Will you have to contribute more towards your provident fund kitty after SC ruling? Here's what experts have to say

While the order came on March 1, several questions with respect to its implementation still need to be answered. Preeti Chandrashekhar, India business leader, Mercer and Punit Gupta, partner EY, discussed the same.

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Chandrashekhar: You have to look at the ruling and compare it with what was there in the bare act. The bare act for provident fund always indicated that all the allowances, which are ordinarily paid to employees, uniformly paid to all of them need to be included. What got excluded primarily was aspects such as commissions, bonuses where it is linked to somebody’s performance etc.

What was happening was companies were structuring their salaries in such a manner so that they were able to get the PF contribution to a minimum level. The Supreme Court ruling included what was there in the act, which means it included special allowances as a part of PF deduction.

If you ask, it was always there. It was just that it was subject to different interpretations, so the SC has made sure that it is now uniformly understood by everyone.

Gupta: Absolutely but this is welfare legislation. The intention of PF was very different to ensure that employees have social security corpus for future savings. So the intention is different. Yes, the intention always was to include all allowances, in fact, the SC in 1962 in the landmark ruling has also said that all allowances, which are ordinarily given to employees are covered under the definition of basic wages. The recent ruling has basically reiterated what it said in 1962 but yes, it will have bigger implications for both employers and employees.

Gupta: In the industry, generally employers contribute towards PF only on basic salary and there have been huge litigations ever since the PF factor was implemented on whether these allowances are covered under the definition of basic wages, there have been multiple high court rulings, a lot of them saying that allowances are covered, some also saying that allowances are not covered. So it has always been a huge issue in India.

There were five-six cases which different high courts ruled that allowances are covered, employers have filed appeals against these high court rulings in SC. The SC clubbed these five rulings and then this is the outcome of those five appeals. So it has always been a matter of debate in India. It is just that the SC has now held that allowances are covered.

But I think I will draw your attention to one point which somewhere has not been dealt in this ruling is the provision to para 26 which allows employees to restrict contribution on Rs 15,000 per month if their salary is more than Rs 15,000. Somewhere the SC ruling hasn’t given any view on that limit. So how will that limit be applicable and whether all employees or only a certain category of employees will get impacted by these ruling is something there still needs to be a lot of clarity on.

Chandrashekhar: Yes. I refer back to the act and also see that in conjunction with the SC ruling. It is very clear that the allowances, which are either things like bonuses, commissions which are related to performance and which are not paid uniformly to everyone are what gets excluded. HRA was always excluded, that continues. But what has got very explicitly stated is this special allowance, which is what is interesting because most organisations - I would say - are having a category called a special allowance, which was like a balancing item. So that is now getting included. That is something which is really clearly spelt out in the new ruling as compared to the ambiguity that was existing earlier and hence the SC ruling helps clarify matters.

However, to Punit Gupta’s point, I would also like to reiterate that all this that you are talking about is for employees whose pay is less than Rs 15,000. So why are we not mentioning Rs 15,000, again going back to what some of the experts are saying, we are not changing the act? The PF act remains the same. What we are doing right now is just clarifying matters, which seemed ambiguous at that point in time. So Rs 15,000 remains.

There is no discussion right now on whether that would change or not and also to the point of there are many organisations saying what is the effective date. Is it retrospective, is it prospective, there again we would need to wait and watch.

Gupta: Right. Definition of the excluded employee under the PF law says that anyone who at the time of joining PF scheme was earning more than Rs 15,000 and is not an existing member of PF then such employee can opt out. If an employee is joining employment for the first time and has a salary of more than Rs 15,000 then such employee is excluded.

Gupta: Absolutely. You cannot unless such an employee leaves employment and is unemployed or employed in a small entity for at least two months then the person can withdraw and then if he joins again then he can opt out. Otherwise, if you continue your employment and once you become a member then you cannot opt out.

Chandrashekhar: I would agree with Punit Gupta here that for all those people who are earning above Rs 15,000, who are members of the EPFO, they cannot just decide to withdraw one day. What can be done, however, is that they can restrict the salary, which will be exposed to PF contribution.

They need not have it on the full salary, they can restrict it but they cannot move out until they are no more employed. They can withdraw the entire PF corpus – subject to taxes – and then they can move on and join a sector where there is no PF and they can remain out of the PF ambit.

Chandrashekhar: I would say – we need to look at the section of the workforce that we are talking about. We are talking about a set of people whose pay is less than Rs 15,000. We do have some element of bonuses and commissions but typically organisations tend to give them a more guaranteed amount of money and less variable pay.

So that would stay because their control on parts of the business and the business profitability etc is very less. So it is not fair to expose them too much on to the variable pay just because I as an organisation want to restrict the provident fund contribution.

However, what some of the companies are doing is that they are looking at restructuring the salary for sure and this is very new, so solutions are emerging as we speak but what we have also seen organisations are giving a one-time amount to employees just to cover the reduced take-home a year or so and then it falls back to the normal course.

Most organisations – what they are doing is – as an example if somebody’s basic was Rs 10,000 and the special allowance was Rs 4,000, so the PF would now be deducted on a total of Rs 14,000. Compare that with a person whose basic was Rs 10,000 and let us say the special allowance was Rs 6,000. So in this case while the total is Rs 16,000, the companies would be restricting the PF contribution to Rs 15,000. So that the effect on such an employee is far lesser but definitely the dichotomy is that the take-home reduces but to your point the contribution towards the retirement kitty does increase.

This would make a dent in the short-term definitely for employees but once companies go through the entire restructuring exercises, you will have more solutions emerging, which would balance out things between the employer and the employee.

Gupta: For example, under PF law if an employee has a basic salary, which is more than Rs 15,000 say Rs 20,000 and is contributing the entire Rs 20,000 then the employee is still complying with PF law because it categorically says that employees whose salary or monthly pay exceeds Rs 15,000 per month then such employee and employer can restrict contributions on Rs 15,000 unless they opt to contribute on a higher salary.

So in our example, if basic salary is Rs 20,000 and their allowances worth Rs 5,000 and if they already contributing Rs 20,000 at least we believe that there will be no issue because the employee is already contributing on more than ceiling limit. Therefore, it is only employees whose current basic is less than Rs 15,000 which will get impacted by this ruling the most.

Gupta: It should not be a problem for companies, for employees with a basic salary of more than Rs 15,000 because that stand can be taken and in the past, there are Supreme Court rulings and circulars issued by PF office to clarify that EPFO or the provident fund office will not mandate employers to contribute beyond the ceiling limit. So that really helps employees with basic more than Rs 15,000.

But a lot of companies also have large chunks of employees with a basic salary below Rs 15,000 per month, like all our housekeeping staff, pantry staff and for such categories, there could be a significant impact of this ruling.

Gupta: Companies can have higher bonuses, the only issue is that changes to salary structure will not just have an impact on PF it will also have an impact on a lot of other things. For example - with a lot of these allowances going down, a lot of tax exemptions goes away and therefore with more variable pay the tax cost can go up. It will also have an implication on the benefit under Gratuity Act or under the Bonus Act.

So companies will have to take a holistic view on whether or not they want to restructure because it is not just PF there could be other implication that they need to bear in mind.

Chandrashekhar: That is a very good question and we are hearing a lot. When the EPFO decided to open up equity as an asset class for the investment there was a lot of apprehensions. Apprehension in terms of equity being risky, we don’t know the returns, they are going to be very volatile, there is a lot of uncertainty etc. But after having traverse to few years everybody is releasing the merits of actually having exposure to equity.

Though we do understand that the exposure is limited so if you look at the exempt provident funds the limit is 15 percent but we have not typically seen companies go beyond 10 percent. So, 6-10 percent is a range in which they have equity exposure for the new funds. So, the overall portfolio does limit its exposure to about 4 percent or so because it is just started a few years back, so that is one point.

The challenge there on the equity side is not so much about the returns. You see there is a technical aspect which relates to how do you account for that equity revenue. It is much easier for me to recognise the revenue when it comes to bonds I have the coupons which take care of the revenue portion, so that is one point.

The second point interestingly is we all thought that equity is really risky. But look what has happened recently in terms of the some of the fixed income securities. So, clearly, it is no more a thought that equity is the only risky asset class which would really hold true because you have other classes which are equally exposed or may be more.

Gupta: The right mix will be specific for each individual, but one fundamental difference that one should note between PF and NPS is that while the former is like a bank account where each month employer and employee contributes and whenever employee decides to leave employment employee basically gets a lump sum amount. There is no pension amount at least from PF account. NPS while it does put a lot of flexibility in terms of how an employee wants to invest, what category, whether they want higher equity or they want higher debt. But then it restricts withdrawal because before 60 years of age employee can practically withdraw 20 percent lump-sum and the balance 80 percent is a mandatory contribution to an annuity plan.

So employees will have to find a right mix. If the intention is to monthly pension post retirement then NPS is the very solid retirement saving plan because the whole intention is to provide monthly pension benefits after retirement, which is currently lacking in EPF. So, EPF is good for having a lump-sum withdrawal post retirement while the NPS is a great tool to have monthly pension, ongoing pension post retirement.

Gupta: I would say to continue with PF because it is the age old retirement saving scheme and has worked really well for our parents and hopefully will work very well for us also. So, do continue 12 percent of the basic towards PF and have a private NPS account or through the corporate. Every year contribute some money to NPS, so that by the end of the retirement you have both lump-sum benefit to take care of through the EPS and you have your monthly pension through the NPS. So have a right mix.

Chandrashekhar: I always say do not put all your eggs in one basket. Both have their advantages and disadvantages. You chose and makes sure that you distribute it across both of them. Of course, from an employer stand point they are different tax incentives for both of them and if we are to go by the recent budget announcement -- NPS for the government employees has increased to 14 percent and we hope that at some point in time that convergence also happens for the corporate sector. So if that happens then obviously both get attractive, so I need to see what my tax liability is, what are my other liabilities.