Provident Fund – Supreme Court Latest Judgement – The Real Story

March 13, 2019

The Supreme Court has recently passed a landmark judgement on the Employee Provident Fund (EPF). This ‘Test of Universality’ judgement is bound to affect and impact the salaried class.

Before we get into understanding how the Supreme Court judgement impacts the salaried class, here is a quick run through about Salary Break Up and Provident Fund.

Salary Break Up

An Employee’s salary is distributed under different heads. This is done to facilitate the maximum Income Tax benefit for the employee. Following are some of the heads under which the salary is distributed:

– Basic salary

– Dearness allowance

– House rent allowance

– Medical allowance

– Conveyance allowance

– Leave travel allowance

– Special allowance

There are guidelines as to what percentage of the employees’ total compensation should be allocated under the different heads given above. Since we cannot provide an elaborate example, here is a very short and quick instance. If an Employees’ salary is Rs. 6,00,000 (six lakhs) per year Cost to Company (CTC), the practice guideline is that 40 to 50 % of the CTC can be allocated under ‘basic salary.’ If we work on a calculation of 50%, it works out to Rs. 3,00,000 (3 lakhs). This sum divided by 12 months works out to Rs. 25,000 (twenty-five thousand). This amount is shown as ‘basic salary’ in the monthly salary statement of the Employee.

For the sake of understanding this entire article, it is essential at this point, to know and understand the head ‘special allowance’. In an Employee’s salary break up, after distributing the maximum possible amounts under the different heads mentioned above, if there is a remaining amount, it is allocated under ‘special allowance’. 

What is the Provident Fund?

According to the EPF Act, 1952, the provident fund is a partnership contributory fund where the Employer and the Employee contribute an equal sum of money in the Employee’s Provident Fund account. The current rate of contribution from the Employer and the Employee is 12% of the Employee’s Basic Salary and Dearness Allowance components. While the Employers’ 12% contribution goes fully into the Employees’ Provident Fund account, the Employees’ 12% contribution is split and 3.67% goes into the Employees’ Provident Fund account, and 8.33% goes into the Pension Scheme.

EPF Calculation till Now

As mentioned earlier, the monthly EPF contribution from the employer and EPF deduction from the Employees’ salaries was calculated at 12% of the Employee’s ‘basic salary’ and ‘dearness allowance’ heads. Companies did not include any other pay break up heads for provident fund contributions.  

Supreme Court Judgement

The Supreme Court judgement is fallout of the case between Vivekananda Vidya Mandir and Regional Provident Fund Commissioner, West Bengal, and many other similar petitions. The core of the case was that the ‘special allowance’ that was being paid was not covered under PF deduction. This also got linked to the fact that other salary heads like HRA, medical allowances etc. were not included for PF deduction calculation.

After taking in all inputs, the Supreme Court ruled that all those allowances which are common and paid to all employees must come under the PF calculation. The court further ruled that only those variable payments or allowances like ‘incentives’ or ‘performance-linked rewards’ which are paid based on the employee’s contribution or excellence in work are exempt from PF calculations.  

The Final Impact

1. This judgement does not impact those employees whose ‘basic salary’ and ‘dearness allowance’ if the total of these two is over Rs. 15,000.

2. HRA is excluded from the definition of minimum wages as per Section 2(b) of the EPF Act of 1952.

3. Employees whose ‘basic salary’ and ‘dearness allowance’ is below Rs. 15,000 may have to pay more through their PF contribution, but this will be dealt with on a case to case basis as it has to be determined whether the allowances being paid to an employee are truly ‘fixed’ or ‘variable’ in nature.

4. Indian employees of Indian companies who work abroad will see an increase in their PF deduction as it looks like the top court’s judgement impact is most seen in this context.

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