PF contribution: Your take home
salary may reduce now
Manish Shah, Senior Tax Professional, Ernst & Young
Did you know that the latest drive of the Provident fund authorities may reduce your take home salary?
Historically, most companies and employees have been restricting their contribution to Provident Fund ('PF')
based on the prescribed percentage (12% each by employer and employee) of Basic salary and Dearness
Allowance only. The underlying accepted principle duly supported by a Supreme Court ruling was that only the
amounts payable to permanent employees for work done should be includible in computing PF contributions
and payments for specific purposes should be excluded (eg. purpose-driven allowances or reimbursements).
Thus, it was settled for quite a substantial period of time that PF contributions were payable only on the salary
paid for the work done or performed generally, and not on other components which were paid to the
employees for specific purposes.
Based on this principle, most companies and employees have been allocating the total annual salary of the
employees, ie Cost to Company ('CTC') into various allowances, reimbursements, etc. This achieved a better
(higher) take home pay effectively, due to more effective quantum of the PF contribution as well as lower
income-tax withholding by the employer due to the tax efficiency of some of these items.
However, in the recent past, there have been two rulings in case of Montage Enterprises Pvt. Ltd. (Madhya
Pradesh High Court) and Reynolds Pens India Pvt. Ltd. and others (Madras High Court), wherein it has been
interestingly held that various allowances paid by the employer to his employees under different heads (such
as Conveyance, Educational, Food Concession, Medical, Special Holidays, Night Shift Incentives, City
Compensatory allowances, etc) qualified as Basic wages under section 2(b) of the PF Act and hence, the
same also needs to be included while calculating PF contribution.
These rulings are based on the hypothesis that generally, fixed monthly amounts (eg Conveyance allowance)
payable to all employees of an organisation or paid without any specific criteria to determine the quantum (eg
Special allowance) are nothing but part of salary paid for work done which are labeled as various types of
allowances, and therefore, need to be included to compute PF contributions.
If these Court rulings are implemented by the PF officers, the primary consequence would be that the employer
will start computing and paying the PF contributions on the most components of salary (especially fixed
allowances) on an immediately effective basis, straightaway resulting in a lower cash salary in the hands of the
Secondly, in absence of any limitation period provision in the present PF laws, the authorities can validly look
at the past years and recover the differential PF contributions right from the commencement of the employee's
PF membership till date, along with interest, damages and penalties. Additionally, while the employer may
need to shell out all these incremental contributions (both employer and employee) for the past period as well,
he would be prohibited to recover these past employees' contributions from their present salary, resulting in
these contributions becoming a pure cost element.
Further, the income-taxman will also not leave the employer, as he would disallow the employee's contributions
to compute tax on his taxable profit, as the same will not be regarded as paid within the normal due dates,
leading to an unwarranted increase in this cost element. Needless to mention, while such additional cost for
the employer may not affect the employee directly, it will certainly have an indirect impact by roll out of lower
amount of variable performance linked payments, a common reality in this modern era.
While the above consequences appear to be foregone conclusions if the EPFO and the PF authorities follow
these rulings, there is one shelter available under proviso to paragraph 26A of the PF Scheme, which allows
PF contributions by employer as well as the employees on a maximum notional salary of Rs 6,500 per month,
instead of the entire salary (including allowances).
Hope this article will help you to clear your doubt
25th August 2011 From India, Kumbakonam