PF contribution – company policy cannot overrule the law
According to Section 6 of the Employees Provident Fund and Miscellaneous Provisions Act, 1952, the provident fund (PF) contribution is to be calculated as 12% of the sum of basic pay, dearness allowance, cash value of food concession and retaining allowance, if any, subject to a maximum of Rs 6,500 per month.
Let us see how employer and employee PF contributions should be calculated.
a. Rate of contribution: Should be 12%. The law allows a 10% contribution under specific conditions. However, for most organizations, the rate is 12%.
b. Basis of calculation: The 12% rate should be applied on the basic pay, dearness allowance, cash value of food concession and retaining allowance, if any.
What constitutes salary for the purpose of PF calculation is an interesting question by itself. There are many court judgments which clarify this. The 2008 judgment by the Supreme Court of India (Citation: CASE NO.: Appeal (civil) 1832 of 2004, PETITIONER: Manipal Academy of Higher Education, RESPONDENT: Provident Fund Commissioner, DATE OF JUDGMENT: 12/03/2008, BENCH: Hon’ble Dr. ARIJIT PASAYAT & Hon’ble P. SATHASIVAM) in which the court clarified that earned leave is not a part of basic salary for the purpose of PF computation, is a must read for payroll managers. The judgment specifies how Section 2b and Section 6 of the Employees Provident Fund and Miscellaneous Provisions Act should be read together in order to determine what constitutes salary.
We can choose to ignore cash value of food concession and retaining allowance, since very few organizations provide those. In most cases, it safe to conclude that the 12% rate should be applied on the basic pay and dearness allowance, if any.
The PF contributions can be calculated on either “full” basic (total basic pay paid to employees) or “restricted” basic (limited to basic pay amount of Rs 6,500 per month).
Organizations in India should fully adopt the rate and the basis of calculation as specified in the law. However, we come across organizations which follow their own business rules — which are not in line with what the law mandates — for calculating the employer and employee contribution to PF.
A multinational company in India, until recently, was deducting and remitting PF amounts at 5% of the gross compensation paid to employees. When we had a discussion with the company as to whether this was in compliance with the PF rules, we were informed that a leading law firm had vetted this management policy and hence the company was comfortable following it. This company some time ago received a notice from the PF department that the PF contribution was less than 12% of basic pay — on account of the company following its own business rule — and the company should remit the difference to the department along with penal interest. The company recently changed its PF calculation rule to 12% of basic pay.
We wonder what was the need for the company to follow its own basis for PF calculation when the basis of calculation is clearly specified in the law.
In addition to calculating PF contribution incorrectly, organizations make mistakes in calculations in the bank challan used for remitting PF contribution each month. Calculations for Accounts 1, 2, 10, 21, and 22 are presented incorrectly in the challan on account of incorrect PF calculation. Payroll managers should appreciate the nuances of PF calculation and the linkages among the underlying components such as contribution to pension fund, provident fund, administration charges etc. It is not difficult for the PF department to figure out mistakes in the PF challan.
It is also important for payroll managers to understand how income tax calculation gets impacted when they follow their own business rule for PF calculation. Some companies add earned leave amounts to the basic pay for PF calculation even though as per law the basic pay does not comprise earned leave. Such companies claim that they do it for the sake of employee welfare (a higher amount of PF saving for the long-term). When heads of pay such as earned leave are added to the basic pay, the employer PF contribution goes beyond 12% of basic pay and any amount under employer contribution to PF beyond 12% is chargeable under the Income Tax Act.
Payroll managers should strive to comply with laws governing statutory deductions to the fullest extent. Ignorantia juris non excusat.