Tax equalisation in India, under the new Labour Codes and tax Act

Tax equalisation in one page

Tax equalisation (TEQ) is a policy, not a calculation trick. The idea is simple. An assignee should pay roughly the same tax as if they had stayed home — no more and no less. This holds regardless of where the assignment actually places their income tax burden.

The employer absorbs the difference. If India’s actual tax bill is higher than the assignee’s home-country hypothetical bill, the employer pays the gap. If India’s bill is lower, the employer may recover the difference from the assignee, depending on the policy’s terms.

TEQ exists because assignees should not have to become personal tax experts, and should not refuse assignments purely over tax exposure. It sits alongside — but separately from — the shadow payroll build that computes the actual India-sourced figures each cycle. See the shadow payroll guide for how that parallel calculation works.

Hypothetical tax vs actual tax

Hypothetical tax is an estimate, withheld from the assignee’s paycheck as if they had stayed home and paid only home-country tax on their normal salary. It funds the employer’s later tax-equalisation settlement and is not itself remitted to any tax authority — it is a payroll deduction, not a tax payment.

Actual tax is the real liability, made up of two parts. The first part is India tax on India-sourced income, charged under the Income-tax Act 2025’s §15 charging rule. The second part is whatever tax the home country still charges on non-India income, reduced by any treaty relief.

The settlement reconciles the two. Where actual tax (India plus any remaining home-country liability) exceeds the hypothetical tax already withheld, the employer pays the difference. This payment goes to the assignee, or to the tax authority directly, depending on the policy. That employer-funded top-up is itself taxable income to the assignee in most cases, which is why tax equalisation settlements loop through a gross-up calculation. See the gross-up mechanics guide for that loop in detail.

Where the Labour Codes shift the equalisation base

The four Labour Codes, in force since 21 November 2025, do not change the tax mechanics of TEQ directly. What they change is the size of the underlying pay base the tax gets calculated on, through the Code on Wages’ 50% wages-deeming rule.

Where an assignee’s excluded pay components exceed 50% of total remuneration, the excess is added back into “wages” for Code-based entitlements. These excluded components include allowances, bonus, employer PF, and similar items. The entitlements affected include gratuity, leave, overtime, and retrenchment compensation. On an India-registered fixed-term contract, this deemed-wages base also drives gratuity accrual from one year of service, pro-rata, rather than the five-year period that used to apply.

That deemed-wages increase is a labour-code effect, not an income-tax effect on its own. But it changes the size of statutory entitlements, like gratuity. Those entitlements then flow into the assignee’s taxable income under the 2025 Act’s own rules. They also flow into the hypothetical-tax comparison that a well-built TEQ policy should track.

Separately, EPF for International Workers under Para 83 still runs on the full uncapped global package, on the legacy 1952-Act machinery. This is independent of the Code on Wages’ deeming rule. A TEQ calculation that only tracks the deemed-wages base and ignores the IW PF base will under-fund the equalisation. See the EPF International Workers guide for that base’s mechanics.

Settlement timing

Year-end is when a TEQ policy actually closes out. The final assignment allowances and any cost-of-living adjustments for the year are finalised. The tax-equalisation settlement itself is calculated and grossed up. The annual TDS certificate — generally called Form 16, now anchored to §130 of the Income-tax Act 2025 — is issued.

Employer-side accruals that feed into the settlement, such as bonus and leave-encashment provisions, run on the 2025 Act’s §37 actual-payment basis. These are deductible to the employer only when actually paid, by the ITR due date, not merely when accrued in the books.

Illustrative example

An assignee’s home-country hypothetical tax, withheld through the year, totals ₹9 lakh. Their actual combined tax liability — India tax on India-sourced salary plus any residual home-country tax — comes to ₹22 lakh once the year’s numbers are final. This total includes a deemed-wages-driven gratuity accrual that increased their taxable salary base.

The employer owes the assignee (or the tax authority, depending on how the policy pays) the ₹13 lakh gap. Because that ₹13 lakh top-up is itself taxable, it needs an iterative gross-up calculation before the true employer cost is known. See the gross-up mechanics guide for why a single-pass calculation understates this.

Practical posture

Build the TEQ calculation on the same three-base structure a shadow payroll uses: IW PF wages (full, uncapped), Labour Code “wages” (50%-deemed), and 2025-Act taxable salary. Do not assume one number covers all three. Reconcile the hypothetical-tax withholding against the actual figures every cycle, not just at year-end, so the final settlement and gross-up are not a single large surprise.

General guidance, not legal advice — work the specific TEQ policy and its numbers through with India counsel or your shadow-payroll provider before relying on it.