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How to structure your salary to minimize tax liability

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Summary

Understanding salary components and their taxation is crucial for employees to maximize their take-home pay

Job satisfaction matters. What matters more is the remuneration. All salaried employees will vouch for that. That’s the reason why they look forward eagerly to the first quarter of the financial year _ when salaries are revised. Thereupon, there is a mad scramble to understand the latest pay package and calculate the percentage of hike received. Not all employees can instantly decipher what the hike implies. The few who do immediately understand that taxes are a bitter part of their lives and jobs. The rest realize it when the salary is credited into their bank accounts.

Understanding the nitty-gritty of salaries is not everyone’s cup of tea. And the salary components can differ from one company to another. Ask Vinay Jhunjhunwala (34), head-treasury with MCPI, part of The Chatterjee Group, Kolkata. Jhunjhunwala received a 25% hike in salary when he joined the firm but his tax liability also trebled. “It was because of the lower LTA (leave travel allowance) and HRA (house rent allowance) component, compared to what I was getting at my previous organisation. Considering the post-tax income, my hike turned out to be just 15-16%," he says.

To avoid such dejections, it’s important for employees to understand salary components, mandatory deductions and their taxation before accepting an offer letter. So, ask the human resource department to explain your salary structure and negotiate for tax-friendly components that will get you the maximum tax benefit.

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The cost to company

Employers calculate your salary in terms of cost to company, or CTC. It is the total amount that a company spends on its employee in a financial year. This includes basic salary, HRA, special allowances and flexi benefits, gratuity, and health insurance, among others. For the benefit of employees, a few large corporations exclude gratuity and insurance premium from the CTC. So, broadly, your salary will have three components—fixed benefits, reimbursements (also called flexi benefits), and other components.

Fixed components include your basic salary, dearness allowance, HRA, children’s education allowance and special allowance. Basic salary, which makes up for 40-50% of your CTC—and the special allowance are fully taxable. However, some tax benefits are available on other components such as HRA and children’s education. HRA generally constitutes 50% of the basic salary. Education allowance for two children is pegged at 100 per month per child.

Flexi benefits and allowances—for uniforms, conveyance, Wi-Fi and mobile, periodicals, meal coupons, car lease, car maintenance, driver’s salary and company-paid accommodation— help lower taxes. All you have to do is provide receipts against these expenses. “This can help employees lower their tax liability significantly. For instance, an employee in the 30% tax slab who opts for the meal coupons of 2,200 per month can save tax of 8,237 per annum," says Latha Iyer, CHRO, Zaggle, a B2B fintech firm in expense management.

A few organizations are even offering reimbursements for OTT subscriptions and also appliances such as laptops in case of work from home.

Other components include contributions to the Employees’ Provident Fund (EPF), National Pension System (NPS), gratuity, insurance premium and variable pay, if any.

The best salary structure

Employees alone can decide whether their salary structure is beneficial. Some prefer more salary in-hand, while others want it to be tax-efficient. For instance, Narendran Sivakumar (30), a senior manager at a Bengaluru-based firm, Strata, says his CTC comprises basic salary (50%), HRA (20%), and special allowance (20%). The remaining is flexi benefits. Employer contribution to EPF and premium paid for employee insurance is not part of his CTC. “I have opted for fuel, internet, uniform and food coupons as flexi benefits. As long as I provide receipts, I get reimbursed for these," he says.

Ashish Sapra, senior manager at a financial services firm in Delhi, does not have any flexi benefits, except meal coupons (1.5%) and LTA (3%). His basic pay, HRA and special allowance are 22%, 11% and 33%, respectively, of the CTC. Variable pay comprises a good chunk of his CTC at 23% and is fully taxable. The structure doesn’t give him much leeway to save on taxes. “My previous organisation offered me fuel and car lease along with driver’s salary. Thankfully, now I have a home loan and can claim deduction for this , else the current salary structure would have increased my tax liability," he says.

Navratan Bohra, deputy vice president at Anand Rathi Shares & Stock Brokers, does not have many flexi benefits or variable components in his salary. So, it gets him a decent post-tax income. “I get 11% of my CTC without any deduction in the form of conveyance and meal voucher reimbursements. While 5% is NPS contribution by employer, the rest goes into basic salary, HRA and special allowance," he says.

Some companies, instead of hiking allowances, offer perks that are not part of the salary and thus has its own tax benefits. It could be a phone or a car for official use . “My company offers me flat 50,000 over and above the CTC to be reimbursed against training and education," says Sivakumar. Some companies offer such perks for gym memberships and travel and accommodation during personal vacations.

The reimbursements model

There is no doubt that reimbursements are tax efficient. However, most employees underestimate its impact. They let go of reimbursements to increase their fixed pay just to avoid paperwork. The accompanying graphic showcases two scenarios. Employee A hasn’t opted for flexi benefits. Employee B has a long list of line items under reimbursements. While the gross pay is higher for employee A, so is the gross taxable income. Employee A ends up paying over 2.5 lakh extra tax even as the CTC is same for both employees at 20 lakh. The take-home salary will also be higher for employee B assuming he claims all reimbursements.

“Now that I am aware of the advantages of flexi components, I would be fine with a slightly lower gross CTC if the company offers me various allowances because it’ll make my post-tax salary higher. Post-tax salary is more important than CTC," says Sivakumar.

Reimbursements are a smart choice but involve administrative hassles for both employers and employees. B2B platforms such as Zaggle helps employers implement bespoke flexi-benefits programmes. “It eliminates the need to juggle multiple cards for various benefits like food, fuel, travel, attire, books and periodicals, internet, and the platform simplifies the entire benefits management workflow," says Iyer.

The new tax regime

The new tax regime, despite having more tax slabs but lower tax rates, does not offer many tax-efficient tools. “Certain deductions or exemptions such as gratuity, leave encashment, daily allowance, conveyance allowance, transport allowance for a specially-abled person, tax beneficial perquisites (e.g. gifts up to 5,000, car and driver related reimbursements, etc.), employer’s contribution towards NPS u/s 80CCD(2), standard deduction of 50,000, are still available under the new regime," says Anurag Jain, co-founder and partner, ByTheBook Consulting LLP.

Note that gifts up to 5,000 by employers is different from 50,000 tax-free gifts that you are eligible to receive in a financial year from people other than your close relatives. Gifts by employers are usually given in your birthday month.

Mint take

Always enquire about flexi components in the salary and make use of it. Focus on post-tax salary over CTC or gross pay. It would be ideal to consult a chartered accountant before accepting a job offer rather than approaching them only when filing income tax returns.

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