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Salary for the purpose of PF calculation

August 1, 2011 7 comments

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%.

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Deduction under section 80GGA of the Income Tax Act

November 2, 2010 7 comments

Can salaried employees claim deduction under Section 80GGA of the Income Tax Act?

Section 80GGA covers the following contributions:

(a) any sum paid by the assessee in the previous year to a university, college or other institution which undertakes scientific research. The university/college/institution should be in the list notified by the Income Tax department.

(b) any sum paid by the assessee in the previous year to an association or institution, which runs programmes for rural development.

(c) any sum paid by the assessee in the previous year to a public sector company or a local authority or to an association or institution approved by the National Committee (please read the tax law to know what National Committee is), for carrying out any eligible project or scheme.

(d) any sum paid by the assessee in the previous year to a rural development fund set up and notified by the Central Government.

(e) any sum paid by the assessee in the previous year to the National Urban Poverty Eradication Fund set up and notified by the Central Government.

Any assessee who does not have income chargeable under the head “Profits and gains of business or profession” can claim deduction under Section 80GGA. Hence, salaried employees who do not have business income can claim deduction under the section.

However, employers while calculating TDS on salary cannot consider deduction under Section 80GGA. Salaried employees can submit information on contributions under Section 80GGA to the Income Tax department while filing their return and seek a tax refund, if applicable.

When should an employee feature in PF Form 10?

July 19, 2010 2 comments

Organizations file Form 10 each month as part of complying with Provident Fund (PF) norms. Form 10 presents details of employees who have left the organization–in other words, the list of employees who have ceased to be PF contributors. Organizations seem to be following different practices when it comes to presenting exited employees in Form 10. Some organizations present exited employees in the Form 10 filed in the very next month while others do it in the Form 10 filed in the month after that. Let us take a look at this issue with the help of an example.

The last date of service for an employee is June 30, 2010 and the final settlement, which contains PF deduction, is done on June 30, 2010. In which Form 10 should this employee feature? Some organizations would show the employee information in the Form 10 pertaining to June 2010 filed in July 2010, while others would show it in the Form 10 pertaining to July 2010 filed in August 2010. We find both these practices being prevalent.

So which is the correct practice?

The Form 10 template reads as follows:

“RETURN OF THE MEMBERS LEAVING DURING THE MONTH OF ________.”

Some PF practitioners argue that if an employee’s last date of service is June 30, 2010, then the employee should feature in Form 10 pertaining to June 2010 filed in July 2010.

The counter-argument is since the employee has PF contribution in June 2010 and the same is remitted before July 15, 2010, the employee cannot feature in Form 10 pertaining to June 2010. The employee ceases to be a PF contributory only in July 2010 and hence should feature in Form 10 pertaining to July 2010 (filed in August 2010).

We concur with the counter-argument presented above and are of the view that the employee should feature in the Form 10 pertaining to the month after the month in which the employee’s last PF contribution is remitted. In the above example, the employee should feature only in Form 10 pertaining to July 2010 (filed in August 2010).

What is the basis of our view?

Each month, organizations present employee count with regard to PF contribution in both PF bank challan and Form 12-A, and unless the employee counts in both the challan and Form 12-A match, one wouldn’t know what the correct number of PF contributors is.

Let us assume that a company which had 50 employees on May 31, 2010, added no new employee in June 2010 and lost one employee on June 30, 2010. If the exited employee’s last date of service is June 30 and his PF deduction (and employer contribution) is remitted by July 15, the employee will feature in the employee count in July PF bank challan, and hence the total employee count in PF bank challan shall be 50.

Let us assume that the organization features the exited employee in June Form 10 (filed in July). In Form 12-A pertaining to June (filed in July), the organization shall present the details of employees as follows.

Details of Subscribers
No. of Subscribers as per last month: 50
No. of new Subscribers (Vide Form 5): 0
No. of Subscribers left service (Vide Form 10): 1
(Nett.) Total Number of Subscribers: 49

In the above example, the total number of subscribers as  per Form 12-A (i.e. 49) is different from the subscriber count in the PF bank challan (i.e. 50).

Let us assume that the organization features the exited employee in July Form 10 (filed in August). In Form 12-A pertaining to June (filed in July), the organization shall present the details of employees as follows.

Details of Subscribers
No. of Subscribers as per last month: 50
No. of new Subscribers (Vide Form 5): 0
No. of Subscribers left service (Vide Form 10): 0
(Nett.) Total Number of Subscribers: 50

If information on exited employee is presented in July Form 10 (filed in August), the subscriber count in June PF bank challan and June Form 12-A will match. We are of the view that employee count in all PF forms, in which the count is presented, should match in order to avoid any ambiguity on the exact number of PF subscribers in an organization. However, we submit that there is no formal instruction from the PF department on when an exited employee should feature in Form 10.

What if the final settlement is delayed?
If the final settlement (which has PF deduction) is delayed, then Form 10 filing shall get delayed. For example, let us assume that an employee’s last date of service is June 30, 2010 and the final settlement is done only on September 30, 2010 and the PF amount pertaining to the final settlement is remitted to the department before October 15, 2010. In such a case, the employee should feature in November Form 10 (filed in December 2010). In the interim period (from July 2010 to September 2010), the employee shall be shown as a zero contributory in the PF bank challan.

Please note that if the last date of service is June 30, 2010, the organization should remit PF for the month of June before July 15 even if the final settlement containing other heads of pay is delayed. The practice of delayed PF remittance on account of delayed final settlement – as stated in the above example—should be avoided. Organizations should strive to remit PF on time even if the final settlement gets delayed.

Please note that the final settlement payment date is relevant from the PF point of view only if final settlement contains PF deduction. Otherwise, the date of final settlement has no relevance to Form 10. For example, let us assume that an employee’s last date of service is June 30, 2010 and the salary for June is paid out on the last day of June and the corresponding PF amount is remitted before July 15. If the employee’s final settlement (containing only heads of pay which have no impact on PF) is done on September 30, 2010, the employee should feature in July Form 10 (filed in August).

Categories: Payroll, Provident Fund

Deduction under Section 80G of the Income Tax Act

July 13, 2010 3 comments

Recently, a payroll manager in a customer organization asked us if his organization can accept information on charitable donations made by employees for calculating deduction under Section 80G of the Income Tax Act. Let us take a look at the conditions that payroll managers should consider while calculating deduction under Section 80G.

1. Consider only specified donations.

According to Section 80G, donation to funds and charitable institutions, which have obtained approval from the Income Tax Department, can be considered for calculation of deduction. You can read the text of Section 80G by clicking here. However, the Income Tax Department has specified that an employer can accept information on only certain donations (such as those to The Prime Minister’s Drought Relief Fund) for the sake of calculating deduction on salary. For other donations, employees should seek tax relief in their tax return filed with the Income Tax Department and cannot route the same through the employer.

Please click the link below and scroll down to the bottom of the page to read the department’s notification on this.

http://www.incometaxindia.gov.in/publications/2_TDS_On_Salaries/Chapter06.asp

To quote from the page pertaining to the above link,

“In respect of section 80G, no deduction should be allowed by the employer/DDO, from the salary income in respect of any donations made for charitable purposes. The tax relief on such donations as admissible u/s 80G will have to be claimed by the taxpayer in the return of income. However, DDOs, on due verification, may allow donations to the following bodies……”

Any donation to a fund/institution not featured in list specified by the Income Tax Department (presented in the above page) should not be considered by the employer for Section 80G deduction calculation.

2. Check proof of donation.

Even if the donation pertains to a fund/institution which can be considered by the employer, please scrutinize the proof of donation in order to check the veracity of the donation. Only donations in cash should be considered. In addition, the donation should have been made in the year in which the deduction is sought.

3. Apply the correct deduction percentage.

Please apply the correct percentage (50% or 100%) as specified by the Income Tax Department for each of the donations while calculating the extent to which the donation can be considered for deduction.

4. Limit on deduction under Section 80G.

For all donations that an employer can consider for calculation of deduction, there is no limit on the total deduction that can be claimed under Section 80G. For example, employees can claim deduction under Section 80G to the extent of even their total income (leading to zero taxable income).

When employees claim deduction under Section 80G by submitting information on donations directly to the Income Tax Department, the aggregate deduction on account of some of the donations is limited to 10% of the employee’s “Gross Total Income.” The term Gross Total Income is defined in the Income Tax Act. Employees need to know for which of the donations the 10% limit is applicable when they seek tax relief under Section 80G in their income tax return.

Payroll rules for food coupon/meal voucher

June 23, 2010 1 comment

We examined issues pertaining to taxation of food coupon/meal voucher in the previous post. Let us take a look at the business rules payroll managers need to consider while administering meal vouchers.

1. When to issue meal vouchers–beginning or end of the month?

Some organizations issue meal vouchers at the end of the month while others issue meal vouchers at the beginning of the month. We have come across a company which issues meal vouchers in advance for each quarter. You may choose to issue meal vouchers whenever you wish. However, in order to claim tax exemption, employees are supposed to use meal vouchers for consuming food during working hours. If an organization issues meal vouchers at the end of a month, it could be argued that the total amount of meal vouchers issued in that month shall be taxable in that month since there is no way the meal vouchers can be used by employees for consumption in that month. In such a case, tax exemption to the extent of Rs. 50 per meal, if applicable, can be claimed only in the next month.

2. Display in payslip.

Some organizations show the value of meal vouchers on both the pay and the deduction side of payslip while some do not. We are of the view that meal voucher–given that it is a non-cash perquisite–is to be kept out of the payslip. After all, we do not show the value of perquisites such as accommodation and car in the payslip.

3. Impact of loss of pay.

Whether or not the value of meal vouchers issued to employees gets impacted by loss of pay shall be determined by the business rules in your organization. But please note that the value of meal vouchers should be adjusted for loss of pay in order to calculate the perquisite value of meal vouchers for taxation.

4. Issuance of meal vouchers in the first and last months of service.

In the first and last months of an employee’s service, if the employee works less than full month, many organizations pay the corresponding value of meal vouchers by cash and tax it fully. This is because the amount payable to employee under the meal voucher head many not correspond to the meal voucher denominations available. For example, if an employee is entitled to get meal voucher to the extent of Rs. 2,000 per month and in the first/last month (a 30-day month) of service he works only for 7 days, then the value of meal vouchers to be issued to the employee for the first/last month shall be Rs. 467 after rounding off. Given that meal vouchers may not add up to Rs. 467 on account of the available denominations, you may consider paying it out as cash in the first/last month of service.

The alternative is to issue meal vouchers for the whole month, irrespective of when an employee joins or leaves the organization, and make a cash deduction in the payroll/final settlement to the extent the employee has not worked for the month.

If you decide to issue meal vouchers in advance each month, you will have to recover the cash value, if applicable, of meal vouchers  from an employee who leaves your organization before the end of month during the final settlement calculation.

5. Meal vouchers as a flexi-pay component.

Some organizations allow employees to switch between meal vouchers and cash as and when employees wish. While there is nothing wrong in giving the flexibility to employees, payroll managers need to take cognizance of the additional administrative effort in managing issuance of meal vouchers and keeping track of the pay structure changes when employees switch from meal vouchers to cash and vice versa.

6. Meal vouchers in case of arrear pay.

Your organization may decide to include meal vouchers when there is a pay hike with retrospective effect. You may issue additional meal vouchers towards “meal voucher arrear” in case of a retrospective hike. But please note that the tax exemption can be availed only to the extent of Rs. 50 per meal.

Categories: Income Tax, Payroll

Taxability of food coupon/meal voucher

June 21, 2010 1 comment

We find a number of organizations that issue food coupons/meal vouchers to employees each month not adhering to perquisite valuation rules issued by the Income Tax Department. Let us examine the text of the perquisite valuation rule governing issuance of meal vouchers and study the underlying conditions that are to be satisfied for availing tax exemption on meal vouchers.

The perquisite valuation rule governing issuance of meal vouchers is as follows. You can take a look at the source by clicking here.

(iii)   The value of free food and non-alcoholic beverages provided by the employer to an employee shall be the amount of expenditure incurred by such employer. The amount so determined shall be reduced by the amount, if any, paid or recovered from the employee for such benefit or amenity:

Provided that nothing contained in this clause shall apply to free food and non-alcoholic beverages provided by such employer during working hours at office or business premises or through paid vouchers which are not transferable and usable only at eating joints, to the extent the value thereof either case does not exceed fifty rupees per meal or to tea or snacks provided during working hours or to free food and non-alcoholic beverages during working hours provided in a remote area or an off-shore installation.

The above rule (Rule 3(7)(iii)) states that value of free food and non-alcoholic beverages or meal vouchers provided by the employer is exempt from income tax to the extent of Rs. 50 per meal. Please note that the tax exemption is to be calculated on a per-meal basis and not on a per-month basis. We find many organizations providing meal vouchers to the extent of Rs. 3,000 per month and not calculating any tax on the same. Some payroll managers argue that Rs. 50 per meal translates into Rs. 100 per day (assuming two meals per day) and finally into Rs. 3,000 per month (for 30 days) and hence meal vouchers are exempt to the extent of Rs. 3,000 per month.

For a meal voucher to be tax exempt to the extent of Rs. 50 per meal, the meal voucher should be used only during working hours. If an employee consumes two meals a day using meal vouchers in a working day and works for 22 days in a month (excluding holidays on Saturdays and Sundays), then meal vouchers can be tax exempt only to the extent of Rs. 2,200 per month (Rs. 50 per meal x 2 x 22 days). If the organization provides meal vouchers worth Rs. 3,000 for the month, then Rs. 800 (Rs. 3,000 – Rs. 2,200) shall be taxable in the hands of the employee.

“Meal” in this case should be understood to refer to breakfast, lunch, and dinner.

Please note that there is no restriction in Rule 3(7)(iii) on how many “meals” can be consumed each day for availing the Rs. 50 per meal exemption limit. One or two “meals” per day during working hours could be considered as reasonable.

In addition, the meal vouchers issued to employees should be non-transferable and used only in eating joints. Since tax exemption is restricted to Rs. 50 per meal, payroll managers would do well to issue meal vouchers only in Rs. 50 (or less) denomination. Issuance of meal vouchers of higher denomination (say, Rs. 100) may attract tax.

At the end of each month, payroll managers should make note of loss of pay and other leave days (Casual Leave etc.) of employees and correspondingly calculate the perquisite value for the meal vouchers issued.

While employers cannot keep track of whether food coupons/meal vouchers are used only during working hours and only in eating joints, payroll managers should inform employees regarding the tax rule governing meal vouchers, and ask employees to adhere to the rules from their end.

Section 206AA: Calculation of TDS on salary

June 17, 2010 1 comment

In the previous post, we talked about Section 206AA and its applicability to TDS on salary. Let us examine how to calculate TDS on salary as per this section.

According to Section 206AA, if a deductee (employee) does not furnish a valid Permanent Account Number to the deductor (employer) then:

tax shall be deducted at the higher of the following rates, namely:—

(i)  at the rate specified in the relevant provision of this Act; or

(ii)  at the rate or rates in force; or

(iii)  at the rate of twenty per cent.

Calculation of TDS on non-salary payments as per Section 206AA is quite straightforward; if the prevailing TDS rate is less than 20% then deduct TDS at 20% else deduct TDS at the prevailing rate.

With regard to TDS on salary, there is more than one way of calculating TDS on account of Section 206AA. This is because TDS on salary is calculated not at a flat rate but on the basis of a combination of tax rates in different income slabs. The question is what slab rate should 20% be compared with. Unfortunately, the Income Tax Department has not specified the method of TDS deduction under Section 206AA. It would be useful if the Income Tax department provides supporting text and numerical examples every time a notification, which has an impact on tax calculation, is issued.

Here is a method, which according to us, goes well with the letter and spirit of Section 206AA.

1. Determine the amount of taxable income after all exemptions and deductions for the year.

2. Apply tax rates as per the following income slabs and calculate the annual tax.

Annual taxable salary (Rs.) Rate (%)
Up to 160,000 (Male employee) 0
Up to 190,000 (Female employee) 0
1,60,001 – 5,00,000 20
5,00,001 – 8,00,000 20
8,00,001 upwards 30

You may have noticed that we have replaced 10% with 20% for the Rs. 1,60,001 – Rs. 5,00,000 income slab in the above table.

By applying the above rates, we can ensure that the TDS on salary is calculated at 20% or higher–as mandated by Section 206AA.

3. Calculate the monthly tax amount and deduct the same from the employee’s pay.

Example: A male employee without a valid PAN has a taxable income of Rs. 190,000 after all exemptions and deductions.

Total annual TDS on account of Section 206AA: Rs. 6,000 (i.e. Rs. 30,000 x 20%).

In this case the employee is in the 10% slab. Please disregard the 10% rate and apply tax at 20%. Use the resulting annual tax amount to determine the monthly tax to be deducted.

Presentation of the TDS amount in Form 16

Please note that Section 206AA pertains only to TDS to be deducted and not the actual tax liability of an employee. The Form 16 issued to employees should present both the actual tax liability (calculated by applying the tax rates as per income slabs) of the employees and the (higher) TDS amount deducted on account of applying the 20% rate.

If the employee in the example (stated above) does not furnish PAN till the end of the year, his Form 16 shall present a tax refund as follows.

1. Total taxable income: Rs. 190,000

2. Total tax for the year: Rs. 3,000

3. TDS deducted: Rs. 6,000

4. Refund: Rs. 3,000

What if an employee has income from previous employment and other income?

Income from previous employment and other income should be considered for calculation of taxable income. However, the rate of 20%, if applicable, should be used for the sake of TDS calculation.

What if an employee submits a valid PAN in the middle of the year?

Whenever an employee submits a valid PAN, stop applying Section 206AA for calculating TDS on salary for the employee.