The Supreme Court of India (SC) earlier this year pronounced a ruling on what constitutes 'basic wages' for the purposes of Provident Fund (PF) contribution. The issue for consideration before the Apex Court was whether 'allowances' should be treated as basic wages for computing PF contributions. The allowances under consideration are typically in the nature of dearness allowance, house rent allowance, travel allowance, canteen allowance, lunch incentive, washing allowance, management allowance, education allowance, medical allowance, special holidays, night shift allowance, city compensatory allowance etc, which form part of a salary.
The Employees Provident Funds and Miscellaneous Provisions Act, 1952 (EPF Act) defines basic wages to include any other allowance similar to dearness allowance, house rent allowance, etc, payable to the employee in respect of his employment or work done in such employment. The phrase 'any other allowance' is not defined in the law and is, hence, open for interpretation. This has led to protracted litigation which finally reached the Apex Court. The industry practice has been to exclude special allowances and specific allowances under the ambit of basic wages for PF calculation.
The SC ruling adjudicated that all allowances are to be included within basic wages for computation of PF contributions unless excluded on the following principles:
# The allowances paid were neither variable nor were linked to any incentive for production, resulting in greater output by an employee;
# The allowances were not paid across the board to all employees of a particular category;
# The allowances were not paid especially to those who availed the opportunity; and
# The allowances (subject matter of the SC ruling) formed a part of basic wage and are camouflaged as allowances to avoid deduction and contribution to PF.
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The SC ruling does not bring out any new law or principle. The SC has interpreted the existing law and carved out its intent. The ruling appears to be clarificatory in nature and the risk of PF authorities applying it retrospectively for past years, looms large. In fact, post the SC ruling, the Employees’ Provident Fund Organisation (EPFO) has issued guidance to Regional Provident Fund Commissioners to take prompt action in all cases involving similar issues. Considering the consequential implications for organisations, various industry bodies have approached the government to limit the impact of this ruling.
Surya Roshni Ltd, one of the appellants in the SC ruling, had filed a review petition on 29 March 2019, against the said ruling. The EPFO, in the meantime, issued a circular instructing field officers to not pursue earlier notices issued till the outcome of the review petition is known. The SC dismissed the review petition on 28 August 2019, as it did not find any rationale for reviewing its earlier order.
Thus, the SC ruling, now being the law of the land, impels the employer fraternity to revisit the salary structure of impacted employee population for computing contribution to PF. The Apex Court's ruling will warrant increased PF contributions by employers for employees whose basic wages are lower than Rs 15,000 per month. Further, foreign nationals, who are required to be treated as International Workers, would also have a higher PF contribution since the wage ceiling of Rs 15,000 per month does not apply to them.
Accordingly, employers are now faced with the task of assessing the impact of this development by revisiting the compensation structure of the impacted population and identify components which need to be included in the calculation of PF contribution (but are not currently included), in light of the recent SC ruling.
Having said that, impact assessment requires consideration of the following factors:
(i) Should the SC ruling apply retrospectively and trigger the need to deposit arrears of PF contributions with PF authorities, along with interest?
(ii) As regards the arrears attributable to employees' contribution, the employers may not be able to recover the same from employees as per the provisions of the EPF Act.
(iii) Deductibility of such PF arrears in computing the taxable income of the employer.
(iv) Cash flow impact requiring a working capital analysis.
(v) Taxability in the hands of concerned employees.
(vi) Implications for the employer if it chooses to bear the tax liability of employees on contribution of such PF arrears.
(vii) Implications / deductibility of damages and interest levied by the PF authorities.
(viii) Taxpayers, along with their auditors, will need to evaluate if appropriate provision needs to be created in the books of accounts.
(ix) Taxpayers operating on cost plus mark-up basis will need to revisit their cost base for suitable adjustments.
While the SC ruling impacts only a limited employee population, employers must carry out an impact assessment and initiate corrective actions before PF authorities land at their doorstep with demand notices.
(By Jimit Shah, Director; Ankush Bhutra, Manager; and Aishwarya Palan, Deputy Manager, Deloitte India)