Are you a member of the Indian Provident Fund (PF)? Do you contribute 12% of your basic salary every month into the PF? Is your CTC (cost to company) divided into basic salary and various allowances such as conveyance allowance, asset allowance, education allowance and special allowance? Are you an HR manager in a company where you handle the above set of employees? If your answer is yes for any of these questions, then you may find this article useful.
After the specific inclusion of international workers in the Provident Fund Scheme in October 2008 and then further amendments in September 2010, the recent Madhya Pradesh and Madras high court rulings are the latest to add to the woes of employees and HR directors/chief financial officers of many companies.
Very briefly, the high courts have held that various allowances such as conveyance allowance and special allowance form part of basic wages for calculation of PF contribution.
Reinforcing existing law
What needs to be considered here is whether the high court rulings have laid down some new principles or are these more a way of reinforcement the existing law. To understand this, let us discuss the concept of PF contribution and basic wages in greater detail.
Under the Provident Fund Act, an employer is required to contribute 12% of the basic wages, dearness allowance and retaining allowance (if any) paid to the employees to the Provident Fund and Pension Scheme. The employee is required to match the contribution made by the employer.
Basic wages are defined to mean all emoluments in accordance with the terms of the contract of employment and which are paid or payable in cash, but does not include cash value of any food concession, dearness allowance, house rent allowance, overtime allowance, bonus, commission or any other similar allowance and presents made by the employer.Thus, the definition of basic wages in the Provident Fund Act seems to suggest the intention of including all cash emoluments unless the same is specifically excluded.
On this topic, the Supreme Court of India has ruled that any payment, which is universally, necessarily and ordinarily paid to all across the board is included in basic wages.
The Supreme Court has also mentioned that a payment that is specifically made to those who avail of an opportunity such as an overtime allowance is not to be included in basic wages. Also, any payment by way of special incentive or work or which is based upon contingencies is excluded.
Therefore, it is fair to say that the high court rulings only serve to reinforce the above principles laid down by the Supreme Court earlier. Subsequent to the high court rulings, the PF head office has issued internal directions to regional offices (available in the public domain) that the rulings of high courts may be utilized by the regional offices as per the merits of the case as and when similar situations arise in the field offices.
This has caused apprehension among the employer community. Whether this would lead to increased PF audit activity? Whether employers would be asked to pay contribution on such allowances retrospectively? Whether this would lead to increased cost of PF in case of international workers and have an impact on their business plan?
The major concern here is of the employees who are worried since this would reduce their take-home salary drastically. In the current CTC structure which is generally followed in most companies, if both the employer’s and the employee’s share of additional contribution is deducted from the CTC, there will be a major impact on the employee’s take-home salary. While there will be some tax saving on the employer’s portion of contribution as the same is non-taxable, the deduction of the employee’s contribution under section 80C of the Income-tax Act will be limited to Rs1 lakh annually.
The way out: But the situation does not seem to be so bleak. Particularly, in case of local employees, the Provident Fund Scheme does provide a cap. There is merit in saying that employer’s and employee’s contribution to the Provident Fund Scheme can be limited to the base of Rs6,500 per month. However, if the employee so chooses, he may opt to make an additional contribution. Therefore, in respect of local employees, the employer can still take a position of limiting monthly contribution to the base of Rs6,500.
Still to be examined
Also, the generally accepted principle of not contributing on special allowance and certain other allowance on the basis of certain old PF circulars may also be examined. The argument that the earlier PF audits did not impose any requirement to contribute on such allowance may also be brought up.
For international workers, this needs to be examined differently as the limit of Rs6,500 per month does not apply to them. For international workers, what needs to be analysed is whether the test of universality needs to be applied for the company as a whole (including local employees) or for the international worker population only. Also, what needs an analysis is whether it can be argued that allowances paid to expatriate employees during the period of assignment can be considered as contingent as these are paid only while they are away from their home country and thus excluded from the scope of basic wages.
Sonu Iyer is tax partner, Ernst & Young.
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