New EPF rule may lead to lower in-hand salary for high earners

Last month the Supreme Court gave an order to include special allowance along with basic pay and dearness allowance while calculating Employee Provident Fund (EPF) deduction. This addresses the long drawn litigation about allowances that need to be considered for contribution under the EPF Scheme. Let us understand the implications of this decision.

Legal provisions of EPF scheme

The EPF scheme is applicable to every employer who employs more than 20 people. Under the scheme the employer is required to deduct 12% of the basic salary and dearness allowance from the employee's salary and make own contribution of the same amount towards EPF.

This is mandatorily applicable to all employees whose monthly pay does not exceed Rs 15,000. For considering this threshold limit the basic pay and dearness allowance are taken into account. Employees whose salaries exceed this limit have an option to opt out of the scheme at the time of joining such establishment.

For employees drawing more than Rs 15,000 monthly salary, the employer has the option to deduct and contribute @ 12% on the base amount of Rs 15,000. Alternatively the employer can consider the entire amount of basic salary and dearness allowance for this purpose.

Since majority of employees perceive "in-hand cash salary" only as salary, the provident fund deductions/contributions are not perceived as part of the salary. So, in order to ensure maximum amount as "in-hand salary" many employers pay employees in the form of various allowances. Such allowances take the form of canteen allowance, conveyance allowance, lunch allowance, House Rent Allowance, special allowance, etc. The EPF scheme excludes cash value of food concession as well as HRA for EPF deduction.

What does the Supreme Court decision say

While there was no dispute with regard to the basic salary, the amount of allowance which the employer should take into account for the purpose of calculating the 12% deduction for EPF, has always been a subject matter of litigation. The same was addressed by the Supreme Court decision last month.

The Supreme Court has applied the "rule of universality" to allowances. If a particular allowance is universally paid to all employees of an establishment, without any reference to the quantum of efforts put in by the employee or the quantum of the output, the same takes the form of salary/dearness allowance and needs to be included for the purpose of determining the quantum of EPF deduction.

So, overtime allowance, performance linked incentives (PLI), bonus, commission or any other similar allowance shall stand excluded, but any special allowance not linked with performance will be included.

Likewise, any variable earning which may vary according to the employee's efficiency and diligence, will be excluded from "basic wages".

So the Supreme Court held that any allowance which is essentially a part of the basic wage, but camouflaged as an allowance to avoid deduction and contribution, has to be considered for the purpose of deduction for provident fund contribution.

Implication

Employees in the lower salary brackets, where amount considered for EPF contribution is lower than Rs 15,000 and who receive such universal allowance not linked to efficiency, will get lower "in-hand salary" as the employer is bound to take into account such allowances while deducting provident contributions. The employer will have to shell out more money in the form of employer's contribution. Such employees will be able to accumulate larger corpus in their provident fund account at the time of their retirement.

For employees who get higher salary with allowances, but the contribution has been pegged at the base amount of Rs 15,000 will not be affected by this decision.

However for employees in higher salary bracket and whose contribution is computed with reference to the higher salary, the contribution toward EPF will go up if they receive such universal allowance and which is not considered hitherto for EPF contribution.

So, in case your cost to the company (CTC) includes employer's contribution as well, and the amount of contribution will go up due to Supreme Court decision, your salary in hand will reduce due to increase in deduction from your salary, as well as your salary coming down to account for increased quantum of employer's contribution.

MORE OR LESS?

• Lower income earners, will get less salary in-hand, as the contribution to PF will increase; PF corpus will be higher 
   
• High income earners will see lower in-hand salary, only if PF is calculated on higher basic income

The writer is a tax and investment expert