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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.

Illustration 1

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.

Illustration 2

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.

Illustration 3

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.

Illustration 4

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%

Note:

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.

Illustration 5

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.

We welcome your point of view. Please leave your comment here or send an email to info@hinote.in if you wish to contact us in private.

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A recent article on Provident Fund (PF) deduction in the Times of India has led to a number of employers and employees believe that there will be a significant increase in PF deduction in the near-future. According to the article, as per a recent directive from the PF department, employers will have to contribute and deduct 12% of gross salary (instead of Basic pay) towards PF, and consequently the PF contribution and deduction will go up significantly. A number of people have expressed concern on account of the possibility of having to make a higher PF contribution.

We have received emails and phone calls from payroll managers seeking our view on this issue. Here is our attempt to decode what the PF department has actually said and hopefully in the process, dispel the myths on this issue.

So, is it 12% of Basic head of pay or 12% of Gross pay?

PF contribution should be calculated on “PF Gross” and not the Basic head of pay.

Gross pay for the purpose of PF calculation is different from the term gross pay which is typically used in the payroll context. For the sake of clarity, we will use the term PF Gross in this post to denote the salary to be considered for PF calculation. PF Gross includes Basic, DA, Conveyance, Other Allowance etc. (heads of pay which are included for PF calculation) and excludes House Rent Allowance, Bonus etc. (heads of pay which are excluded for PF calculation) as per the provisions of the PF Act.

According to the Employees Provident Fund and Miscellaneous Provisions Act, 1952 , called the PF Act, the statute which governs Provident Fund contribution, the PF contribution should be calculated as 12% of “basic wages” (plus DA, cash value of food concession, and retaining allowance, if any), subject to a maximum of Rs 6500/- per month. In case an employee earns basic wages (plus DA, cash value of food concession, and retaining allowance, if any) of more than Rs 6500 per month, they can opt for a higher PF deduction (more than 12% of Rs 6500) at the joint request of the employee and the employer.

According to the PF Act:

1. PF contribution should be calculated on “basic wages” (plus DA, cash value of food concession, and retaining allowance, if any) and;

2. beyond basic wages (plus DA, cash value of food concession, and retaining allowance, if any) of Rs 6500 per month, the PF contribution is not mandatory but can be made if employees and employers so wish.

Let us examine the above in greater detail.

Basic wages, as stated in the PF Act, is not the same as the “Basic” head of pay.

Here is what is stated in Section 2b of the PF Act.

2(b) “basic wages” means all emoluments which are earned by an employee while on duty or on leave or on holidays with wages in either case in accordance with the terms of the contract of employment and which are paid or payable in cash to him, but does not include-

(i) the cash value of any food concession;

(ii) any dearness allowance that is to say, all cash payments by whatever name called paid to an employee on account of a rise in the cost of living, house-rent allowance, overtime allowance, bonus, commission or any other similar allowance payable to the employee in respect of his employment or of work done in such employment;

(iii) any presents made by the employer;

A reading of Section 2b along with Section 6 of the PF Act leads us to understand that PF contribution should be calculated on basic wages, dearness allowance, cash value of food concession, and retaining allowance, if any.

It is not easy for a casual reader to figure out in the PF Act the exact definition of salary for the purpose of PF calculation. For example, while Dearness Allowance (DA) and cash value of food concession are excluded from the definition of Basic Wages in Section 2b, giving one an impression that DA and cash value of food concession are excluded for PF calculation. However, DA and cash value of food concession are included for the purpose of PF calculation (in addition to Basic Wages) in Section 6 of the PF Act, and Section 29 under Chapter 5 of the Employees’ Provident Fund Scheme, 1952. The text in the PF Act is somewhat laborious to read.

According to Section 2b of the PF Act,  basic wages means all emoluments which are earned by an employee in accordance with the terms of the contract of employment and which are paid or payable in cash to him. Section 2b explicitly excludes certain heads of pay such as house rent allowance, bonus, and overtime allowance, commission or any other similar allowance for the purpose of PF calculation.

Employers have all along been interpreting “basic wages” as the head of pay which is commonly called Basic and DA, if any, and hence have been calculating PF contribution on Basic (plus DA). While organizations offer salary under heads of pay such as Conveyance, Travel Allowance, Medical Allowance, Other Allowance, and Special Allowance, such heads of pay have been ignored for the purpose of PF calculation. This was probably because employers have all along interpreted “commission or any other similar allowance” excluded for PF calculation (as specified in sub-point ii of Section 2b in the PF Act) to mean commission and all allowances/heads of pay other than Basic (and DA).

Clarifications from the PF department

The PF department in its circular dated 30-Nov-2012 (Point no. 12) has clarified that “commission or similar allowance” means only commission and commission-like allowances and not allowances which are “necessarily and uniformly” paid to employees. In other words, pay paid under the heads such as Special Allowance and Other Allowance should be included for the purpose of PF calculation unless explicitly left out by the PF Act.

On the issue of determining salary for the purpose of PF calculation, court judgments in the last couple of years favour the PF department. In their judgements, the Madras High Court and Madhya Pradesh High Court have stated that organizations should add other allowances to Basic while calculating PF. You can read the PF department circulars which append the court judgements here and here.  As per the judgements, barring heads of pay such as House Rent Allowance and Bonus which are explicitly excluded (in the PF Act) from salary for the calculation of PF, the PF Gross of an employee should be used for the calculation of PF.

The PF department too has been reiterating that salary for PF calculation should include heads of pay other than Basic and DA, time and time again. Please take a look at a publication issued by the PF department which clarifies what basic wages are here. The PF department has also been conducting inspections in organizations and raising demand for additional recovery of PF from employers who have been calculating PF on the Basic head of pay instead of PF Gross.

What are payroll managers concerned about?

There are reports that the PF department has started actively advising employers to change the basis of PF calculation. Payroll managers fear that the change in salary amount on which PF is calculated will lead to a significant increase in the salary cost for employers. Employees may also get impacted if employers, not wanting to go beyond the budgeted cost-to-company figure, decide to pass on the burden on account of additional PF contribution to the employees.

We believe the above concern is not as serious as it is made out to be.

The additional burden to employees and employers may not be as severe as it looks since any PF contribution on PF Gross (which includes Basic wages, DA, cash value of food concession, and retaining allowance, if any) over Rs 6500 is not mandatory.  Employers are mandated to calculate PF as 12% of PF Gross only for employees whose PF Gross is Rs 6500 or less per month. For employees whose PF Gross is more than Rs 6500 per month, the organization could continue deducting PF on Basic head of pay (if the amount paid under Basic is above Rs 6500 per month) or restrict PF Gross to Rs 6500 for the purpose of PF calculation. In other words, the change in the basis of PF calculation is required only for employees whose PF Gross is Rs 6500 or less per month.

We will examine some illustrations on the practical aspects of PF calculation in the next post.

We welcome your point of view. Please leave your comment here or send an email to [mailto]info@hinote.in[/mailto] if you wish to contact us in private.

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