2016

 

Payroll Manager: We are a new organization which is defining the business rules for its payroll process. Our organization’s pay period is monthly, and we would like to define our pay period as the length of time from the 21st of a calendar month to the 20th of the next calendar month.

Hinote: When do you plan to make the salary payment each month?

Payroll Manager: We would like to make salary payments on the last day of each calendar month, for the month ended the previous 20th.

Hinote: Why have you defined the pay period as 21st to 20th?

Payroll Manager: In our industry, many employees quit their organization abruptly, without providing notice to their employer. By paying salary on the last day of a calendar month, we would be able to “retain” about 10 days’ (from 21st till the day salary is paid) salary.

We believe this would discourage employees from leaving our organization without providing any notice (since their 10 days’ salary would be with the company).

What is your view on this?

We find that the most frequently used pay period (the period of time for which salary is paid), at least in the organized sector in India, is monthly.

According to Section 4 of the Payment of Wages Act, 1936, one of the relevant statutes governing salary payments,

4. Fixation of wage-periods

(1) Every person responsible for the payment of wages under section 3 shall fix periods (in this Act referred to as wage-periods) in respect of which such wages shall be payable.

(2) No wage-period shall exceed one month.

There isn’t a single statute which governs fixation of pay period and deadline for salary payments in India. The Payment of Wages Act, 1936, covers only certain categories of organizations and employees. As you would be aware, Labour is in the Concurrent List of the Indian constitution. One may also have to look at state-level legislations such as The Shops and Establishments Act while determining the relevant statute related to pay period for a particular organization.

The Payment of Wages Act states that the maximum pay period cannot be more than a month. Other statutes such as The Shops and Establishment Act too state that a single pay period cannot be greater than one month.

Some organizations define “month” as calendar month, while other organizations specify their own dates to define month – for example, from the 21st of a calendar month to the 20th of the next calendar month.

If an organization chooses month as pay period for salary, which is better between the following options? Should month be defined as calendar month or can it be a period of time, say, from the 21st of a calendar month to the 20th of the next calendar month?

In our view, defining month as anything other than calendar month leads to problems in salary processing and statutory compliance. It is best if month is defined as calendar month whenever salary is paid monthly.

Let us take a look at the problems faced by payroll managers when they define their own month (instead of calendar month) for salary calculation.

Difficulty in salary calculation

When the pay period is spread across 2 calendar months, what should the base days for pay computation be? For example, should pay be computed for 26 or 30 days? We discussed the superiority of calendar day logic (over using a fixed number of days such as 26 or 30) for pay calculation in an earlier blog post. The calendar day logic will not work if the salary month is different from calendar month.

Of course, one can use the exact number of worked days for an employee and the total number of pay days (say, 26 or 30) and calculate pay, if the salary month is defined as 21st to 20th or 26th to 25th for that matter. However, in such cases, implementing an automated salary arrear calculation, by way of a business rule in the payroll software that you may be using, may not be possible and the payroll manager adopting 21st to 20th as the salary month may have to compute arrear salary manually. In addition, usage of non-calendar salary months may lead to incorrect computation of loss of pay amounts and loss of pay reversal amounts.

Problems with income tax calculation

The tax year is from April 1 to March 31 as per the Income Tax Act. If a company defines its pay period as, say, 21st to 20th, compliance with the tax law may be difficult. In the month of March, the company’s salary month would end on March 20 (for the month February 21st to March 20th). If salary for the period from March 21st to March 31st accrues in the books of accounts of the company for the month of March, the company will have to calculate income tax on salary for that period as per the tax rates prevailing for the year ending March 31. If for the salary paid for the period from March 21 to April 20, tax rates are applied as per the rates prevailing in the new tax year starting April 1, the company may be calculating tax in contravention to Section 15 of the Income Tax Act. As a consequence, Form 16 issued to employees may present incorrect data regarding salary paid and income tax deducted.

Problems with PF/ESI calculation

The term month, for all practical purposes, refers to calendar month, when it comes to Provident Fund (PF) and Employee State Insurance (ESI) calculations. If a company follows 21st to 20th as salary month, the amount remitted to the PF/ESI department may be different from the PF/ESI amount which should be accrued in the books of accounts since the PF/ESI amount for a calendar month could be different from the PF/ESI amount payable for the salary month, from 21st to 20th.

If new PF or ESI deduction rates are mandated by the respective departments from a certain month, computation of PF/ESI deductions may be incorrect if an organization follows non-calendar month for pay computation. For example, let us assume that a new PF deduction rate, say, 15% of Basic wages comes into effect from March 1 of a PF year. If an organization follows February 21 to March 20 as the salary month, the PF amount for salary paid for Feb 21 to Feb 28 may be calculated at 15% (the new rate) in March payroll run while the new PF rate comes into existence only from March 1 (and not February 21).

Our discussion with the payroll manager (referred to at the beginning of this post) ended as follows.

Hinote: So, for the above reasons, we recommend that you define pay period as calendar month for your organization.

Payroll Manager: Sounds good. But what about employees leaving our organization as soon as they draw their salary, without any notice – the problem I mentioned at the beginning of this blog post? How can we hold back some of their salary to ensure that they do not leave without adequate notice?

Hinote: The statutes governing pay period for salary (Payment of Wages Act, The Shops and Establishments Act, etc.) require employers to make salary payments within a certain number of days after the end of a pay period. Your organization can hold salary back only until the period specified in law. For example, if your organization is covered under The Shops and Establishments Act (S & E) and if the S & E Act in your state requires you to make the salary payment within 7 days from the end of a pay period, you could wait until that time to pay the salary. For example, for the pay period pertaining to calendar month ending, say, June 30, you need to pay the salary on or before the 7th of July, in this case. Hence, the salary for the period from the 1st of July to the 7th of July can be considered as the “held back” salary.

Please note that your organization needs to adopt the correct legal procedures with regard to dealing with an employee who leaves without any notice. No organization cannot hold back any salary payable to an employee just on the basis of its whims and fancies.

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Update: The ESI wage ceiling enhancement to Rs 21,000 has been notified. Please read the relevant post here.

The Ministry of Labour and Employment has, by way of a gazette notification, sought feedback regarding enhancing the ESI wage limit from Rs 15,000 per month to Rs 21,000 per month.

As you are aware, the current limit is Rs 15,000 – in other words, employees who draw an ESI wage of more than Rs 15,000 cannot come under ESI currently. If this proposal is implemented, employees drawing an ESI wage of up to Rs 21,000 will need to become ESI members.

As far as your organization is concerned, you may see some of the current employees (whose salary is between Rs 15,000 and Rs 21,000) getting into ESI for the first time on account of the wage ceiling enhancement. Also, there could be an increase in the cost to company on account of employer ESI contribution to such employees (who get added to ESI).

Should this be implemented for Oct 2016 payroll?

As of 22-Oct-2016, the date of this post, the wage limit enhancement to Rs 21,000 is still at the proposal stage. According to the gazette notification, all stakeholders can give feedback to the ministry on the proposal until the end of 30 days from the date of the notification (06-Oct-2016). The government will make a final decision on this after considering the feedback received, and publish a final notification if the wage ceiling enhancement is to be given effect.

Many payroll managers wish to know if the wage ceiling enhancement should be given effect for Oct 2016 itself. To our knowledge, some payroll managers have already implemented this for Oct 2016. Their argument is that the proposal will definitely be given effect from 01-Oct-2016 and hence they are better off implementing this in Oct 2016 payroll. We wonder on what basis they are so sure that the proposal will be implemented. Surely, hearsay cannot be the basis for implementing such an important change. What if the government does not implement this at all or implements this prospectively (and not from 01-Oct-2016)?

Our take

We need to wait for the final notification from the government for us to implement this in payroll. There is no legal basis for implementing this for Oct 2016 payroll when the government is yet to issue the final notification. In other words, no payroll manager should second-guess governmental decisions.

As far as future is concerned, there are 3 possibilities.

Scenario 1: The wage ceiling enhancement does not get implemented by the government.

Action required: Nothing, since it would mean status quo with regard to ESI wage limit.

Scenario 2: The wage ceiling enhancement gets implemented in November 2016 or later with prospective effect.

Action required: You will have to implement this in payroll from the date from which it is given effect by the government.

Scenario 3: The wage ceiling enhancement gets implemented in November 2016 with retrospective effect (say, from 01-Oct-2016).

Action required: If the wage ceiling enhancement is given effect from 01-Oct-2016, you will need to re-run Oct 2016 payroll as soon as the notification comes (say, in Nov 2016 first or second week before the deadline for Oct 2016 ESI remittance) and ensure that you do the ESI deduction for the additional employees in Oct 16 payroll. Since you would have completed Oct 16 payroll processing by the last week of Oct 2016, you will need to decide on how to recover the ESI deduction for Oct 16 from the individual employees (whose salary is between Rs 15,000 and Rs 21,000 in Oct 2016). Of course, documents such as salary register and payslip would undergo a change for the employees who are impacted.

We hope the government takes into account the problems that employers are likely to face in implementing wage ceiling enhancement retrospectively, while announcing its final decision in this regard.

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The Employee Provident Fund Organization (commonly referred to as the PF Department), has notified (dated 26-Sep-2016) a form called New Form No. 11. This replaces the earlier Form No. 11 (New).

Form No. 11 – what is that for?

While many payroll managers know that employees need to submit Form No. 11, not many seem to be aware of the importance of Form No. 11 particularly in the light of the PF Department’s notification dated 29-Aug-2014. In fact, in many organizations, new employees are not even asked to submit Form No. 11 and this leads to inadequate PF compliance.

Form No. 11 is the document through which a new employee submits their PF information to their employer. The key information contained in Form No. 11 are as follows.

a. Employee’s prior PF status – whether member or not.

If an employee was a member of PF during their previous employment, they cannot be left out of PF in the new organization as long as their earlier PF amount was not withdrawn. We find many payroll managers not being fully informed about the rules under which a new employee may be left out of Provident Fund. Some are under the impression that if an employee’s PF wage is more than Rs 15,000 per month, they can be automatically left out of PF. This is wrong. If an employee submits his PF information in Form No. 11, the employer has to include the employee for PF.

b. If PF member in his previous organization, then was the employee a member of EPS?

The notification dated 29-Aug-2014 notifies an important change related to Employee Pension Scheme (EPS). According to the notification,

As EPS will henceforth apply only to EPF members whose pay at the time of becoming a PF member is not more than Rs.15,000 per month on or after 01.09.2014, the entire employer and employee contribution shall remain in the provident fund and no diversion shall be made to EPS for all new PF members on or after 01.09.2014 having salary more than Rs.15,000 at the time of joining.

Effective 01-Sep-2014, any new employee who becomes PF member for the first time and whose salary is higher than Rs 15,000 cannot be a member of EPS. In other words, the entire 12% contribution should be placed under Employee Provident Fund and there shall be no contribution to Family Pension Fund.

But what if a new employee was under EPS in their earlier employment?

In such a case the employee should come under EPS in their new organization even if the employee’s salary is higher than Rs 15,000.

The Form No. 11 requires the employees to state whether or not they were a member of EPS in their earlier organization. On the basis of the employee’s declaration in Form No. 11, the employer should include/exclude him in/from EPS.

We find many payroll managers complaining that they are unable to get the correct information regarding EPS applicability from new employees. Some say that the new employees are just unable to clearly state whether they were under EPS in their previous organization. Many employees do not even seem to know how the 12% contribution is bifurcated and what EPS is. Consequently, in many organizations, all new employees are brought under EPS whether or not they are eligible for it, as an easy way out.

c. Other information
Form No. 11 also presents other information such as details of an international worker (if applicable) and KYC details.

The PF Department requires that the New Form No. 11 – Declaration Form be “retained by the employer for future reference.” You may be aware that the PF Department has enabled online transactions for PF transfer and withdrawal and hence it is extremely important that new employees provide accurate information regarding their PF status by submitting Form No. 11.

If you are responsible for PF compliance in your organization, please ensure that you get a signed copy of New Form No. 11 from new employees as soon as they join your organization. In addition, please get the employer declaration in the form duly signed, and store the New Form No. 11 for future reference.

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The Ministry of Labour and Employment, Government of India, has amended the Employees’ State Insurance (Central) Rules, 1950 by introducing a new rule called Rule 51B, stated as follows.

“51B. In areas where the Act is implemented for the first time, the rates of employer’s and employee’s contribution for the initial twenty-four months from such date of implementation, shall be as under:-

(a) Employer’s contribution – A sum (rounded to the next higher rupee) equal to three per cent of the wages payable to an employee; and

(b) Employee’s contribution – A sum (rounded to next higher rupee) equal to one per cent of the wages payable to
an employee:

Provided that on completion of twenty-four months from the date of implementation of the Act, the rate of contribution as provided under rule 51 shall be applicable.”

You can read the gazette notification dated 06-Oct-2016 here.

What does the notification say?

As per Rule 51 of the Employees’ State Insurance (Central) Rules, 1950, the employer’s contribution to ESI is 4.75% of an employee’s ESI wage while the employee contribution is 1.75% of the employee’s ESI wage.

The Employee State Insurance Corporation continually expands its operations to cover new areas all over India. According to the notification, the ESI calculation for new ESI locations shall be as follows.

Employer contribution: 3% of wage, rounded to next higher rupee
Employee contribution: 1% of wage, rounded to next higher rupee

The above rates shall be in force for a period of 24 months from the time a new ESI location is introduced. After 24 months from the date of implementation of a new ESI location, the ESI calculation shall be as per Rule 51 (Employer contribution at 4.75% of wage and Employee contribution at 1.75% of wage).

In case your organization has operation in a place where ESI is implemented for the first time, this notification shall be relevant to you. Given that the ESI remittance happens for each location code, we presume that the ESI portal will be able to validate the ESI contribution calculations as per the rates notified for new ESI locations.

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Someone asked us a question on Form 16 recently.

In case an employee has no tax liability and hence no tax is deducted from the employee’s salary, can/should the employer issue Form 16 to the employee?

The typical answers we come across are as follows.

a. Form 16 cannot be issued to an employee with zero tax. This is because Form 16 can be generated only if tax is deducted from an employee’s salary.

b. Part A of Form 16 cannot be issued while Part B alone can be issued.

Both the above answers are wrong.

The question has 2 parts – whether an employer can issue Form 16 to a zero tax employee and whether an employer should issue Form 16 to a zero tax employee.

Can Form 16 be issued?

A Form 16 comprises 2 parts – Part A (downloaded from the TRACES site) and Part B (prepared by the organization issuing Form 16). Any organization can create Part B. However, for Part A to be available on the TRACES site, an organization has to include the employee record (including zero tax employees) in Annexure II of the fourth quarter (Jan – Mar) Form 24Q.  You would be aware that Part A also contains information on salary paid to an employee and the tax deducted from an employee’s salary for each of the 4 quarters. Hence, for the salary and tax figures to appear in Part A, the employee record should also feature in Annexure I of Form 24Q. In fact, the employee record need not feature in Annexure I in Form 24Q of all quarters. Please note that if the employee record features in Annexure I of only one Form 24Q and Annexure II of the fourth quarter of Form 24Q, his Part A will be available for download on the TRACES site. Just that the fields (in Part A) pertaining to salary and tax amounts for the quarters in which the employee record is not included in Annexure I will be shown as blanks.

Once Part A is downloaded from the TRACES site, the organization can create Form B, and issue the signed Form 16 to a zero tax employee.

Here is a screenshot of Part A for an employee with no TDS.

So, can Form 16 be issued to a zero tax employee? Of course, it can be issued!

Should Form 16 be issued?

As per the diktat issued by the Income Tax Department, an organization need not include an employee record in Form 24Q until the quarter any tax is deducted from the employee’s salary. Once tax is deducted in a quarter, the employee should feature in Form 24Q for that quarter and the subsequent quarters until end of the year as long as the employee receives salary, even if no tax deducted in any of the subsequent quarters. Let us explain this with examples.

An employee works for the entire year and receives salary for all the 12 months.

1. Tax deducted in the first quarter.

The employee should feature in Form 24Q of all 4 quarters.

2. Tax deducted in the third quarter; no tax in the first 2 quarters.

The employee should definitely feature in Form 24Q of third and fourth quarters. The employer can choose to include or exclude the employee in Form 24Q for the first and second quarters.

3. No tax deducted in all four quarters.

The employer, at their discretion, can choose to include or exclude the employee record in Form 24Q.

So, should Form 16 be issued to a zero tax employee? It is up to the employer.

Since it is not mandatory for zero tax (for the whole year) employees to feature in Form 24Q, many employers do not issue Form 16 to zero TDS employees. However, there are also many employers who issue Form 16 (with both Part A and Part B) to zero TDS employees.

A word on the department’s diktat

We wonder why the Income Department does not insist on employers including zero tax employees in Form 24Q. Form 24Q presents not only tax figures but also salary figures. There can be instances where the Income Tax Department may never get to know instances of tax evasion because of this.

For example, let us assume that an employee works for 2 employers in the year 2016-17 and receives Rs 2.4 lakh from each employer. Both the employers do not deduct tax since the employee receives a salary which is in the zero tax bracket and both the employers decide not to include the employee record in their Form 24Q filings for the year.

This is a case where an employee receives Rs 4.8 lakh in a year and is liable to pay a certain tax. Since the employers do not show the employee record in their Form 24Q filings, the Income Tax Department will never get to know the salary of the employee. If the employee does not pay the tax by himself and file his tax return, the Income Tax Department may never be able to levy tax on the employee’s salary.

The whole process of Form 24Q needs a revamp. But that is a topic for another day.

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The issue

An employee changes job in the middle of a year and submits his investment details (for tax saving) to the company he joins. The employee seeks benefits under Section 24 (interest on housing loan), Section 80C etc. of the Income Tax Act, from the new employer. The employee, while in his earlier company, too availed benefits under Section 24, 80C etc. for the year. Will the company which he joins be providing him with a “double” tax benefit if it were to consider benefits under sections such as 24 and 80C?

This is a question we received recently from the Chief Financial Officer (CFO) of a company we know. It looks as though payroll managers and CFOs are worried that they may be providing excessive tax benefits to employees who join their organization in the middle of a year.

In order to ensure that they do not give “double” tax benefit to employees, some payroll managers argue that they should reduce the interest (on housing loan) amount (Section 24) and life insurance premium amount (Section 80C) to the extent of an employee’s service period with their organization in a particular year. For example, if an employee submits that he would be paying Rs 1 lakh as interest on his housing loan for the year and works with the company for 6 months, say, from October to March, the company would consider only Rs 50,000 (which is Rs 1 lakh adjusted for the 6 month period of employment) towards tax benefit while calculating TDS on salary for the employee.

So, should an employer be worried about providing a double tax benefit to an employee who works for a part of a year?

The short answer is, “no.” There is no question of an employer providing a double benefit to an employee by considering the employee’s entire annual interest (on housing loan) amount or the annual life insurance premium amount.

What does the law say?

Let us take a look at Section 24 to explain this – our reasoning below applies to sections 80C, 80D etc. as well.

Section 192 (2B) of the Income Tax Act clearly specifies that employees, for the purpose of tax deduction, may submit details of income from house property (including loss from house property, if any) in a financial year to their employer.

Interest deduction under Section 24 of the Income Tax Act pertains to income from house property for a previous year and has nothing with the period of employment in the year or the income from salary received during the period of employment in a year. Employees can submit information related to their income from house property (and the interest deduction details) to their employer for timely tax remittance. There is nothing in Section 192 or in any other section which links interest deduction with period of employment. When an employer calculates salary TDS for a year, he should calculate the Income from House Property (after considering interest deduction) for the whole year even if an employee has worked only for a part of the year with the employer.

Section 192 imposes no restrictions on the tax benefit — under sections such as 80C, 24 etc. — that can be provided when an employee moves from one organization to another.

In fact, one could argue that considering income or interest deduction on house property for a part of a year (on the basis of the period of employment) would not be in line with Section 192 since such a thing could lead to over or under-deduction of tax despite the employee submitting information for the entire year. Consequently, the employee could be put to inconvenience with regard to timely tax payment.

Let us take a look at a case where linking housing loan interest with the period of employment could lead to problems.

For a live employee, we consider the housing loan interest of an employee and calculate TDS for the entire year in April itself. Let us assume that the employee leaves abruptly in September end and submits the housing loan interest certificate as part of the exit formalities. If we were to consider housing loan interest proportionately only until September, we could see an under-deduction of tax since we would be abruptly reducing the housing loan interest benefit by half while calculating TDS during settlement. This is not what the law mandates. This problem would occur not just for exiting employees but also for new joinees who join an organization in the middle of a year. For new joinees we may be over-deducting tax if we do not consider the housing loan interest for the entire year.

As an aside, you may be aware that for the purpose of tax calculation we need to consider only the home loan interest payable for the year. In fact, an employee need not even have paid any interest in a year in order to claim the benefit as per Section 24. Also, the timing of interest payment has nothing to do with the period of employment in a year.

Apportioning benefits under 80C etc. deductions across employers, in case of multiple employers within a year, too is not correct.

The treatment of 80C etc. deductions is similar to interest deduction on housing loan as described in the previous paragraphs. All these deductions are for a year and have nothing to do with the period of employment with a particular employer. Section 80C does not allow an employer to apportion 80C amounts as per the period of employment.

What about the issue of double benefit?

Here is an actual question we received recently.

The Form-16 is meant to reflect the taxable income of an employee. By showing deductions for home loan interest and 80C deduction in both the Form 16s (issued by the 2 employer), is the taxable income for the year not getting understated?

Some people seem to be under the impression that if the annual figures of 80C amounts and interest on housing loan are considered by 2 employers in a year, there could be a case of double benefit to an employee. This is totally without any basis.

When an employee submits Form 12B (previous employment information) to his employer, the employer should consider the salary income before the housing loan interest and 80C etc. deductions from the first employer. In other words, the top line salary (after Section 10 exemptions) from the first employer should be added to the top line salary of the second employer when the second employer calculates TDS. The second employer should consider the tax deducted by the first employer and the employee’s investment declaration for the year. Whether the TDS calculated by the first employer is correct or incorrect is immaterial to the second employer as long as the second employer calculates tax correctly with the information he has at his disposal.

Since the second employer considers only the top line salary (before any deduction) from the first employer and applies deductions under sections 24, 80C etc. only once, there is no double benefit to the employee.

One can do a simple test to check if there is any double benefit (and hence under-deduction of tax) to an employee who works in 2 organizations in a year. Calculate the tax liability for the year (by creating a simple Excel sheet for tax calculation) without looking at the Form 16 tax numbers and check if the tax amount you have arrived at is the same as the total tax across the 2 Form 16s. If the tax amount you calculate matches with the Form 16 tax numbers (taking into account Form 16 from both organizations) you can conclude that the numbers in Form 16 are correct. If there is double benefit, the tax you calculate would be higher than the total of the tax amounts in the 2 Form 16s.

If the annual housing loan interest amount is shown in 2 Form 16s, it does not mean that the employee has paid/will pay the total of 2 interest amounts for the year. Form 16 should be read at the level of an individual employer and deductions shown in the 2 Form 16s cannot be added up.

What about Section 10 exemptions such as HRA exemption?

Should the second employer provide House Rent Allowance exemption on the basis of the rent paid during the employee’s stint with the organization (part of the year) or full-year rent?

The House Rent Allowance (HRA) exemption should be provided only for the period the employee is with the organization and hence only the rent paid during the period of employment should be considered. This is because HRA exemption is tied to the head of pay called House Rent Allowance which is paid only for the employee’s service duration with the organization. We cannot provide exemption on a head of pay (HRA, in this case) when it is not paid to an employee (i.e. after he leaves the employment). The rent amount as a factor under Section 10(13A) is tied to the period of HRA received. For example, when HRA is paid for the period Apr to Sep, the HRA exemption can be calculated only for that period and hence rent (as a factor for HRA exemption calculation) for that period alone can be considered.

In summary, Section 10 exemptions (such as those on HRA and Leave Travel Allowance) are organization specific while deductions such as housing loan interest and 80C amounts are financial year specific.

Instances of excessive tax benefits

There can be instances of excessive tax benefits when an employee moves from one employer to another and does not submit Form 12B (previous employment salary and tax) information to the new employer. For example, in FY 2015-16, an employee receives a taxable salary of Rs 2 lakh from the first employer and Rs 2 lakh from the second employer. The first employer does not deduct any tax from the employee’s salary since the salary paid to the employee is in the 0% slab. The employee does not submit Form 12B to the second employer, and as a result, the second employer does not deduct any tax since the salary paid to the employee is in the 0% slab.

For the year, the total taxable salary received by the employee is Rs 4 lakh which is in the 10% slab while both the employers have not deducted any tax. Clearly, the employee receives an excessive tax benefit in this case. However, both the employers have complied with Section 192 and calculated TDS correctly, and hence cannot be faulted. The employee should take the blame for not revealing the previous employment income to the second employer.

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