Higher gratuity liability due to labour codes must be treated as expense: ICAI

India's labour market, characterized by its vastness and complexity, has long operated under a labyrinthine system of over 200 state and 40 central laws. This archaic framework, often criticized for hindering industrial growth and failing to adequately protect worker rights in a modern economy, prompted the government to embark on a significant reformative journey. The Second National Commission on Labour, established in 2002, had already highlighted the need for rationalization and simplification of these laws, setting the stage for future reforms.

The core of these reforms materialized in 2020 with the consolidation of 29 central labour laws into four comprehensive codes: the Code on Wages, 2019; the Industrial Relations Code, 2020; the Code on Social Security, 2020; and the Occupational Safety, Health and Working Conditions Code, 2020. While these codes aim to simplify compliance for businesses and extend social security benefits to a wider segment of the workforce, their implementation has far-reaching implications, particularly concerning employee benefits like gratuity.

The recent advisory from the Institute of Chartered Accountants of India (ICAI) directly addresses one such implication: the anticipated rise in gratuity liability for companies. Gratuity, a statutory payment made by employers to employees as a token of appreciation for long service, was previously governed primarily by the Payment of Gratuity Act, 1972. The new Code on Social Security, 2020, and the Code on Wages, 2019, introduce crucial changes that redefine 'wages' and significantly alter eligibility criteria.

Under the new codes, the definition of 'wages' for the purpose of calculating gratuity has been broadened. It mandates that allowances (like HRA, conveyance allowance, etc.) cannot exceed 50% of the total remuneration. If they do, the excess amount is to be considered part of the 'basic wages', thereby increasing the base on which gratuity is calculated. More significantly, the codes have eased the eligibility for gratuity, especially for fixed-term employees and contractual workers, who previously might have struggled to meet the five-year continuous service requirement. Now, gratuity will be paid on a pro-rata basis even to fixed-term employees, regardless of the five-year service condition, provided their contract tenure ends.

This redefinition and eased eligibility mean that companies will face a higher gratuity payout obligation. The ICAI, as the premier accounting body in India, has advised companies to recognize this increased liability as an 'expense' in their interim financial statements, specifically for the December quarter. This ensures accurate financial reporting and compliance with existing accounting standards like Ind AS 19 (Employee Benefits) or AS 15. The advisory underscores the importance of transparent financial practices and the need for companies to proactively account for changes brought about by new legislation.

Key stakeholders in this development include the Government of India, which spearheaded these reforms with twin objectives of enhancing 'Ease of Doing Business' and ensuring 'Labour Welfare'. Employers and companies are directly impacted by the increased financial burden and the need to adjust their accounting practices and human resource policies. Workers, particularly those in the fixed-term and contractual categories, are the direct beneficiaries of enhanced social security and greater financial stability. The ICAI plays a crucial role as a regulatory and advisory body, ensuring that corporate India adheres to proper financial reporting standards as these legislative changes unfold.

This development holds immense significance for India. Economically, while it may initially increase the cost of compliance for businesses, potentially impacting short-term profitability, it is expected to formalize a significant portion of the workforce. Enhanced social security can boost consumer demand and reduce income inequality, contributing to broader economic stability. Socially, it extends a safety net to vulnerable workers, reducing precarity and providing a fairer share of benefits. From a governance perspective, it demonstrates the government's commitment to modernizing labour laws and creating a more equitable and transparent labour market.

The constitutional underpinnings of these reforms can be traced to the Directive Principles of State Policy (DPSP) in Part IV of the Indian Constitution. Articles like 39 (a living wage), 41 (right to work, education, public assistance), 43 (living wage, decent standard of life), and 43A (participation of workers in management) provide the philosophical framework for welfare-oriented labour legislation. Labour itself falls under the Concurrent List (Entry 22 of the Seventh Schedule), allowing both the central and state governments to legislate on the subject. The new codes aim to harmonize these efforts.

Looking ahead, the full implementation of these labour codes, which has seen some delays due to states needing to frame their own rules, will reshape India's industrial landscape. Companies will need to overhaul their HR and payroll systems, while workers will gain greater protection. The formalization drive could lead to more organized sector employment and better data on the workforce. However, challenges such as potential resistance from some industries due to increased costs and the need for continuous clarity on implementation rules will persist. This move by ICAI is a crucial step in ensuring that the financial implications are transparently addressed, paving the way for smoother transition and compliance in India's evolving labour ecosystem.