In our previous post we talked about the why PF should be calculated on gross salary and not on Basic head of pay.
Since employees and employers are not mandated to contribute PF on PF Gross (please read our previous post for the definition of PF Gross) over and above Rs 6,500 per month, the employees whose PF gross is over Rs 6,500 per month will not be impacted on account of calculation of PF on gross salary. The employees who will be impacted are those who receive PF Gross of less than Rs 6,500 per month.
Switching to calculating PF on gross salary
If your organization currently calculates PF as 12% of Basic head of pay, please consider changing the basis of your PF calculation at the earliest. Here are the steps towards changing the basis of PF calculation.
1. Define PF Gross for the purpose of PF calculation.
Please examine the heads of pay in the pay structure used in your organization and determine (as per the PF Act) what all heads of pay should be considered and left out for the purpose of PF calculation.
Heads of pay to be included in PF Gross are Basic, DA, cash value of food concession, all allowances (Conveyance, Transport Allowance, Other Allowance, Special Allowance etc.) except House Rent Allowance (HRA). Please exclude HRA, Overtime Allowance, Bonus, Commission and such other similar pay from PF Gross. If you pay any performance based pay (say, incentives calculated on sales, production and other performance parameters) which are similar to bonus and commission, please exclude such heads of pay. Both statutory and performance-based bonus should be excluded from PF Gross.
2. Employees whose Basic (plus DA) is more than Rs 6,500 per month.
For employees whose earned Basic (plus DA) is more than Rs 6,500 per month, you could continue deducting PF on Basic pay (plus DA). Of course, if you do not mind the additional cost, you can switch to calculating PF on their PF Gross even though you are not required to do the same.
3. Employees whose Basic (plus DA) is less than Rs 6,500 per month.
Please determine the PF Gross and calculate PF as 12% of PF Gross. In case 12% of PF Gross is more than Rs 780 (i.e. 12% of Rs 6,500), you can choose to restrict PF to Rs 780 per month.
Here are some illustrations for PF calculation.
Salary: An employee receives Basic pay of Rs 10,000 per month.
PF calculation: Since the employee’s Basic is above Rs 6,500, the stipulated ceiling for mandatory PF Gross, his PF contribution can be calculated as 12% of Basic i.e. Rs 1,200 in this case.
Salary: An employee receives Basic pay of Rs 3,000 per month and Rs 3,000 under Special Allowance.
PF calculation: Since the employee receives Rs 3,000 under Basic and Rs 3,000 under Special Allowance, a head of pay which should be in PF Gross, the PF contribution cannot be calculated as 12% of Rs 3,000 but should be calculated as 12% of Rs 6,000 (the PF Gross), which is Rs 720.
Salary: An employee receives Basic pay of Rs 3,000 per month and Rs 3,000 each under Special Allowance and Other Allowance.
PF calculation: Since the employee receives Rs 3,000 under Basic and Rs 3,000 each under Special Allowance and Other Allowance, heads of pay which should be in PF Gross, the PF contribution cannot be calculated as 12% of Rs 3,000 but should be calculated as 12% of Rs 9,000 (the PF Gross), which is Rs 1080. In this case, since the PF Gross is greater than Rs 6,500, you have the option of restricting the PF Gross to Rs 6,500 for calculation of PF. In other words, you can calculate PF as 12% of Rs 6,500 instead of Rs 9,000.
3. PF calculation in the first and last month of service and in case of loss of pay.
It should be noted that PF calculation is on earned pay (the actual pay made to an employee after adjusting for loss of pay) and not fixed pay stated in the appointment letter. Even if the fixed Basic pay is above Rs 6,500, if an employee does not work the whole month in his first or last month of service or has loss of pay, his earned Basic pay could fall below Rs 6,500 in a month. In such a month, PF should be calculated on PF Gross instead of just Basic pay.
Salary: an employee receives Rs 10,000 per month under the Basic head of pay and Rs 10,000 under Special Allowance (a head of pay to be included for PF calculation). He joins the company in the middle of a 30-day month and gets paid only for 15 days.
PF calculation: The earned Basic for the month shall be Rs 5,000 while his earned PF Gross is Rs 10,000. If one were to calculate PF only on Basic pay, the employee’s PF shall be 12% of Rs 5000 for the first month. However, since the earned Basic amount is less than Rs 6,500 in the first month of service, you need to calculate PF on PF Gross (Rs 10,000) instead of just Basic head of pay for the first month. As stated in Illustration 3, even here since the PF Gross is greater than Rs 6,500, you have the option of restricting the PF Gross to Rs 6,500 for calculation of PF.
From the second month onwards, you can switch to calculating PF on earned Basic as long it remains above Rs 6,500 per month.
The basis of PF calculation should be PF Gross whenever Basic falls below Rs 6,500 in a month.
The above illustration holds even in an employee’s last month of service and when an employee has loss of pay — instances when the earned Basic could fall below Rs 6,500 in a month.
Please note that even if you are calculating PF only on restricted Basic (Rs 6,500) instead of full Basic (the actual Basic amount), the PF calculation should be on PF Gross instead of Basic head of pay in case PF contribution falls below Rs 780 per month.
For those of you who are mathematically inclined, here is a simple algorithm for PF calculation. This sums up the basis of PF calculation if you wish to continue calculating PF on Basic (when the earned Basic is greater tha Rs 6,500) and switch to PF Gross when the earned Basic falls below Rs 6,500 per month.
MAX (ROUND (IF (Earned Basic >= 6500, Earned Basic, MIN (PF Gross, 6500))), 0) * 12%
1. The Min function ensures that PF Gross is restricted to Rs 6,500 when the Basic pay is less than Rs 6,500.
2. If you are calculating PF on restricted Basic (i.e. maximum of Rs 6,500) the above algorithm will not work. For PF calculation on restricted Basic, please modify the algorithm as follows.
MAX (ROUND (IF (Earned Basic >= 6500, 6500, MIN (PF Gross, 6500))), 0) * 12%
3. The Max function compares the PF Gross with zero and chooses the higher of the two for PF calculation. What is the need for the Max function here? The answer is quite simple. In case you have figured it out, please post the answer in the comments section of this blog. If you need the answer, let us know.
4. Specify the PF Gross clearly in ECR and other PF records.
Please ensure that the salary amount on which PF is calculated is entered accurately in the online Electronic Challan Cum Receipt (ECR) and other records. In case of any inspection or notice from the PF department, you will need to explain the basis of PF calculation.
5. Salary for PF calculation should not be less than “minimum wages.”
The PF department, by way of a circular, has stated that the salary for the purpose of PF calculation should not be less than the minimum wages specified by the Minimum Wages Act. For example, if the PF Gross is Rs 2,000 per month and the minimum wages is Rs 3,000 the PF department may not accept the PF calculation and ask the organization to calculate PF on at least the minimum wages. If an organization is in full compliance with the Minimum Wages Act, it will automatically comply with this dictat of the PF department.
6. Assess the income tax liability.
As per the Fourth Schedule of the Income Tax Act, 1961, the employer contribution to PF is exempt from income tax only to the extent of 12% of Basic pay and DA. When PF calculation is based on PF Gross instead of Basic (plus DA), the employer contribution to PF could attract tax. The employer contribution over and above 12% of Basic head of pay and DA shall be taxable. Please ensure that the employer PF in excess of 12% of Basic (plus DA) is taxed in the hands of the employee while calculating tax on salary paid to employees.
Employer PF contribution: An employee receives Rs 5,000 per month under the Basic head of pay and Rs 6,500 is the PF Gross. The employee has no DA. The employer contribution is calculated as 12% of PF Gross i.e. 12% of Rs 6,500 which is Rs 780.
Tax liability: The employer contribution which is exempt from tax is 12% of Basic, Rs 600 (12% of Rs 5,000). Since the employer contribution is Rs 780, the amount of Rs 180 (Rs 780 – Rs 600) should be added to taxable salary of the employee. The taxable employer PF amount should be presented in the Form 16 of the employee.
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