This article has been written by Kalpesh Shailendra Amrute pursuing the Diploma in Labour, Employment and Industrial Laws (including POSH) for HR Managers from LawSikho. This article has been edited by  Ruchika Mohapatra (Associate, Lawsikho).


As a human resources professional, designing a good compensation structure is a task, after all, it is an important tool that helps us to attract, motivate and retain talented employees and remain ahead of the competition in the market. Effective compensation planning is always based on three dimensions – internal equity, external equity, and individual equity. To achieve that, one has to consider many factors like the industry, location, experience and skill set, budgetary provisions, etc. However, one factor that cannot be ignored is the set of statutory norms related to compensation. This article mainly focuses on the important labour statutes related to compensation that exist in India and provisions thereunder that one should know, before designing a comprehensive compensation plan. At the same time, it also throws some light on the changes proposed in the soon to be implemented new wage code as well, keeping in mind the service sector in India.

Meaning of compensation and compensation management 

Compensation simply means money paid to an individual against something. In our case, it is against the services that a person offers to the organization and/or any damages that one may suffer while performing their job/ as a part of their duties while trying to earn their livelihood.  

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“Compensation management” is a step-by-step process to determine the right pay structure for each job that mutually benefits both the organization as well as the employee. A typical compensation structure involves –

  • Fixed salary & wages – Monthly/hourly rate of pay, irrespective of the number of hours put in by employees.
  • Incentives – It simply means ‘payment by result’. It may vary between  individuals doing a similar job, depending on their performance. Incentive programs can be for an individual as well as for groups.
  • Benefits – It can be both statutory and voluntary, it involve Provident Fund, Gratuity, Insurance, canteen, recreation, transport, etc.
  • Perquisites – These are exclusively for top executives and often involve  facilities like club memberships, stock option schemes, paid holidays, and like. 
  • Non-monetary – Flexible working hours, WFH facility, equal growth opportunities 

Important legislations related to compensation in India

Labour is a subject under the concurrent list as per the Constitution of India, both the Union government as well as the state governments are authorized to make laws on the subject. While certain statutes are applicable across the nation, some are state-specific acts, whose applicability is confined to a specific region. 

Below are some important acts, provisions of which need to be taken into consideration before outlining any compensation plan.  

  1. Minimum Wages Act – This Act was first enacted in 1948 to fix minimum wages (Basic + Dearness Allowance) to be provided to different classes of workers – unskilled, semi-skilled, skilled, and highly skilled. The Act purports to prevent the exploitation of labour and allows them to live a dignified life with respectable pay. Rates of minimum wages are declared by various states through its notification in the official gazette from time to time, rates may differ from industry to industry. Section 12 of the act, mandates every employer to pay minimum wages applicable to them at the same time and  also prevents any unauthorized deduction from the wages. 
  1. House Rent Allowance (HRA) – H.R.A. is usually paid around 50 % of Basic + DA in metro cities (Mumbai, Delhi, Kolkata, Chennai) and 40 % in non-metro cities, mainly to help employees to gain maximum benefit under the income tax rules. However, there are some states like Maharashtra and West Bengal which has state-specific laws (The Maharashtra Workmen’s Minimum House-Rent Allowance Act, 1983 and West Bengal Workmen’s House-rent Allowance Act, 1974 respectively) which mandates every establishment employing 50 or more persons to pay a minimum 5 % of wages (Basic + DA) as an HRA allowance.  
  1. Employee’s Provident Fund & Miscellaneous Provisions Act (PF Act) – This Act tops the list of social security legislations for a myriad of reasons. Provisions under this Act provide cushion to the employees’ post  their retirement. Even though the Act was first enacted in 1952,  modifications have been made to it from time to time. It covers three important schemes – 

Key highlights 

  • Applicability – Every establishment employing 20 or more persons
  • Contribution –  
Employee Share (EE) (% of PF Wages)Employer Share (ER) (% of PF Wages)
PF Contribution12 3.67
PF Admin Charges.50
EDLI .50
EDLI Admin Charges
  • Wage ceiling amount – INR 15,000 P.M. 
  • What includes PF Wages – Any allowance paid universally, necessary, and ordinarily paid all across the board, such wages are to be considered as PF wages as per The Supreme Court of India clarification in the case of Surya Roshni Ltd V/S EPFO & Others in 2012.
  • Allowances excluded from PF wages – Allowances that are available to and especially paid to those who avail of the opportunity are not considered PF wages. E.g. Night Shift Allowance, Washing Allowance, Relocation Allowance, Canteen Allowance, incentives provided to employees, Bonus or commission payable to a particular employee, etc.
  1. Employees State Insurance Act (ESIC) – The Act first enacted in 1948, is a first of its kind to provide compulsory insurance cover to a certain class of workers for medical care. Important benefits that a worker, as well as their family, get under this Act are – 
  • Sickness benefit, 
  • Disablement (employment injury) benefit, 
  • Dependent’s benefit, 
  • Maternity benefit, 
  • Medical benefit 

Key highlights

  • Applicability – to all establishments employing 10 or more persons
  • Employee eligibility – Drawing monthly fixed gross salary up to INR 21000
  • Monthly Contribution –
Employee Share (EE) (% of monthly fixed gross salary)Employer Share (ER) (% of monthly fixed gross salary)
  1. The Payment of Bonus Act – First enacted in 1965, this Act was amended recently in 2007 and  then again in 2015. Employees play an important role in helping their organizations earn a profit, which is essential for the overall growth of the economy. Therefore, this act was brought in to ensure that certain classes of employees, especially those working at the ground level get their legitimate share from the company’s profit.  

Key highlights

  • Applicability – Organizations employing 20 or more persons.
  • Infancy Benefit – In the first five accounting years for new establishments, unless profit is made
  • Employee eligibility – Monthly salary less than or equal to INR 21000 and minimum 30 days of working in that financial year
  • Percentage of bonus – Minimum 8.33%, Maximum 20% of salary
  •  Time limit to pay bonus – Within 8 months from the end of the accounting year
  • Bonus Calculation – (Considered as 8.33% uniformly for better understanding) 
Scenario 1Scenario 2Scenario 3
If the minimum wage in the state is lower than INR 7000 then, the salary considered to calculate the Bonus is INR 7000 in this caseIf the minimum wage applicable is INR 10,000, then, salary considered to calculate bonus is INR 10,000 (higher than INR 7000)If the employer decides to pay a bonus on actual salary (assuming it is INR 20,500)
Bonus Calculation –= 7000*12 = 84,000 * 8.33%               = INR 6997.2                                                                                                                                                             Bonus Calculation –=10000*12=1,20,000 * 8.33%              = INR 9996 Bonus Calculation -= 20,500 * 12 = 2,46,000 * 8.33%              = INR 20,492
  1. The Payment of Gratuity Act – The term “gratuity” is derived from the word “gratitude” which means thankfulness. It is paid by the employer to his employee as a token of gratitude for serving the organization for a longer period. An employee is eligible for gratuity payment in the following cases (provided they complete minimum required years of service) –
  • On attaining the age of superannuation or retirement;
  • Voluntary resignation;
  • Death or total disablement.

Key highlights

  • Applicability – Every establishment employing 10 or more persons
  • Employee eligibility – After completion of 5 years of continuous service in the same organization
  • Period Calculation – One year – For an establishment is working less than 6 days a week,                                                
  • It’s 190 days, in other cases 240 days.
  • Six months – 95 days for establishment working less than 6 days a week                                                                                       120 days in other cases. (In case of rounding off a year post 5 years of service)
  • Salary for calculation – Last drawn monthly Basic + DA
  • Calculation formula – Last drawn Basic + DA * 15/26 * No. of years of service
  • Maximum Tax exempted gratuity – INR 20 lacs as per Section 10 of the Income Tax.
  1. The Maternity Benefit Act (MB Act) – Before the enactment of this Act in 1961, many acts existed in the county both at, central and state levels, lacking uniformity. Even though the ESIC Act superseded these acts, it does not cover all women workers in the country. The objective of this act is to manage the employment of women workers during their pregnancy. As per section 5 [sub-section B (4)] of the amended act in 2017, maternity benefits were extended to adopting mothers as well as commissioning mothers. However, this is to be noted that as per section 61 of the ESIC act if a woman employee is entitled to receive maternity benefit under this act, cannot claim the same as per MB act.

Key highlights

  • Employee eligibility – Woman employee with a minimum of 80 days of working before her expected date of delivery 
  • Maternity leave – 26 weeks with fully paid salary up to two surviving children

12 weeks with fully paid salary in case of more than two surviving                             children, for adopting mother, commissioning mother

  • Medical bonus – INR 3500, in case no provision for post-natal care/post-delivery care is provided for by the employer free of charge.
  • Creche facility – Applicable to establishments having 50 or more employees. 
  1. The Equal Remuneration Act (ER Act) and various constitutional provisions– The most critical action to ensure pay parity and to prevent discrimination between men and women employees. Article 39 of the Constitution envisages that the State shall direct its policy towards securing that, and there is equal pay for equal work for both men and women. Article 14 and 15 of the Constitution of India prevents discrimination between two people of the same gender if, –
  • Nature of work is same or similar
  • No difference in their skills, efforts, responsibilities, working conditions as well as the seniority level.
  • However, the difference in payment is permitted based on – experience, age, education, qualification, and performance.
  1. Employee’s Compensation Act (EC Act) – Even though the original act was enacted in 1923 and was restricted only to workmen, in 2007-08 it was made all-inclusive (Shops & Establishment, etc.) provided the incident happens during employment. It mainly protects employees working in hazardous employment, a risk to life including disability or death. It covers – Partial disablement, full disablement, death.

Amount of compensation (amount needs to be deposited strictly with EC commissioner)

• In case of death – 50% of monthly wages or INR 1,20,000 whichever is higher

• In case of permanent disablement – 60% of wages or INR 1,40,000 whichever is higher

* A separate DD needs to be prepared in the case of each employee.

Wages/Salary to be considered for payment of compensation – INR 15,000 irrespective of actual salary (either less than or greater than 15000). Ref Sec 4.1(b) and a notification dated Jan 03rd, 2020 of the Govt. Of India.

Proposed changes as per new codes and their impact

As a part of “ease of doing business” the Govt. Of India has clubbed 29 major labour legislation into four codes (yet to be implemented) –

 Major changes impacting compensation are –

Code NameProposed ChangeIts impact on compensation
Code on Wages, 2019Revised definition on wagesWages = 50 % (Basic + DA + RA) and 50% Other Allowances (HRA + Conveyance + OT + Commission + ER PF +Retrenchment Comp)Since many of the payouts like leave encashment, PF, and gratuity is mainly calculated on Basic + DA, it is more likely that the take-home salary of an employee is going to be affected. 
Code on Wages, 2019Central floor rate for minimum wageThe minimum rates of wages fixed by the State Government cannot be less than floor wages as determined by the Central Government. The Code applies to all the establishments irrespective of the number of employees working in the establishment. It also applies to all the employees employed in both the organized and the unorganized sector.This move will help to cover as many workers under minimum wages, at the same time with the presence of a central base rate, the difference between minimum wages for various states for similar work gets reduced. This may reduce the movement of a certain class of employees to particular states only in search of higher wages.
Code on Social Security, 2020Introduction & legitimize the gig employees & platform employeese.g. freelancers, persons working for Ola, Zomato, Urban company, etc.This move will bring more people under the umbrella of the organized sector, also will force such companies to redefine their compensation strategies to include these types of employees
Code on Social Security, 2020Pro-rata gratuity for fixed-term employmentWhile this is discriminatory between a full-time employee leaving before completing five years of service and a fixed-term employee. At the same time companies are required to shell out more money if they go for short-term employment contracts.

Area of further improvement

While it is a good move on the part of  the government to make an honest effort to make these age-old labour laws work in a more synchronized way and increase their relevance with contemporary labour issues, there is still a reasonable scope for further improvement.

  • While efforts were made to reduce confusion between various terms like worker, workmen, employee, etc. further differentiation between “management” and “staff” would negate the ambiguity and make it easier to compensate them as situation demands.
  • Need uniformity in maternity benefits. While the MB act provides a maternity bonus of INR 3500, the National Food & Safety Act, 2013 (NFSA) has a provision of INR 6000.
  • While the inclusion of the creche facility is a welcome move, its practical implacability has been ignored. A provision of Creche expenses reimbursement “instead of” should be considered as well.
  • More clarity on the wage components, to be included or excluded while calculation of PF, ESIC, Bonus, etc. is desired. In general, while ESIC is calculated on monthly gross salary, others are mainly calculated on basic wages. Bringing uniformity will not only help employers to comply better but will also help employees to understand their pay structure more comfortably.


Compensation plays a crucial role in managing talented employees for and in any organization. While there is no “standard way” to design the compensation structure, HR has the luxury to design the same within budgetary provisions using their organizational policies. A market-driven, performance fostering yet cost-effective compensation plan is desired, one cannot neglect the statutory norms set by government authorities for payment of certain allowances at a predetermined rate. Any compromise on saving a penny today or lack of awareness may cost dearer in the future as authorities can easily keep track of company records in a tech-driven era. Therefore, priority should be given to including relevant mandatory allowances before splashing out any attractive benefits. After all, mandatory regulatory pay remains the backbone of any sound compensation plan. 



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