Appraisal season 2026: Will performance‑linked incentives lead to a higher EPF contribution?

The new definition of wages under the labour codes requires employers to consider 50% of the total remuneration, including basic pay, dearness allowance, and retaining allowance, as wages for calculating statutory contributions such as the Employees Provident Fund (EPF) and gratuity.

Further, labour codes say that if payments or allowances other than the basic pay, dearness allowance and retaining allowance exceed 50% of total remuneration, then the excess amount must be added to wages. Such a situation can lead to higher EPF and other statutory contributions for an employee.

As appraisal season for 2026 is here, there are questions on whether the performance-linked incentives granted to employees after the appraisal process should be added to wages for calculating statutory contributions.

The answer is that annual performance-linked incentives cannot be included in wages for calculation under the labour codes. Recently, the Union Ministry of Labour and Employer clarified this in a fresh set of FAQs.

"No. Annual performance-based incentives do not form a part of 'wages' for computation under the Labour Codes," the ministry said in response to the query: "Do annual performance-based incentives form a part of 'wages' for computation under the Labour Codes?"

Therefore, any incentives you receive in 2026 for your performance, including the performance-linked variable component of your pay package, will not lead to a higher EPF contribution. However, such incentives can increase your tax liability (we will talk about it in another article soon).

What is considered "wages" under the labour codes?

According to the ministry, the definition of wages for calculating statutory contributions under the labour codes covers the following:

• All remuneration whether by way of salary, allowances or otherwise. These include basic pay, dearness allowance and retaining allowance.

• If the allowances (except gratuity and retrenchment compensation) exceeds 50% of all remuneration, the excess amount shall be added back to wages. Please note that leave encashment is not a part of allowances under the labour codes.

What is not considered as a part of "wages"?

The following components of an employee's pay package are not considered part of the wages:

• Performance-based incentives

• Employee Stock Option Plans (ESOPs)

• Variable part of the component

• Reimbursement-based payments to the employee

"Performance-based incentives, Employee Stock Option Plans (ESOPs), variable part of the component or reimbursement-based payments to the employee shall not be part of the wages," the ministry said.

The new definition of wages under the labour codes came into effect from November 21, 2025.