Provident Fund Contribution

Latest (EPFO) Provident Fund Status may reduce your take home salary - Historically, most companies and employees have been restricting their contribution to Provident Fund ('PF') based on the prescribed percentage (12% each by employer and employee) of Basic Salary and DA only. The underlying accepted principle duly supported by a Supreme Court ruling was that only the amounts payable to permanent employees for work done should be includible in computing PF contributions and payments for specific purposes should be excluded (eg. purpose-driven allowances or reimbursements).

Thus, it was settled for quite a substantial period of time that PF contributions were payable only on the salary paid for the work done or performed generally, and not on other components which were paid to the employees for specific purposes.

Based on this principle, most companies and employees have been allocating the total annual salary of the employees, i.e. Cost to Company ('CTC') into various allowances, reimbursements, etc. This achieved a better (higher) take home pay effectively, due to more effective quantum of the PF contribution as well as lower income-tax withholding by the employer due to the tax efficiency of some of these items.

However, in the recent past, there have been two rulings in case of Montage Enterprises Pvt. Ltd. (Madhya Pradesh High Court) and Reynolds Pens India Pvt. Ltd. and others (Madras High Court), wherein it has been interestingly held that various allowances paid by the employer to his employees under different heads (such as Conveyance, Educational, Food Concession, Medical, Special Holidays, Night Shift Incentives, City Compensatory allowances, etc) qualified as Basic wages under section 2(b) of the PF Act and hence, the same also needs to be included while calculating PF contribution.

These rulings are based on the hypothesis that generally, fixed monthly amounts (eg Conveyance allowance) payable to all employees of an organisation or paid without any specific criteria to determine the quantum (eg Special allowance) are nothing but part of salary paid for work done which are labelled as various types of allowances, and therefore, need to be included to compute PF contributions.

If these Court rulings are implemented by the PF officers, the primary consequence would be that the employer will start computing and paying the PF contributions on the most components of salary (especially fixed allowances) on an immediately effective basis, straightaway resulting in a lower cash salary in the hands of the employee.

Secondly, in absence of any limitation period provision in the present PF laws, the authorities can validly look at the past years and recover the differential PF contributions right from the commencement of the employee's PF membership till date, along with interest, damages and penalties. Additionally, while the employer may need to shell out all these incremental contributions (both employer and employee) for the past period as well, he would be prohibited to recover these past employees' contributions from their present salary, resulting in these contributions becoming a pure cost element.

Further, the income-taxman will also not leave the employer, as he would disallow the employee's contributions to compute tax on his taxable profit, as the same will not be regarded as paid within the normal due dates, leading to an unwarranted increase in this cost element. Needless to mention, while such additional cost for the employer may not affect the employee directly, it will certainly have an indirect impact by roll out of lower amount of variable performance linked payments, a common reality in this modern era.

While the above consequences appear to be foregone conclusions if the EPFO and the PF authorities follow these rulings, there is one shelter available under proviso to paragraph 26A of the PF Scheme, which allows PF contributions by employer as well as the employees on a maximum notional salary of Rs 6,500 per month, instead of the entire salary (including allowances).

Interestingly, this is not being implemented by too many employers currently - likely reasons being that the PF contributions are in-built as a part of the employee's CTC and they give a tax shield to the employee. Further, while this option may be available (if offered by the employer) to reduce PF contributions for new employees, whether the PF authorities will allow this to limit the past/ future PF contributions of the existing employees is an issue that needs to be explored. Also, this option will not be of any help in cases where the salary (even after inclusion of other allowances) remains below Rs 6,500 per month.

As can be seen from the above, while apparently this may seen quite innocuous, this may open up a big Pandora's box not only due to the sheer wide-spread impact (being a common practice across employers) but also create significant additional costs for the employers. Therefore, these judgments (if implemented) could have a far reaching impact on employee's net take home and employer's costs.

It is learnt that the Employee Provident Fund Organisation ('EPFO') (apex statutory body administering the PF legislation in India) has taken strict cognizance of these recent High Court cases and has issued specific letters to all-India PF offices to utilize the same in every case.

This means that the PF officers are now specifically directed to examine the contributions in the case of every company presently covered, and they are free to conduct a factual evaluation of the employment contract as well as the pay structure, along with the other supporting / descriptions to identify and determine whether the pay has been split into several headings to avoid/ lower PF contributions.

In summary, while the intent of the EPFO/ PF authorities to implement the ruling for benefit of the employees in general is quite laudable, it remains to be seen how unsettling these will be on the employers and the employees.


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