CTC Structuring Under the Code on Wages: What Karnataka Employers Need to Revisit in 2026

The Code on Wages has changed the way employers must analyse salary structures. For Karnataka employers, the next challenge is aligning the statutory definition of wages with minimum-wage requirements, payroll deductions and the State’s evolving rules. 

Introduction

The implementation of the Code on Wages, 2019 (“Code”) from 21 November 2025 has brought a significant change to the way employers must examine employee compensation structures in India. The Code consolidates the legal framework governing minimum wages, payment of wages, bonus and equal remuneration and replaces four central labour laws relating to these subjects. The Ministry of Labour and Employment has confirmed that the Code’s definition of “wages” took effect from 21 November 2025. 

One of the most discussed aspects of the Code is the so-called “50% wage rule”. The expression is convenient but potentially misleading. The Code does not prescribe that an employee’s basic salary must necessarily constitute 50% of CTC. Instead, Section 2(y) adopts a broader definition of wages and provides that where specified excluded components exceed 50% of total remuneration, the excess is added back to wages. 

For employers, particularly technology companies, startups, IT/ITES businesses and other organisations where allowances form a significant part of compensation, this can have important consequences for the statutory wage base and consequently for employment costs. 

The issue is particularly relevant in Karnataka. The State published the draft Code on Wages (Karnataka) Rules, 2026 on 23 January 2026 for public consultation. The draft is intended to operationalise the Code at the State level, but it should not be treated as the final Karnataka rules. At the same time, the Central Government notified the Code on Wages (Central) Rules, 2026 on 8 May 2026. For Karnataka employers, therefore, 2026 is a transition year in which salary structures should be reviewed against the statutory framework while continuing to monitor the final State rules. 

What does “wages” mean under the Code?

Section 2(y) of the Code defines “wages” broadly as remuneration payable to an employee under the terms of employment. It expressly includes: 

• basic pay; 
• dearness allowance; and 
• retaining allowance, if any. 

The definition then excludes specified components, including, among others: 

• certain statutory bonuses; 
• employer contributions to provident or pension funds; 
• conveyance allowance or travelling concession; 
• amounts paid towards special expenses; 
• house rent allowance; 
• remuneration payable under an award, settlement or court order; 
• overtime allowance; 
• commission; 
• gratuity on termination; and 
• retrenchment compensation and certain other retirement or termination benefits. 

However, the exclusions are subject to an important proviso. Where payments falling within specified exclusion categories exceed 50% of total remuneration, the amount exceeding that threshold is deemed to be remuneration and is added back to wages. This is the provision that has generated the widespread reference to the “50% rule”. 

The important distinction

The Code therefore does not say: “Basic salary must be 50% of CTC.” The statutory test is instead: If specified excluded components exceed 50% of remuneration, the excess is added back to wages. 

This distinction matters because an employer may structure compensation using several components that fall within the statutory definition of wages without necessarily redesignating every component as “basic salary”. The precise calculation must, however, be undertaken in accordance with the Code and applicable rules. 

Why does the 50% rule matter to employers?

The statutory definition of wages can affect several employment-related obligations because different labour-law entitlements use wages as their calculation base. The impact will depend on the applicable statutory provision and the employee’s circumstances, but employers should examine the implications for areas such as: 

• gratuity; 
• statutory bonus; 
• minimum wages; 
• overtime; 
• deductions from wages; and 
• other benefits or contributions whose calculation is linked to the statutory wage concept. 

The Government’s FAQs have specifically clarified that the revised definition of wages applies to gratuity from 21 November 2025 and that variable components such as overtime allowance may enter the calculation where the statutory 50% threshold is crossed. This means that salary restructuring should not be approached as a simple payroll exercise. A change in the statutory wage base can potentially affect the employer’s overall employment cost even where the employee’s contractual CTC remains unchanged. 

CTC is not the same as “wages”

This distinction should be the starting point for every salary-structure review. CTC (Cost to Company) is a commercial and payroll concept. It may include: 

• basic salary; 
• allowances; 
• employer provident fund contribution; 
• gratuity provision; 
• insurance benefits; 
• performance-linked incentives; 
• variable pay; and 
• other benefits. 

“Wages”, on the other hand, is a statutory concept defined by the Code. Therefore, an employer cannot assume that: CTC = wages under the Code. Nor does the Code prescribe a universal CTC template for employers. The correct exercise is to map each component of the compensation package against the statutory definition and determine whether it is included, excluded or subject to the add-back mechanism. 

What has changed in 2026?

The regulatory position has developed significantly since the Code was enacted.The Code on Wages became effective from 21 November 2025. The Central Government subsequently notified the Code on Wages (Central) Rules, 2026 on 8 May 2026, providing the central procedural framework for implementation. Karnataka had earlier published draft rules in January 2026. Notification No. LD 157 LET 2020 (P-1), dated 23 January 2026, published the draft Code on Wages (Karnataka) Rules, 2026 and invited objections and suggestions within 45 days. 

The draft rules address matters including minimum-wage determination, payment of wages, claims and related procedural requirements. However, draft rules should not be treated as final law. For employers operating in Karnataka, this means the immediate compliance exercise should distinguish between: 

1. obligations already arising under the Code; 
2. requirements under the applicable Central Rules; and 
3. provisions contained in Karnataka’s draft rules that may inform the likely direction of State-level implementation but should not be treated as finally operative until notified. 

Minimum wages and the wage definition are separate tests

One of the weaknesses in many discussions of CTC restructuring is the assumption that satisfying the 50% wage test automatically means that the employer’s salary structure is compliant. It does not. The Code’s definition of wages and the applicable minimum-wage requirement are distinct legal tests. The Government’s FAQs expressly distinguish between the two: minimum wages are fixed by the appropriate Government, whereas wages are determined in accordance with the statutory definition in Section 2(y). 

Accordingly, an employer should ask two separate questions: 
First: What constitutes wages for the purposes of the Code? 
Second: Is the employee being paid at least the applicable minimum wage for the relevant category, employment and geographical area? 

A salary structure can therefore satisfy the wage-definition test while still requiring a separate examination against the applicable minimum-wage notification. This is particularly important in Karnataka, where minimum wages may vary by employment category and other prescribed classifications.

What does this mean for Karnataka employers?

Karnataka employers should approach salary restructuring as a two-level compliance exercise. 

Level 1: Central statutory framework

The employer should first map the existing compensation structure against Section 2(y) of the Code and the applicable Central Rules. This requires identifying: 

• components that form part of wages; 
• excluded components; 
• components potentially subject to the 50% add-back; 
• variable compensation; 
• statutory contributions; and 
• benefits calculated by reference to wages. 

Level 2: Karnataka requirements

The employer should then examine the applicable Karnataka minimum-wage notifications and State-level requirements. The January 2026 draft Karnataka Rules indicate the State’s proposed procedural framework for implementing the Code. However, employers should track the final notification before treating provisions contained only in the draft as binding requirements. 

This distinction is particularly important for businesses with large employee populations, where even a small change in the applicable wage base can materially affect annual employment costs. 

Does an employer need to restructure every salary package to “50% basic”?

No. There is no statutory requirement under Section 2(y) that an employer mechanically redesignate 50% of CTC as basic salary. Instead, employers should conduct a component-by-component analysis. For example, consider an employee whose annual remuneration is ₹12 lakh and whose compensation includes: 

• basic pay: ₹3.6 lakh; 
• HRA: ₹3.6 lakh; 
• conveyance and other excluded allowances: ₹2.4 lakh; 
• variable or other remuneration: ₹2.4 lakh. 

The employer should not simply conclude that the basic salary must be increased to ₹6 lakh. The correct approach is to identify which components fall within the exclusions under Section 2(y), calculate the aggregate of those exclusions, and determine whether the 50% threshold is exceeded. Any excess is then brought back into wages in accordance with the statutory formula. The exact result will depend on the nature and contractual character of each component. This is why a salary-structure audit is preferable to a blanket “50% basic salary” restructuring exercise. 

Impact on gratuity and other employment costs

The wage definition can have a significant financial impact where employer contributions or statutory benefits are calculated on the relevant wage base. For example, if the statutory wage base increases as a consequence of the add-back mechanism, an employer may face a higher cost in relation to benefits or contributions that are calculated by reference to wages, depending on the applicable legislation and the employee’s circumstances. 

The Government has expressly clarified that the revised definition of wages applies to gratuity from 21 November 2025. Employers should therefore model the financial effect before implementing any restructuring. This is particularly important for companies with: 

• large employee headcounts; 
• high employer-funded benefits; 
• long-serving employees; 
• significant variable-pay structures; or 
• contractual benefits linked to basic salary or statutory wages. 

The 50% deduction ceiling is a separate compliance issue

The intern’s draft also correctly identifies, but conflates with salary restructuring, the Code’s 50% ceiling on deductions. Section 18(3) provides that the total deductions made from an employee’s wages in any wage period cannot exceed 50% of such wages, subject to the statutory framework. Where authorised deductions exceed that threshold, the excess may be recovered in the prescribed manner. This is different from the 50% wage-definition test. 

In other words: 50% wage rule→ concerns how “wages” are calculated. 50% deduction rule → concerns how much can be deducted from wages in a wage period. 

Employers should keep these concepts separate when reviewing payroll processes. 

Contract labour: another area requiring attention

For businesses that rely extensively on contract labour, including IT/ITES, facilities management, logistics and manufacturing operations, the compliance analysis cannot stop with direct employees. 

The Code contains provisions dealing with payment of wages and liabilities in relation to employees engaged through contractors. The contractual allocation of payroll responsibility should therefore be reviewed alongside the statutory obligations imposed on the principal employer and contractor. 

Employers should consider: 

• whether contractor wage structures comply with applicable minimum wages; 
• whether wage payments are being made within the prescribed timelines; 
• whether statutory records are maintained; 
• whether contractor deductions are compliant; and 
• whether the principal employer has adequate contractual audit and indemnity mechanisms. 

A company’s labour-code compliance programme should therefore extend beyond its internal payroll to the contractor ecosystem where the law so requires. 

Should employers change existing employment contracts?

This requires a case-by-case assessment. The implementation of the Code does not automatically mean that every employment agreement must be rewritten overnight. However, employers should review whether existing salary structures and contractual language are compatible with the statutory requirements. Where restructuring is required, employers should consider: 

• whether the change affects only the allocation of components or also the employee’s contractual entitlement; 
• whether any allowance is contractual or discretionary; 
• whether variable pay is genuinely variable; 
• whether employee consent is required under the applicable contractual and employment framework; 
• whether the restructuring affects take-home pay; 
• whether statutory contributions or benefits increase; and 
• whether payroll, HRIS and employment documentation are aligned. 

A restructuring that merely reallocates components within the same overall CTC may have a different legal character from a restructuring that reduces an employee’s contractual remuneration. The distinction should be documented carefully. 

What should Karnataka employers do now?

Employers do not need to wait for every aspect of the State framework to be finalised before beginning their compliance review. A sensible approach would be to undertake the following: 

Step 1: Map the existing CTC: Prepare a complete inventory of all fixed, variable and employer-funded components. 

Step 2: Classify each component: Identify whether each component is: 

• included in wages; 
• expressly excluded; 
• subject to the 50% add-back mechanism; or 
• dependent on the circumstances of payment. 

Step 3: Calculate the statutory wage base: Run payroll simulations using the Section 2(y) methodology.

Step 4: Assess downstream impact: Model the potential effect on gratuity, bonus, statutory contributions and other benefits that depend on the relevant wage base. 

Step 5: Check minimum wages separately: Map employees against the applicable Karnataka employment category, skill classification and geographical requirements. 

Step 6: Review contract labour: Extend the audit to contractor wage structures where applicable. 

Step 7: Review employment documentation: Identify contracts, salary letters and HR policies that may require amendment. 

Step 8: Monitor Karnataka’s final rules: The January 2026 Karnataka Rules were published as a draft and should not be treated as the final State framework. Employers should monitor the final notification and update their compliance matrix accordingly. 

The bigger issue: CTC restructuring is not a mathematical exercise

The most significant mistake employers can make is to treat the new wage definition as requiring every employee’s compensation to be converted into a predetermined formula. There is no universal statutory CTC structure. The correct approach is legal classification first, financial modelling second. 

For example, two employees with the same CTC may have very different statutory wage bases because the composition of their remuneration differs. Similarly, two companies may adopt different salary structures and both remain compliant, provided their respective structures satisfy the applicable statutory requirements. 

This is particularly important for startups and technology companies, where compensation packages may include substantial allowances, performance-linked pay, equity-linked benefits or other components that do not fit neatly into traditional salary structures. 

Conclusion

The Code on Wages has made the statutory definition of “wages” more important than ever for employers reviewing compensation structures. But the reform does not create a mandatory “50% basic salary” rule. The actual statutory test is concerned with the relationship between remuneration and specified excluded components, with the excess over the prescribed threshold being added back into wages. 

For Karnataka employers, the compliance exercise is further shaped by the interaction between the Central framework, applicable minimum-wage notifications and the State’s evolving rules. The Central Rules were notified in May 2026, while Karnataka’s January 2026 Wage Rules remain a draft framework pending finalisation. 

The practical response should therefore not be to mechanically increase basic salary to 50% of CTC. Instead, employers should undertake a structured compensation audit, identify the statutory wage base, separately verify minimum-wage compliance, model the impact on employee benefits and contributions, review contractor arrangements, and update employment documentation where necessary. For Karnataka employers, the key compliance question in 2026 is therefore no longer simply “Is basic salary 50% of CTC?” 

It is: “Does the overall compensation structure, when tested against the statutory definition of wages and applicable State and Central requirements, produce a compliant wage base and sustainable employment cost?” That is the more accurate way to approach CTC restructuring under India’s new wage regime. 

Last Updated on 19 August, 2026