Payroll Finance Function- Part 1: Labour Laws Compliance

The role of finance in payroll can be classified into four core pillars: Labour Law Compliance, Tax Law Compliance, Payroll Accounting, and Financial Controls & Provisions.

We shall discuss Labour law compliance in this article

Labour Laws Compliance

In shorts: Provident Fund, ESIC, Professional Tax, Gratuity, Bonus - all statutory obligations to be monitored and filed by Finance and also to ensures wage structures align with the New Wage Code.

The labour law related compliance can be divided into two sections. One is relating to the obligations relating to statutory deductions and another is compliance to New wage code.

Part A- New Wage code:

The detailed impact of new labour code for the topic under discussion is listed and summarized below:

1. The 48-Hour Full & Final Settlement Rule: When an employee resigns, is dismissed, or face retrenchment, Finance must compute and fully disburse all salary, statutory bonuses, and leave encashment payouts within 48 hours of their last working day. So, no question of processing final settlements in the standard next-month payroll cycle.
2. 50% statutory floor rule : Section 2(y) of the Code on Wages mentions about Meaning, Basic Salary + Dearness Allowance (DA) + Retaining Allowance must legally comprise at least 50% of the employee’s total remuneration (Gross CTC).

   The Section also provides that if an employee’s total variable allowances including overtime payout, exceed 50% of their total monthly remuneration, the excess amount automatically cascades back into the statutory "Wage" definition. (ie excess portion is automatically reclassified as "Wages”)

   Why? In the past, organizations suppressed Basic Salaries to 30–40% of the overall Cost to Company (CTC) and the remainder was packaged into flexible allowances (e.g., Special Allowance, LTA) to limit statutory contribution, which are mostly based on basic pay.

3. Accelerated One-Year Gratuity Provisions: As far as Fixed-term employees (FTEs), Contract workers directly employed on fixed-term contracts are concerned, Finance department shall create provisions wrt gratuity payouts for those FTEs who finishes 12 months of service. Continue provisioning for permanent employees under the 5-year rule.
4. The 50% cap on Net Deduction (for employees): Under the new rules, the total cumulative deductions allowed from an employee's monthly payslip including statutory taxes, PF, advances, and recoveries from salary cannot exceed 50% of their total monthly wages.
5. Worker Reskilling Fund: For every worker retrenched, the employer must contribute an amount equal to 15 days of the worker's last drawn wages into a government-managed Worker Re-Skilling Fund. The employer must electronically transfer these liquid funds to the government within 10 days of the retrenchment action.

   The government will then credit this amount to the worker’s account within 45 days of retrenchment, making employee layoffs more expensive for corporate cash reserves.

Part B- Compliance wrt Statutory deductions

Employees' Provident Fund (EPF) Management

1. Dual Contribution % : Finance department is responsible for calculating a matching 12% deduction from the employee and a 12% contribution from the employer.
2. Salary limit: PF contributions are normally calculated at 12% of basic pay + DA, but for statutory purposes the wage ceiling is capped at ₹15,000. Thus, mandatory PF contributions are limited to ₹1,800 each from employee and employer.

   But, employees can opt for Voluntary Provident Fund (VPF) to contribute more than 12% . VPF allows contributions up to 100% of basic pay + DA. Employers, however, are not required to match contributions beyond the statutory ceiling.

   However, under the New Wage Code, this limit will apply to an expanded base since the core basic wage must legally comprise at least 50% of the total Gross CTC.
3. Admin cost: Finance pays an extra 0.50% administration fee (under EPF Account No. 2) directly from company expenses. It does not cut this from the employee's pay.
4. The 15th-Day Monthly Deadline: All collected PF funds must be reconciled and paid to the EPFO portal by the 15th of the following month.
5. Compensatory fine: If an employer delays depositing PF contributions, they must pay 12% p.a interest on the delayed amount. This is a compensatory interest, meant to cover the loss to employees because their PF money wasn’t deposited on time. (Section 7Q)
6. Punitive damages: In addition to interest, the PF authorities can impose penalty damages for default, to discourage employers from delaying PF deposits. The penalty can range from 5% to 25% of the arrears, depending on how long the delay continues. (Section 14B)

Employees' State Insurance Corporation (ESIC)

Finance manages the medical insurance fund through the official ESIC Portal.

1. Which employer is Covered: ESIC becomes mandatory once the company employs 10 or more persons (includes permanent ees or casual/temporary workers or contract staff or part-timers or apprentice or probation staff). Once covered, the obligation continues even if headcount later drops below the threshold.

   The Company here refers to Factories using power, Shops, hotels, restaurants, cinemas, transport services, educational institutions (depending on the state laws). There are exempted establishments too, which for the sake of brevity isn’t listed here.

2. Salary limit for coverage: Even if an establishment is covered, only employees earning up to ₹21,000/month are eligible for ESIC benefits.
3. Contribution: Every month, Finance deducts 0.75% from the employee's salary and adds a 3.25% contribution from the company funds.
4. Hazardous Work Rule: If the company operates in a risky environment (like a factory handling hazardous materials), ESIC must be paid for every single employee from day one, regardless of the usual headcount limits.

Regional Taxes (Professional Tax & Labor Welfare Fund)

1. State-Specific Slab Deductions: Finance must track and deduct localized Professional Tax based on employee work locations, such as Government of Tamil Nadu levies PT subject to maximum cap of ₹1,250 every six months.
2. Bi-Annual Welfare Fund Remittances: Contributions to the Labour Welfare Fund consisting of small dual payments from both employer and employee, shall be deposited twice a year, within the June and December due dates.

Payment of Gratuity & Liability Provisioning

1. Formula for Gratuity calculation: Upon an employee's exit, Finance must compute their legal gratuity payout using the mandatory formula: (Last Drawn Wage × 15 × Years of Service) ÷ 26.

   Note: Because the New Wage Code expands the basic salary component to a 50% minimum, the "Last Drawn Wage" baseline spikes.

2. Gratuity for FTEs: As already discussed under New labour code provisions, Gratuity funds must be provisioned for Fixed-Term Employees immediately after 12 months of service. 5 Year rule doesn’t apply to them.
3. Tax free limit: gratuity payouts up to ₹20 Lakhs are kept tax-free during final settlements. in case of pyt exceeding 20L, the excess portion becomes taxable.

   Remember, ₹20 Lakhs is the maximum life time exemption that an employee can claim under Gratuity in his life time, while deducting tax on gratuity payouts.

Statutory Annual Bonus Allocations

1. Bonus %: By law, the annual bonus must be between a minimum of 8.33% and a maximum of 20%, calculated on employee's basic salary+ DA.
2. Cap on Salary: The bonus is calculated on ₹7,000 or the state minimum wage (whichever is higher), even for high-earning staff.
3. Who is eligible? Finance department must review attendance records to ensure any worker with at least 30 working days in the financial year is included in the bonus payout.