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%.
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).
The basis of calculation of loss of pay for employees is fairly well established, yet, we come across many instances of incorrect calculation of loss of pay in organizations. The mistakes we are talking about here are not calculation errors but those on account of organizations adopting an incorrect basis for calculation of loss of pay.
Let us look at a common mistake committed by payroll managers while calculating loss of pay on employee salary.
Loss of pay amount as a deduction in payroll
Some payroll managers view loss of pay as a deduction in payroll instead of a reduction in pay. For example, an employee receives a monthly Basic salary of Rs. 10,000 in April and is entitled to no other head of pay. The Provident Fund (PF) contribution is Rs. 1,200 per month (12% of Rs. 10,000). The company in which the employee works follows the calendar day basis for pay calculation. If the employee has no loss of pay in April, his salary statement will read as follows.
|Basic Salary||:||Rs. 10,000|
|Provident Fund||:||Rs. 1,200|
|Net Pay||:||Rs. 8,800|
If the employee has 15 days loss of pay for April, the company calculates the loss of pay to be Rs. 5,000 for April, shows this as a deduction, and calculates the net pay as follows.
|Basic Salary||:||Rs. 10,000|
|Provident Fund||:||Rs. 1,200|
|Loss of Pay Deduction||:||Rs. 5,000|
|Net Pay||:||Rs. 3,800|
The above method is wrong since PF is calculated on “fixed” Basic instead of “earned” Basic for the month. Instead of presenting the loss of pay amount as a deduction, the company should reduce the pay to arrive at the net pay. For the above example, the net pay should be calculated as follows.
|Basic Salary||:||Rs. 5,000|
|Provident Fund||:||Rs. 600|
|Net Pay||:||Rs. 4,400|
In the above example, the company ends up paying a lower net salary — Rs. 3,800 instead of Rs. 4,400 for the month — on account of incorrect loss of pay calculation.
Specifying loss of pay as a deduction in payroll leads to incorrect income tax, PF, and Employee State Insurance (ESI) deduction calculation.
When loss of pay is stated as a deduction, the income tax, if the employee has taxable income, is calculated on full pay and hence the employee ends up paying income tax on salary he doesn’t receive. While for PF and ESI, both employer contribution and employee deduction are overstated.
Presenting loss of pay as a deduction (instead of reduction in pay) may look like a silly mistake. But you would be surprised to know that there are many companies that commit this silly mistake while processing payroll each month.
We will examine some more issues pertaining to loss of pay calculation in the next post.
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.