Salary for the purpose of PF calculation
According to the provisions of the Employees Provident Fund and Miscellaneous Provisions Act, 1952 , called the PF Act, the statute which governs Provident Fund (PF) contribution, the PF contribution should be calculated as 12%** of the basic wages plus DA plus cash value of food concession plus retaining allowance, if any, subject to a maximum of Rs.6500/- per month. In case an employee earns more than Rs 6500, they can opt for a higher PF deduction (greater than 12% of Rs 6500) at the joint request of the employee and the employer.
Almost all organizations interpret basic wages as the head of pay commonly called Basic, and DA, if any, and hence calculate 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 are ignored for the purpose of PF calculation. The definition of salary for the purpose of PF calculation has been a subject of great debate mired in litigation over the years. While organizations argue that basic wages are nothing more than the head of pay called Basic, the PF department argues that basic wages is not just the Basic head of pay and should include other heads of pay such as Conveyance, Special Allowance etc. In addition, the PF department contends that the salary for the purpose of PF calculation cannot be lesser than the minimum wages as mandated by the Minimum Wages Act.
On the issue of determining salary for the purpose of PF calculation, a couple of recent judgments 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 gross pay of an employee should be used for the calculation of PF.
We currently see the PF department actively going behind organizations and advising them to change the basis of PF calculation.
The change in salary amount on which PF is calculated could lead to a significant increase in salary cost for employers. Employees may also get impacted if employers, not wanting to go beyond the cost-to-company figure, decide to pass on the burden on account of additional PF contribution to the employees. However, since employees are not mandated to contribute PF on salary over and above Rs 6500 per month, the employees whose PF is over Rs 780 per month (12% on Rs 6500) will not be impacted on account of the change in the salary amount for the purpose of PF calculation. The employees who will be impacted are those who receive less than Rs 6,500 under the Basic head of pay each month.
While there is a possibility of organizations going on appeal against the recent judgments favouring the PF department, we are of the view that companies should try to comply with the PF department’s directive on the calculation of PF. There is no denying the vigour with which the department is imposing its writ in this regard currently.
If your organization calculates PF as 12% of Basic head of pay, please follow the below-steps in order to change the basis of PF calculation.
1. Define salary 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. Let us call the total of amounts under all the heads of pay considered for PF calculation as “PF Gross.”
2. Calculate PF each month as per the following logic.
If 12% of Basic head of pay is greater than Rs 780, then PF contribution = 12% of Basic head of pay, else PF contribution = 12% of PF Gross.
For example, let us assume that an employee receives Rs 10,000 per month under the Basic head of pay. Since his PF is Rs 1,200 (12% of Rs 10,000), which is well above Rs 780, the PF contribution can continue to be calculated as 12% of Basic.
In case 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, which is Rs 720.
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.
3. PF calculation in the first, last month of service and in case of loss of pay.
Even if Basic 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 Basic could fall below Rs 6,500 in a month. In such as month, PF should be calculated on PF Gross instead of just Basic.
For example, let us assume that an employee receives Rs 10,000 per month under the Basic head of pay and Rs 10,000 under Special Allowance. He joins the company in the middle of a month and works only for 15 days (in a 30-day month). The Basic for the month shall be Rs 5,000 while his PF Gross is Rs 10,000. Please calculate PF on PF Gross instead of just Basic head of pay for the first month. The basis of PF calculation should be PF Gross whenever Basic falls below Rs 6,500 in a month.
4. Salary for PF calculation should not be less than “minimum wages.”
In a recent circular, the PF department has stated that the salary for the purpose of PF calculation should not be an amount which is less than the minimum wages as 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.
5. Assess the impact on income tax calculation.
As per the Income Tax Act, if an employer contributes over and above 12% of Basic head of pay and DA, the employer PF contribution amount in excess of 12% of Basic and DA shall be taxable. As your organization moves from calculating PF from 12% on Basic to 12% on PF Gross it is likely that the employer contribution could go in excess of 12% on Basic. Please ensure that the excess employer PF is taxed in the hands of the employee while calculating the tax on salary paid to employees.
** The rate of contribution is 10% for organizations in specified sectors such as Brick, Beedi, Jute, Guar gum and Coir. For organizations in the large majority of sectors, the contribution is 12%.