SC ruling on PF contribution likely to dent your take-home salary

The Supreme Court (SC) recently upheld what the Employees’ Provident Fund Organisation (EPFO) has been maintaining regarding the definition of the term ‘basic salary’ for calculating Employee Provident Fund (EPF) contribution. The apex court ruled that some other allowances that an employee receives, such as special allowance, will be considered as part of basic salary. The clubbing of allowances means an employee’s basic salary will now be higher, and consequently both the employee and the employer’s contribution to EPF will rise in tandem.

But the SC’s ruling will not impact all salaried class persons. “Two categories of employees will be affected — those who earn a basic salary of up to Rs 15,000 a month and international workers,” says Kuldip Kumar, partner and leader–personal tax, PwC. Adds William Vivian John, partner at law firm L&L Partners: “The formulation of basic wages cuts across a host of other employment laws, which can play out in different ways for employers. Companies will have to consider closely and account for the implications.”

According to the EPFO’s regulations, the contribution of employer and employee to EPF has to be equal — 12 per cent of basic salary. But if an employee earns a basic pay of over Rs 15,000 a month, the employer has the discretion to restrict its contribution, and also the employee’s, to Rs 1,800, that is, 12 per cent of Rs 15,000. The company can choose whether to contribute an amount higher than Rs 1,800. “Due to this, some salaried employees may see an impact and those with basic pay of over Rs 15,000 may not see any impact,” says Puneet Gupta, tax director-people advisory services, EY India.

What constitutes basic salary now? The SC has specified conditions for determining whether allowances should be clubbed with basic pay. Allowances given to all employees, or to a category of staff, will be considered as part of basic pay. Variable pay or incentives will not be considered as basic pay. Allowances linked to an employee’s productivity will not be considered as basic salary, nor benefits taxed as perquisites.

Say, an employer gives telephone allowance to everyone, but the amount varies from one employee to another. Tax experts say that this will be clubbed with basic salary. It is not a variable allowance (but a fixed amount every month), which means it is not an incentive and every employee receives it.

Impact on salary: To estimate the impact on your salary, first, you need to know the details of the SC case. To reduce their contribution to EPF, employers keep the basic pay as a limited portion of the overall salary. They add other allowances to the salary.

Say, an individual earns Rs 25,000 a month. The package could look like this: Basic pay of Rs 6,000, a special allowance of Rs 9,000, and the rest in other allowances such as mobile bill reimbursement, housing rent allowance and leave travel allowance. In this case, the employer needs to contribute only Rs 720 to EPF. Now, it will need to club allowances and contribute minimum of Rs 1,800 a month to EPF. “For a salaried person, it means that contribution to the retirement kitty will increase, but the take-home salary will drop,” says Archit Gupta, founder and chief executive officer of ClearTax. 

Many employers contribute a higher amount than the minimum threshold of Rs 1,800, even if the employee’s basic salary is over Rs 15,000. Such conditions are stated in the contract, and it’s not legal for employers to change the terms and conditions of a contract before its expiry, according to tax experts. So, will such companies need to increase their contribution to EPF, abiding by the terms of their contracts? The basic pay in such cases will also increase, as stipulated by the SC. According to tax experts, there are case laws where the courts have held that employers don’t need to increase their contribution as it’s discretionary.

International workers will be affected: The EPF rules for domestic and international workers are different. For such workers, there’s no minimum threshold limit of Rs 15,000. The employer has to contribute 12 per cent of basic pay to EPF compulsorily. Say, an expatriate earns Rs 1 lakh as basic salary, another Rs 1 lakh as special allowance, and Rs 2 lakh as perks. In such cases, the standard practice for employers was to contribute 12 per cent of the basic pay (Rs 1 lakh in the example). Now, their burden will increase substantially, and so will that of employees.

The change came as the apex court found that there was no data on record to show the “extra amounts paid to the workmen were in fact paid for the extra work which had exceeded the normal output prescribed”. The retirement body had challenged the prevailing practice, according to which special allowances were a part of dearness allowances, which in turn is a part of the basic wage. EPFO’s views were upheld by the two-judge bench, which observed that all incentives being paid, apart from the basic salary, must have direct linkage with the extra work being done by the worker. According to Punit Dutt Tyagi, executive partner at Lakshmikumaran & Sridharan, the judgment clarifies what could be inferred from previous judgments.

IMPLICATIONS OF SC RULING

• According to SC, allowances given to all employees, or a category of staff, will be considered part of basic
• As basic increases, PF contribution of both employers and employees will rise, and in-hand salary will drop, for those with basic pay up to Rs 15,000
• This order will not be applicable to employees with basic salary of over Rs 15,000 a month
• For international workers, both employer and employee contribution could increase