributions computed on enhanced wage base |
| Gratuity | Increased gratuity liability |
| Leave Encashment | Higher payout at separation |
| Bonus / Other wage-linked benefits | Upward recalibration |
In effect, statutory payouts will not be restricted to 50% basic salary alone, but will also include such residual allowances while computing wages.
The Way Forward: Safer Salary Structuring
Employers are advised to undertake a comprehensive review of allowance design, not just wage percentages. Best practices include:
- Avoid parking amounts in vague or residual allowance heads
- Align allowances strictly with recognised statutory exclusions
- Clearly define the purpose, eligibility, and variability of each allowance
- Ensure documentation and payroll logic supports the exclusion claimed
Where exclusions are intended, they should be parked in “safer heads” that are expressly recognised under the Code and supported by policy documentation.
Conclusion
The 50% wages rule is a necessary but not sufficient condition for compliance under the Labour Codes. True compliance requires a deeper evaluation of what constitutes wages, not merely how wages are split.
HR and Payroll professionals must move beyond formula-based structuring and adopt a risk-based, principle-driven approach to salary design. A proactive review today can help avoid substantial financial exposure and litigation risk tomorrow.
CA Darshan Balai
darshan@payrule.in