Introduction
If you’re hiring employees in India or drafting employment agreements for your business, you’re operating in one of the most reformed labour law environments in recent history. India’s four new Labour Codes came into force on November 21, 2025, replacing 29 separate laws with a unified framework that fundamentally changes how employment contracts must be structured.
Whether you’re an HR professional, a business owner, or a founder building your first team, understanding how to properly structure salary, benefits, leave entitlements, and legal clauses isn’t optional anymore. It’s the foundation of compliance, and getting it wrong can lead to statutory penalties, employee disputes, and legal exposure.
This guide walks you through everything you need to know about employment contracts in India under the new legal framework, backed by data from official government sources and verified labour law provisions.
Understanding India’s New Labour Codes 2025
On November 21, 2025, India activated all four labour codes that consolidate 29 legacy labour laws into a streamlined framework covering wages, social security, industrial relations, and workplace safety. For employment contracts, the most immediate impact comes from the Code on Wages, 2019 and the Code on Social Security, 2020.
The new codes introduce a uniform definition of “wages” requiring that basic pay must form at least 50% of total remuneration, meaning allowances cannot be used excessively to reduce statutory obligations like Provident Fund, bonus, and gratuity payouts. This is a fundamental shift from the common practice of keeping basic pay at 30-40% of CTC.
Fixed-term employees now become eligible for gratuity after completing one year of service, a major change from the earlier requirement of five years. This extends social security coverage and increases benefit obligations for employers.
How to Structure Salary Under the New Wage Definition
The 50% basic pay rule changes everything about salary structuring in India. Here’s what you need to know.
What Counts as “Wages”
Under the new wage definition, three core components must make up at least 50% of total pay: basic salary, dearness allowance, and retaining allowance. If allowances like HRA, travel allowance, medical allowance, or bonuses exceed 50% of total compensation, the excess value must be added back to wages for calculating statutory benefits.
This means if you’re paying someone Rs. 50,000 per month, at least Rs. 25,000 must be structured as basic pay. The remaining Rs. 25,000 can be split across HRA, special allowances, and other components.
Impact on Take-Home Pay and Statutory Contributions
While CTC might stay constant, take-home pay could decrease due to higher PF contributions calculated on the increased basic salary component. Since PF contributions are tied to basic pay, a higher basic means both employer and employee contributions go up.
For employees earning above the PF wage ceiling, this may not apply, but for most employees, expect a slight reduction in take-home accompanied by increased retirement savings.
Gratuity liabilities for employers are also likely to rise 25-50% according to industry estimates, because gratuity is calculated on a larger wage base.
Salary Structure Example (Compliant with 2025 Codes)
Here’s how a Rs. 50,000 monthly CTC can be structured:
- Basic Salary: Rs. 25,000 (50%)
- House Rent Allowance (HRA): Rs. 10,000 (20%)
- Special Allowance: Rs. 8,000 (16%)
- Transport Allowance: Rs. 2,000 (4%)
- Medical Allowance: Rs. 2,000 (4%)
- Performance Bonus: Rs. 3,000 (6%)
Employer Contributions:
- Provident Fund (12% of basic): Rs. 3,000
- ESI (if applicable): Based on gross wages
Statutory Benefits You Must Include
Provident Fund (PF) and Employee State Insurance (ESI)
Provident fund, pension, and insurance benefits are now ensured for all employees, whether on contract or permanent. PF applies to establishments with 20 or more employees, calculated at 12% of basic salary plus dearness allowance, contributed by both employer and employee.
ESI applies to employees earning up to Rs. 21,000 per month and provides medical benefits. ESIC provides 70% of average daily wages as cash during medical leave, up to 91 days in two consecutive benefit periods.
Gratuity
Gratuity is calculated as 15 days’ wages based on the last drawn salary for every completed year of service, subject to a maximum of Rs. 20 lakhs. Under the new codes, fixed-term employees qualify after just one year instead of five.
Bonus
Employees earning up to Rs. 21,000 per month maybe entitled to an annual bonus, typically calculated between 8.33% to 20% of wages, depending on company profits and applicable acts.
Leave Policies: What the Law Requires
Leave entitlements in India are governed by the Factories Act, 1948 and state-specific Shops and Establishments Acts. Here’s what you must provide.
Annual Leave (Earned Leave/Privilege Leave)
Under the Factories Act, adult workers are entitled to one day of leave for every 20 days worked, which amounts to approximately 15 days of annual leave per year after completing 240 days of employment. The Shops and Establishment Act mandates 18 working days of fully paid vacation or earned leave each year, though provisions vary by state.
Employees can carry over unused eligible leave days into the following year, typically limited to 30-45 days depending on the state, with excess leave automatically converted into cash.
Sick Leave
Employees are generally entitled to 5-12 days of paid sick leave per year under state laws or employer policies. A medical certificate is often required for absences longer than 2-3 days. Sick leave typically cannot be carried forward or encashed.
Casual Leave
Most states mandate 7 casual leaves each year. Casual leave is granted for at least half a day, with up to a maximum of three days per month, and requires management approval. It cannot be carried forward or accumulated.
Maternity Leave
Female employees receive 26 weeks of paid leave for their first two children and 12 weeks for any subsequent children under the Maternity Benefit Act. Commissioning mothers and adopting mothers are entitled to 12 weeks of paid leave from the date the child is handed over.
Paternity Leave
Central government employees are entitled to 15 days of paid paternity leave. There’s no statutory paternity leave requirement for the private sector, though many companies offer 5-10 days as part of HR policy.
Public Holidays
There are three mandatory national holidays in India: Republic Day (January 26), Independence Day (August 15), and Gandhi Jayanti (October 2). Additional holidays vary by state and typically include 12-14 festival holidays.
Essential Legal Clauses for Employment Contracts
Every employment contract in India should include these critical clauses to protect both employer and employee interests.
1. Appointment and Term of Employment
The contract must explicitly state whether the employment is permanent, fixed-term, or on probation, with clear specification of duration for fixed-term roles and typical probation periods of 3-6 months.
2. Job Title, Description, and Reporting Structure
Clearly define the role, responsibilities, reporting manager, and work location. Include language allowing reasonable modification of duties based on business needs.
3. Remuneration and Benefits
This clause transparently stipulates an overview of the employee’s compensation structure and additional benefits including basic salary, allowances, bonuses, PF, ESI, health insurance, and any performance-based incentives.
4. Working Hours and Overtime
Normal working hours are capped at 8 hours per day and 48 hours per week, with overtime allowed only with worker consent and paid at twice the regular rate.
5. Probation Period
The probation clause should clearly specify the duration of probation (typically 3-6 months), the employer’s right to extend it, and notice requirements during this period, with confirmation conditional upon written approval rather than automatic.
6. Leave Entitlements
Specify all leave types (earned, casual, sick, maternity, paternity) with accrual rates, carry-forward rules, and encashment provisions in line with state labour laws.
7. Termination and Notice Period
This clause should cover termination for convenience with notice or salary in lieu, immediate termination for misconduct or breach of trust, voluntary resignation requirements, and the specific notice period (commonly 30-90 days depending on seniority).
In case of retrenchment, employees who have been in continuous service for at least 1 year must receive notice of 1 or 3 months (or equivalent pay) and retrenchment compensation calculated at 15 days’ average pay for every completed year of service.
8. Confidentiality and Non-Disclosure
Confidentiality clauses protect proprietary information, trade secrets, and sensitive business data by prohibiting employees from disclosing confidential information acquired during employment, with obligations extending beyond termination.
9. Intellectual Property Rights
This clause ensures that all work created during employment — including inventions, designs, software, and documentation — vests exclusively with the employer, with obligations to assist with IP registration even after termination.
10. Non-Compete and Non-Solicitation Clauses
Post-termination non-compete clauses are generally unenforceable under Section 27 of the Indian Contract Act, which states that any agreement in restraint of trade is void. However, non-solicitation clauses preventing former employees from soliciting staff or clients have been upheld by courts when reasonable in duration (typically up to 3 years) and necessary to protect legitimate business interests.
Non-compete restrictions during employment are valid and enforceable.
11. Code of Conduct and Disciplinary Action
Incorporate the company’s code of conduct by reference and reserve the right to amend internal policies, linking violations to defined disciplinary outcomes to enhance transparency and legal defensibility.
12. Data Protection and IT Usage
These clauses establish employer ownership of data, define monitoring rights for company systems and devices, and impose obligations to return or delete data upon exit.
13. Dispute Resolution
Specify the mechanism for resolving disputes, whether through arbitration, conciliation, or courts, and the applicable jurisdiction.
Common Mistakes to Avoid When Drafting Employment Contracts
- Non-compliant salary structure — Keeping basic pay below 50% violates the new wage codes
- Vague job descriptions — Leads to disputes over scope of work
- Missing statutory benefits — PF, ESI, and gratuity must be explicitly mentioned
- Overly broad non-compete clauses — Post-termination restrictions are unenforceable
- Inadequate leave policies — Must meet minimum statutory requirements for each state
- No termination process — Failing to specify grounds and notice periods creates legal risk
- Ignoring state-specific variations — Labour laws differ across states
How My Legal Pal Can Help
Drafting a legally compliant employment contract that balances employer protection with employee rights isn’t simple — especially with the new labour codes reshaping the landscape. One poorly worded clause can expose your business to statutory penalties, employee disputes, or unenforceable terms.
At My Legal Pal, we connect you with experienced employment law advocates who draft contracts tailored to your industry, role, and state-specific requirements. Whether you need a single employment agreement, a template for your growing team, or a full policy review, our advocates ensure your contracts are compliant, enforceable, and professionally structured.
Get Your Employment Contract Drafted by an Expert
Frequently Asked Questions
Q1. Is a written employment contract mandatory in India?
While not legally mandatory for all establishments, a written contract is strongly advisable and required under certain labour laws (like the Industrial Standing Orders Act for establishments with 100+ workers). The new labour codes emphasize written appointment letters for formalization and transparency.
Q2. What is the minimum basic salary percentage required under the new labour codes?
Basic salary must constitute at least 50% of total remuneration (CTC). Allowances like HRA, transport, and bonuses cannot exceed 50% of total pay.
Q3. How much annual leave are employees entitled to in India?
Under the Factories Act, employees earn 1 day of leave for every 20 days worked (approximately 15 days annually after 240 days of service). The Shops and Establishments Act mandates 18 days of paid annual leave in most states.
Q4. Are fixed-term employees entitled to the same benefits as permanent employees?
Yes. Under the new labour codes, fixed-term employees are entitled to the same statutory benefits as permanent staff, including PF, ESI, bonus, and gratuity (after 1 year instead of 5).
Q5. Can an employer enforce a non-compete clause after employment ends?
No. Post-termination non-compete clauses are generally unenforceable under Section 27 of the Indian Contract Act. However, non-solicitation clauses (preventing poaching of clients/employees) can be enforceable if reasonable in scope and duration.
Q6. What is the standard notice period for termination in India?
Notice periods vary by employment contract and seniority, typically ranging from 30 to 90 days. For retrenchment, labour law requires 1 to 3 months’ notice or payment in lieu, along with retrenchment compensation.
Q7. How is gratuity calculated under the new codes?
Gratuity is calculated as 15 days’ wages for every completed year of service, based on the last drawn salary, with a cap of Rs. 20 lakhs. Fixed-term employees now qualify after 1 year instead of 5 years.
Conclusion
India’s labour law environment has fundamentally changed with the 2025 codes, and employment contracts must reflect this new reality. From the 50% basic pay rule to expanded social security coverage and stricter leave entitlements, compliance isn’t optional.
A well-drafted employment contract is more than a legal formality. It’s the foundation of a transparent, fair, and legally defensible employment relationship that protects both your business and your employees.
Don’t leave your contracts to generic templates or outdated formats. Get them drafted right the first time.
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