Calculate PF on gross pay and NOT on Basic head of pay – Part I
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.