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Friday, March 14, 2014

The higher Provident Fund deduction - is it good or bad for you?

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On November 30th 2012, the Employee Provident Fund Office (EPFO) issued a circular on the calculation of Provident Fund contribution. According to the circular, all allowances, except those specifically disallowed by the EPF Act, should be included in ‘Basic Salary’ while computing PF. Will this move benefit employees or be detrimental?  

Contents of the circular: The EPF Act has specified that basic wages will exclude the cash value of any food concession and any dearness allowance which is paid to the employee on account of a rise in the cost of living, house-rent allowance, overtime allowance, bonus, commission or any other similar allowance in respect of his employment. Though the Act does not specify about any other allowance, employers have, over time, split the basic salary into various allowances and set aside these components from PF calculation. The circular issued on Nov 30th 2012 states that “basic wages by its own definition encompasses all the payments except the specified exclusions. All such allowances which are ordinarily, necessarily and uniformly paid to the employees are to be treated as part of the basic wages”.  Note that the circular does not specify the allowances to be included in the basic pay, which has resulted in uncertainty on this issue.

Reason behind the circular: PF has been historically calculated on the basis of the employee’s basic salary and dearness allowance. Both the employee and employer each contribute 12% of the basic pay and dearness allowance taken together. It has been claimed by PF authorities that there are many employers who break-up the basic salary into several components like education allowance, conveyance allowance, medical allowance, night allowance etc. By doing this, the actual amount of basic salary eligible for PF computation is reduced, and this in turn reduces the amount to be contributed by employers also towards the employee’s PF. This circular has therefore been issued with the intention of standardizing the PF calculation. But while the intention of the PF office may have been to straighten such employers who reduce PF contribution from their pockets, this move will also result in a reduced take-home salary for the employee.

How the employee payslip will look after the change:
Suppose Raj is a Government employee drawing every month Rs. 20,000 as basic salary, Rs. 5,000 as conveyance allowance and Rs. 4,000 as education allowance. Both Raj and his employer put it Rs. 2,400 each towards PF every month (12% of Rs.20,000 basic salary). Post this circular, the conveyance allowance and education allowance will also have to be included in the computation, resulting in a monthly contribution of Rs. 3480 (12% of Rs. 29,000).

What does this mean for the employee?
As you can see above, the new move will reduce the take-home pay and this is unquestionably not good for the monthly pay check. However, don’t forget that the shortfall in your monthly take-home salary is an addition to your retirement savings, which gets enhanced not only by your increased contribution, but also by your employer’s increased contribution. Therefore, this move is positive to the employee over the long term. If the Employer decides not to absorb the increase in their contribution to Employee's PF, then the Employee's monthly salary can go down further. 

What is the current status? 
According to recent news reports, the issue has been kept on hold for the time being and the old method will continue till further announcement. However, this matter is likely to arise again. Start planning your finances today to avoid getting a rude shock when you see a fall in your take-home salary in the coming months.

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