Key Takeaways
- The four Labor Codes were notified as effective on November 21, 2025. The 50% Basic + DA + Retaining Allowance rule is now live and changes how PF, gratuity, bonus, and leave encashment are computed.
- PF remains 12% + 12% on Basic + DA capped at Rs 15,000; ESI remains 0.75% + 3.25% of gross wages with Rs 21,000 eligibility, but the wage definition under the Code on Wages is now the binding base.
- From FY 2026-27, Hyderabad, Bengaluru, Pune, and Ahmedabad qualify for the 50% HRA exemption alongside Mumbai, Delhi, Kolkata, and Chennai (old regime only).
- Form 130 replaces Form 16 as the TDS certificate for salaries under the Income Tax Act 2025, applicable from FY 2026-27 onwards. Form 16 issued for FY 2025-26 (AY 2026-27 returns) remains valid.
- Central rules under the Code on Wages were finalised around April 2026, but state-level rules vary. Compliance is now a current obligation, not a future one.
Payroll compliance has changed materially in the last six months. The four Labor Codes that had been in draft for years are now in force. The Income Tax Act 2025 has come into effect and reshapes the TDS certificate landscape. The HRA metro list has expanded to cover four more cities. Each of these affects how you structure salaries, deduct statutory contributions, and report payroll to the tax authorities.
This guide covers the FY 2026-27 picture for employers in India, with the practical actions you need to take now.
Looking for expert help with end-to-end payroll compliance and statutory filing for FY 2026-27? The team at Tax Garden, based in Kondapur, Hyderabad, helps Indian SMEs stay compliant end-to-end: filings, notices, and advisory, all in one place.
1. Labor Codes: Now In Force
The Government of India notified the four Labor Codes as effective on November 21, 2025. The codes are:
- Code on Wages, 2019
- Industrial Relations Code, 2020
- Code on Social Security, 2020
- Occupational Safety, Health and Working Conditions Code, 2020
These codes consolidate 29 earlier central labor laws into four. The substantive provisions are now live. Central rules under the Code on Wages were finalised around April 2026. State rules are still being notified at different speeds, so the operational picture differs across states.
What this means for employers: the substantive obligations (wage definition, payment timelines, social security contributions, working conditions) are binding now. Treat compliance as a current task, not a future project.
2. The 50% Basic + DA + Retaining Allowance Rule
The Code on Wages introduces a new statutory definition of "wages." The key principle: Basic Pay + Dearness Allowance + Retaining Allowance must form at least 50% of total remuneration. If the sum of all allowances (HRA, conveyance, special allowance, etc.) crosses 50% of total CTC, the excess automatically gets added back to "wages" for statutory calculations.
What This Affects
- Provident Fund contributions rise because the PF base (Basic + DA, capped at Rs 15,000) is now harder to suppress with allowance-heavy structures
- Gratuity liability rises because gratuity is computed on last drawn Basic + DA
- Leave encashment rises because it is computed on Basic + DA
- Bonus liability rises because it is computed on the wage definition
Practical Action for Employers
Review every salary structure in your CTC sheet:
- List each component: Basic, DA, HRA, conveyance, special allowance, other allowances
- Compute Basic + DA + Retaining Allowance as a percentage of gross CTC
- If the percentage is below 50%, restructure: increase Basic, reduce allowance heavy components like Special Allowance
- Recompute PF, gratuity, and leave encashment on the new base
- Communicate net-pay impact to employees in advance, since restructuring usually reduces take-home in the short term but improves retirement corpus and gratuity
If your existing structure has Basic at 30% to 35% of CTC (a common legacy pattern), the 50% rule will materially change your statutory liability.
3. Provident Fund (PF) Structure for FY 2026-27
The contribution rates remain unchanged but the base is now the new wage definition.
Contribution Rates
- Employee Contribution: 12% of Basic + DA
- Employer Contribution: 12% of Basic + DA, allocated between EPF and the Employee Pension Scheme
Wage Ceiling
The mandatory coverage limit continues at Rs 15,000 per month. Discussions about raising the ceiling to Rs 21,000 or Rs 25,000 have been ongoing for several years, but no notification has been issued. Plan for Rs 15,000 until the EPFO formally changes it.
Practical Action
Where employees are already covered under the higher voluntary PF (above Rs 15,000), confirm the consent letter is on record. Ensure monthly PF challans are deposited by the 15th of the following month. Late deposits attract interest at 12% per annum and damages up to 25% of the delayed amount.
4. Employee State Insurance (ESI) Structure
Contribution Rates
- Employee Portion: 0.75% of gross wages
- Employer Portion: 3.25% of gross wages
Eligibility Threshold
The eligibility limit remains Rs 21,000 per month. Employees crossing this in a contribution period are transitioned out of the scheme at the start of the next contribution period.
Practical Action
Run a monthly review of who has crossed the Rs 21,000 threshold. Transition them at the right cycle. Mistimed transitions are a frequent audit finding.
5. HRA Exemption: Hyderabad, Bengaluru, Pune, Ahmedabad Now Metro for HRA
A significant change for the salaried population: from FY 2026-27 (April 1, 2026), Hyderabad, Bengaluru, Pune, and Ahmedabad qualify for the 50% HRA exemption rate. Earlier, only Mumbai, Delhi, Kolkata, and Chennai got 50%; everywhere else was 40%.
What Applies When
| Period | Cities at 50% HRA |
|---|---|
| Up to FY 2025-26 | Mumbai, Delhi, Kolkata, Chennai |
| FY 2026-27 onwards | Mumbai, Delhi, Kolkata, Chennai, Hyderabad, Bengaluru, Pune, Ahmedabad |
This means:
- For ITR filings being made in 2026 (AY 2026-27, on FY 2025-26 income), the old 4-city rule applies
- For FY 2026-27 payroll (April 2026 onwards), the 8-city rule applies in TDS calculations on salary
How HRA Exemption Is Computed
The exemption is the least of:
- Actual HRA received
- 50% of (Basic + DA) for metro cities, or 40% of (Basic + DA) for non-metro
- Rent paid minus 10% of (Basic + DA)
This applies only under the old tax regime. Employees on the new tax regime do not get HRA exemption.
Practical Action for Employers
- Update your payroll software's HRA exemption logic effective April 1, 2026
- Communicate the change to employees in the four newly added cities. Many will want to recompute their FY 2026-27 declaration
- Ensure landlord PAN is collected if annual rent exceeds Rs 1,00,000. Without it, the HRA exemption is disallowed
6. Form 130 Replaces Form 16 from FY 2026-27
Under the Income Tax Act 2025, the TDS certificate for salaries is being renumbered. Form 16 is replaced by Form 130. The structure is similar; the form number is what changes.
Key Dates
- Form 16 for FY 2025-26 (issued by June 15, 2026) remains valid for AY 2026-27 returns
- Form 130 for FY 2026-27 will be the certificate format from FY 2026-27 onwards (issued by June 15, 2027)
Practical Action
- Continue issuing Form 16 for FY 2025-26 in the existing format
- Update payroll vendors and TDS reporting systems to support Form 130 for FY 2026-27 deductions
- Brief the finance and HR teams on the new form name to avoid confusion when employees ask for the certificate
For more on TDS form renumbering, see our TDS/TCS section changes guide and Form 130 replaces Form 16.
7. Gratuity Calculation
The framework for gratuity remains unchanged: 15 days of last drawn salary for every completed year of service, subject to the Rs 20 lakh ceiling for tax-exempt gratuity.
What has changed is the base. Because the wage definition under the Code on Wages now forces Basic + DA up to at least 50% of CTC, the "last drawn salary" used in the gratuity formula is higher than it was under allowance-heavy legacy structures. Expect gratuity provisioning on your books to rise proportionately.
8. Statutory Compliance Calendar for FY 2026-27
Monthly
- PF deposit by 15th of the following month
- ESI deposit by 15th of the following month
- TDS deposit by 7th of the following month (April-Feb), April 30 for March deductions
- Salary disbursement timeline as per the Code on Wages (within 7 days of wage period ending for monthly payouts)
Quarterly
- TDS return Form 24Q for salary deductions: July 31, October 31, January 31, May 31
Annual
- Form 16 (FY 2025-26) issued by June 15, 2026
- Form 130 (FY 2026-27) issued by June 15, 2027
- Bonus payment under the Payment of Bonus Act by November 30 (for accounting year ending in March)
- Annual return on labor welfare fund and labor licenses, where applicable
9. Critical Errors That Trigger Audits and Penalties
- Suppressing Basic Pay below 50% of CTC. Once the Code on Wages rules are formally invoked in your state, this will be flagged and statutory shortfall will be recovered with damages.
- Late PF or ESI deposits. Interest at 12% per annum and damages up to 25%. The damages clause is automatic, not discretionary.
- Wrong HRA exemption for new metro cities. Employees in Hyderabad, Bengaluru, Pune, or Ahmedabad expecting 50% from April 2026 will dispute payroll computations otherwise.
- Missing landlord PAN. Annual rent above Rs 1,00,000 without landlord PAN means full HRA disallowance during AIS reconciliation.
- Issuing Form 16 in the Form 130 format prematurely. Stick with Form 16 for FY 2025-26 deductions; switch only for FY 2026-27 onwards.
10. Strategic Focus for the Year
- Restructure CTC sheets to comply with the 50% Basic + DA rule before your next appraisal cycle
- Update payroll software for the 8-city HRA list and the Form 130 transition
- Train HR and finance teams on the new Labor Code obligations: payment timelines, recordkeeping, social security
- Plan retirement contribution communication for employees, since the 50% rule typically raises PF contributions and reduces take-home
Conclusion
Payroll has shifted from a back-office task to a live regulatory frontier. The Labor Codes are in force, the wage definition has changed, the HRA list has grown, and the TDS certificate is being renamed. Employers who restructure CTCs proactively reduce the risk of statutory shortfalls; those who delay may face compliance gaps that are harder to resolve retroactively.
If your organisation has more than 25 employees, this is the year to engage external help on payroll review and statutory restructuring. Tax Garden's payroll compliance services cover salary structure design, monthly PF and ESI filings, TDS deposits, quarterly Form 24Q, annual Form 16 (and Form 130 from FY 2026-27), and labor code obligations. Pricing is fixed upfront.
For statutory deduction numbers in detail, see PF and ESI compliance employer contribution rates 2026 and Professional tax state-wise rates 2026.
Looking for expert help with salary structure restructuring under Code on Wages and 50 percent Basic DA rule? The team at Tax Garden, based in Kondapur, Hyderabad, helps Indian SMEs stay compliant end-to-end: filings, notices, and advisory, all in one place.
Frequently Asked Questions
Are the Labor Codes in force in 2026?
Yes. The four Labor Codes (Code on Wages, Industrial Relations, Social Security, and Occupational Safety) were notified as effective on November 21, 2025. Central rules under the Code on Wages were finalised around April 2026; state rules vary in implementation status.
What is the 50% Basic + DA rule and when did it apply from?
Under the Code on Wages, Basic + DA + Retaining Allowance must form at least 50% of total remuneration. Any allowance excess gets added back to wages for PF, ESI, gratuity, bonus, and leave encashment computation. The rule is in force from the November 21, 2025 notification.
Have PF or ESI rates changed for FY 2026-27?
No. PF remains 12% + 12% (on Basic + DA capped at Rs 15,000). ESI remains 0.75% + 3.25% of gross wages, with Rs 21,000 eligibility. The wage definition under the Code on Wages is now the binding base for these computations.
Which cities qualify for 50% HRA exemption in FY 2026-27?
Eight cities: Mumbai, Delhi, Kolkata, Chennai, Hyderabad, Bengaluru, Pune, and Ahmedabad. Hyderabad, Bengaluru, Pune, and Ahmedabad were added with effect from April 1, 2026. The HRA exemption applies only under the old tax regime.
Has Form 16 been replaced?
Form 16 is being renumbered to Form 130 under the Income Tax Act 2025. Form 16 issued for FY 2025-26 (covering AY 2026-27 returns) remains valid. From FY 2026-27 onwards, employers will issue Form 130.
What is the penalty for late PF or ESI deposits?
Interest at 12% per annum plus damages up to 25% of the delayed amount, depending on delay duration. Deposits must hit the EPFO or ESIC bank by the 15th of the following month.
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Sources
This guide is verified against the November 21, 2025 Labor Code commencement notification, the Code on Wages 2019, the Code on Social Security 2020, the Finance Act 2025 (HRA metro expansion), the Income Tax Act 2025 (Form 130 renumbering), and confirmatory coverage from the Ministry of Labour and Employment, EPFO, ESIC circulars, ClearTax, Taxmann, and Tax Guru. Always confirm specific state-level Labor Code rules with the relevant state notifications, since implementation timelines differ by state.
