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 ensure 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 w.r.t the topic under discussion is listed and summarized below:

1. 50% Cap rule : As per Section 2(y) of the Code on Wages provides that the Wages (aka Core Wages or Statutory wages) shall strictly comprise Basic Salary + Dearness Allowance (DA) + Retaining Allowance.

   The Section also provides that the Specified exclsuions that include HRA, Conveyance, overtime payout and bonus shall not exceed 50% of employee's total monthly remuneration. If these exclusions exceed 50%, the excess amount is automatically reclassified as wages.

   Why? In the past, organizations suppressed basic Salaries to 30–40% of overall 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.

2. 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.
3. 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.
4. 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.
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 : The primary legislation governing EPF management is: Code on Social Security. The Key objective of this code is to institutionalise mandatory long-term savings among industrial and corporate workforces. Both employers and employees contribute to this fund, which earns interest over time and builds a financial safety net for retirement.

1. Applicability Threshold : EPF is applicable to Employees whose Basic + DA + Retaining allowance ≤ ₹15,000/month. For salaries above the ceiling, employees can voluntarily choose to opt for Voluntary Provident Fund (VPF) and contribute even up to 100% of their core wages, though employers are not legally obligated to match any contributions beyond the statutory requirement.
2. Dual Contribution % : Every month, the employer deducts 12% of core wages from the employee's salary and contributes a matching 12% from business's own funds. Out of the employer’s 12% contribution, 8.33% goes to the Employees Pension fund, while the remaining 3.67% stays in the Provident Fund.
3. Admin cost: Employer Overhead: An additional 1% of Core Wages is paid entirely by the employer, split as 0.50% for life insurance (EDLI) and 0.50% for administrative fees. Its borne by the company and is not deducted from the employee's pay.
4. The 15th-Day filing Deadline: All the PF funds collected shall be paid to the EPFO through the ECR portal by 15th of the following month.
1. 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)
2. 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)

The law governing ESI operations is the Code on Social Security. Its objective is providing comprehensive healthcare and financial shielding for workers.

1. Applicability Threshold: For an employer, Registration under ESIC law is mandatory if the establishment employs 10 or more people, even on any single day of the preceding 12 months. ESI Coverage is applicable ONLY to those Employees whose Basic + DA + Retaining allowance is ≤ ₹21,000/month. If an employee's Core wage is above ₹21,000, they are completely excluded from the scheme. Neither the employee nor the employer can choose to voluntarily pay ESI premiums for that employee to access the ESIC's medical benefits.
2. Exemptions to the Headcount Rule: 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 under law. Also, Establishments with fewer than 10 employees can choose to voluntarily register under ESIC, if both the employer and employees mutually consent.
3. Contribution rate : Every month, the employer deducts 0.75 % from the employee's monthly wages and from its side, contributes 3.25% from its own funds. Employees earning an average daily wageof ₹176 or less are completely exempt from their 0.75% deduction. The employer must still pay the 3.25% share.
4. Contribution Period Lock: ESI operates in fixed 6-month blocks (April–September and October–March). If an employee's wages cross ₹21,000 mid-cycle, deductions cannot be stopped until the end of that specific six-month contribution period
5. Remittance: A mandatory regional tax governed entirely by individual State Legislations to fund medical, housing, and educational welfare for lower-income workforces. Collected funds must be deposited to the government by the 15th of the following month. The penalty framework for delay/default in remittance is identical to PF compliance.

Regional Taxes

Professional Tax: Governed by individual State Legislations via explicit permission from Article 276 of the Constitution that allows states to bypass the Central Government's exclusive right to tax income).The contributions collected by state governments (through City Corporations/local bodies) fund the public infrastructure and public welfare initiatives.

1. It’s a regional tax on income earned through employment, profession, or trade, authorized under Article 276 of the Constitution of India.
2. Eligibility : Any business establishment with even a single employee must register for PT and obtain Enrolment Certificate for the business. As far as employees are concerned, Deductions for PT apply only if gross income* exceeds 21,000 per half-year.
3. Overall cap: Finance department must deduct localized Professional Tax based on employee work locations. for example Government of Tamil Nadu levies PT on income based slabs, collected semi-annually. But Delhi, Haryana, and Rajasthan do not levy professional tax at all. However, The irrespective of State, PT is subject to overall cap of ₹2500 per year.

   * The concept of core-wages apply only to central statutes

Welfare Fund Remittances: It’s a mandatory regional tax governed entirely by individual State Legislations (State Labour Welfare boards) to fund medical, housing, and educational welfare for lower-income workforces.

1. Threshold: For Employers: Headcount-driven. Mandatory only if the business employs 5 to 10+ workers (varies state to state). For Employees: No salary cap. Applies on flat fee basis to all workers but managerial and supervisory staff are completely exempt.
2. Contribution: Made to the Labour Welfare Fund by both employer and employee (as deduction from wages) and are usually a small, state-specified fixed amount (eg ₹10 to ₹30). Deduction is usually bi-annual and the amount so collected are to be deposited LWB within the due dates as applicable to that respective state.

Payment of Gratuity

Governed by the Code on Social Security, Gratuity is a mandatory terminal benefit designed to financially reward the employees for their long-term, continuous service to an organization.

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

Regulated by the Code on Wages, a statutory bonus is a mandatory payment that ensures low-income workers get a fair, annual share of a company's profits.

1. Under the New labour code, the Stautory bonus is mandated under the Code on Wages 2019 (governed by law) and is different from the performance bonus in corporates. It is legally mandatory only for employees earning core wages up to ₹21,000 per month. 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 + Retaining allowance.
2. Cap on Salary: But,the bonus is not calculated on the Core wages earned by employee, rather the calculation base is capped at ₹7,000 or the state minimum wage for that job category (whichever is higher)
3. Who is eligible? Any worker with attendance for at least 30 working days in the financial year is included in the bonus payout.
4. Due date: The statutory due date for paying a statutory bonus is within 8 months from the close of the accounting financial year.