Written by Anjali Yadav & Raja Pathak, students pursuing B.A. LL.B. (Hons.) at Dr. Ram Manohar Lohiya National Law University (RMLNLU), Lucknow

I. Introduction

It has been rightly said that “Without labour, nothing prospers”. India, being a labour-intensive country, possesses several challenges for the middle-class people often regarded as “workers”. To address this, the Ministry of Labour and Employment issued a gazette notification dated 21st November 2025, thereby bringing the four Labour Codes into force. One of the baffling changes this law has introduced is the 50% wages rule. Section (2)(y) of the Code on Wages Act, 2019 has standardised the “wages” definition across all the Codes. It has expressly excluded HRA, conveyance, etc and the excluded items within the definition of Section 2(a)-(i) of the Code, if it exceeds 50% of the total remuneration, then it will be added back to the wages. It will eventually affect the statutory cost of labour, particularly Provident Fund P, ESIC, gratuity, etc. This rule is not just a compliance issue but a key factor for the valuation issues under M&A transactions. It might also affect the deal structuring or post-merger integration. This piece will critically examine the challenges incurred by the 50% wage rule on M&A deals, and further suggest plausible solutions for the M&A due diligence and valuation challenges by the employer.

II. The 50% Wage Rule: A Hidden Variable in M&A Valuations

The mandate that Basic Pay, Dearness Allowances, and Retained Allowances to be 50% of the total salary of an individual has changed the cost dynamics of firms and made M&A economics different from what existed previously. All those allowances that exceed the statutory limit become wages, which means that the employer has to pay extra amounts in terms of Provident Fund, gratuity, bonus, etc.

Thus, for labour-intensive firms, especially from the IT, telecoms, start-ups, manufacturing and services industries, there is an increased cost of employing staff without any rise in the Cost to Company (CTC) of employees. Given the fact that the cost of employment is one of the main expenses of firms, the increased cost becomes a negative for Earnings Before Interest, Taxes, Depreciation, and Amortisation (“EBITDA”) and negatively impacts cash flow projections. Thus, a target firm with a traditional allowance-based salary structure appears to be more profitable.

Further, employment compliance becomes an important factor in M&A due diligence. Apart from determining whether statutory contributions have been made, it will be necessary to establish whether the compensation offered is in accordance with Section 2(y). Failure to do so will lead to contingent liabilities in respect of provident fund and gratuity obligations, necessitating the buyer to modify the valuation framework or negotiate a reduction in the purchase price or take protective steps via representations, warranties, indemnity, and escrow provisions. This is confirmed in the landmark ruling by the Supreme Court of Regional Provident Fund Commissioner (II), West Bengal v. Vivekananda Vidyamandir that universal allowances constitute “basic wages” for provident fund purposes.

III. Valuation Challenges and Deal Structuring Responses

The expansion of wage base for calculating statutory benefits such as provident fund, gratuity, bonus and other social security contributions under the Social Security Code, 2020, increases recurring employment costs, thereby reducing EBITDA and projected cash flows. For instance, if a company with an annual payroll of ₹100 crore is required to increase its wage component by 10% to comply with the 50% threshold, the employer’s statutory contributions under Sections 16 & 54 of the Social Security Code, 2020, also increase correspondingly, reducing profitability and affecting enterprise valuation.

As a result, it has become a material valuation concern that directly influences enterprise valuation, purchase price negotiations and risk allocation. Consequently, employers face the challenge of balancing regulatory compliance with preserving enterprise value and maintaining investor confidence, making labour law compliance a strategic consideration rather than merely an operational obligation.

IV. Governance and Strategic Implications

There are implications of this rule beyond transactions with respect to corporate governance. The board and management have no choice but to view compliance with labour laws as a strategic risk. Compensation committees would have to manage the redesign of the compensation system, while audit or compliance committees would need to manage payroll systems in line with the Code on Wages.

Enforcement timing and seriousness also pay a due consideration. The Ministry of Labour has warned about heavy fines for non-compliance of up to ₹50,000 or imprisonment under Section 54(1)(a) of the Code on Wages, 2019. In addition, Indian firms are now operating within the ESG/CSR framework, which requires them to report on their labour practices and human capital metrics. Non-compliance could therefore be serve as an ESG signal for investors and becomes a key part of the firm’s risk profile and reputation.

Investors and lenders are paying closer attention. For instance, Private equity firms will almost certainly insist on checks for compliance with the labour codes during due diligence. Foreign stakeholders familiar with stringent labour legislation will be demanding effective board supervision. Thus, labour compliance is a central financial issue in transactions, and labour-related issues have shifted “from HR to Board oversight in many companies.”

V. The Way Forward: Integrating Labour Compliance into Corporate Strategy

The 50% wage rule necessitates a shift from reactive compliance to proactive corporate governance. As the Labour Codes, compliance increasingly affects financial planning, regulatory risk, and business transactions. The companies must embed compliance into their compensation and governance strategies. The following measures can help organisations ensure statutory compliance while mitigating legal and financial risks:-

1. Mandatory Labour Due Diligence in M&A Transactions

The Government should mandate that a mandatory due diligence report be a part of the M&A process in respect of any labour issues relating to wages that may arise before the completion of the deal. For instance, under Article 6 of the EU Corporate Sustainability Due Diligence Directive, companies to take appropriate measures to assess the situation and, further, under Article 7, to take preventive action plans. This enables the buyer to make a proper assessment of their liabilities and negotiate appropriate valuation adjustments or contractual protections.

2. Independent Wage Compliance Audits

The companies must carry out independent audits at specified intervals regarding compliance with the statutory definition of wages and computation of provident fund, gratuity, bonus and other statutory payments. These audits need to be carried out prior to any significant business restructuring or acquisition in order to discover any hidden labour costs that could impact the valuation of the business. Drawing the inference from the Australian Fair Work Act 2009 under Sections 535 and 536, it requires employers to maintain accurate employment records and issue compliant payslips, thereby facilitating effective regulatory audits and enforcement.

3. Board-Level Oversight of Labour Compliance

Labour law compliance should be incorporated into corporate governance by requiring the Board of Directors or the Audit Committee to periodically review wage structures, statutory contribution obligations and labour compliance reports. Elevating labour compliance to the board level would enable companies to identify regulatory risks at an early stage and strengthen investor confidence during mergers and acquisitions. This approach aligns with Provision 29 of the UK Corporate Governance Code 2024, which requires boards to establish effective systems of risk management and internal controls and continuously monitor their effectiveness.

4. Contractual Safeguards for Managing Wage Compliance Risks

To address the risks of material valuation, transactional documents should incorporate specific contractual safeguards that protect buyers from historical non-compliance. A similar approach is followed by the American Bar Association SPA agreement, which presents some key contractual responses to mitigate the risks is as follows:

• Representations and Warranties: The seller represents that the target company complies with the statutory definition of wages and the 50% wage threshold. Any breach gives the buyer contractual remedies for losses arising from inaccurate disclosures.

• Indemnity Clauses: Specific indemnities are negotiated to cover liabilities arising from pre-closing non-compliance, including unpaid provident fund, gratuity, bonus, ESI contributions, interest, penalties and regulatory claims. This ensures that historical liabilities remain the seller’s responsibility.

• Escrow or Holdback Arrangements: A portion of the purchase consideration is retained for a specified period to satisfy any labour law claims that may arise after closing. This provides immediate financial security without resorting to litigation.

• Earn-Outs and Deferred Consideration: Where the financial impact of the revised wage structure is uncertain, part of the consideration may be linked to the target’s post-closing performance, allowing valuation risks to be shared between the buyer and seller.

VI. Conclusion

The 50% wage rule marks a fundamental shift in the relationship between labour regulation and corporate governance. Now, no longer labour law compliance be viewed as a post-closing or operational concern but as an integral determinant of enterprise valuation, transaction structuring and investment decisions. As businesses adapt to this evolving regulatory landscape, a critical question emerges: Should labour law compliance continue to be treated merely as a statutory obligation, or should it become a core parameter of corporate valuation and governance? Equally important is whether India’s M&A framework is adequately equipped to account for the financial consequences of non-compliance with the new labour codes. The answers to these questions will shape not only the future of corporate transactions but also the broader integration of labour rights into India’s corporate governance framework.

Caveat: The views, analyses, and information presented in this article are provided in good faith and for general informational purposes only. No representation or warranty, express or implied, is made regarding the accuracy, adequacy, validity, reliability, or completeness of the information. Readers should conduct their own research and seek professional guidance where appropriate. Neither the author nor the publisher shall be held responsible for any loss, liability, or consequence arising from reliance on this content.