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Impact of Supreme Court’s recent ruling on ‘basic wages’ for computation of PF contributions

The Hon’ble Supreme Court of India (“SC”) in its judgment dated February 28, 2019 has altered the long understood legal position relating to ‘basic wages’ for computing provident fund (“PF”) contributions under the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 (“EPF Act”).[1]

NASSCOM understands that organisations across the country have been following the practice of excluding certain allowances from the basic wages for the purposes of computation of PF contributions. This has been in conformity with the broadly understood position of the law. While there was an attempt to clarify this matter by the Employees Provident Fund Organisation’s (“EPFO”), through its circular dated November 20, 2012 (“PF Circular”), this PF Circular was subsequently withdrawn vide another circular dated December 18, 2012. The withdrawal of the above circular, thus, consolidated the position that the practice of excluding certain allowances from the definition of basic wages was on a sound legal footing.[2]

Now, in light of the SC ruling:

  1. Take home salary for employees could reduce significantly as their PF deductions would increase.
  2. Employers’ financial burden could increase substantially as they could be required to pay their share as well as the employees’ share of the difference on the contribution for the past periods.[3] Moreover, the employers could be saddled with interest costs for delayed contributions.
  3. To illustrate (refer illustration given below for the working):
    • For a domestic worker with Rs 20,000/- pm CTC, the future monthly take home salary could reduce by 9.29% and the employer could face a cash outflow of nearly six times the monthly CTC for the arrears.
    • For an International Worker (IW) with Rs. 200,000/- pm CTC, the future monthly take home salary could reduce by 7.01% and the employer could face cash outflow of nearly thirteen times the monthly CTC for the arrears.
  4. Further, inclusion of additional allowances in the basic wage could result in the PF wages for domestic workers exceeding the statutory wage ceiling of INR 15,000. Questions arise on whether such employees can be excluded from the coverage of PF.
  5. The ruling could also impact the liabilities of firms on account gratuity. The impact of the ruling would be across all the industries in India and it would severely affect the IT-BPM industry owing to factors including the size of the workforce and the fluidity of intra-industry employee migration. Moreover, a large number of IWs are employed by IT companies, and the wage limit for PF contribution is not applicable for them. Therefore, the impact in relation to them would be even more severe.
  6. The IT-BPM sector is already facing stiff economic competition against other emerging economies which have adopted pro-industry policies and the SC judgement will increase the competitive pressure.
  7. Giving effect to the ruling retrospectively might just not be practically possible given the movement of employees as it will require employers to track down even those employees (including IWs) and contract workers who may have resigned or retired from services and some of whom may have withdrawn their PF balances and closed their PF accounts.

A retrospective application would hurt industry’s competitiveness and ultimately impact the employment prospects negatively. There are also challenges around prospective implementation of the SC ruling due to ambiguity on which allowances may be excluded from the basic wages for the purpose of PF contributions.

Therefore, NASSCOM has requested the EPFO and the Ministry of Labour & Employment to:

  • Clarify through a circular that the current industry practices on the treatment of basis wages would not be treated as a ground for non-compliance and that the judgment would not be applied retrospectively.
  • Conduct a detailed study of the matter along with the industry to finalise the rules for the prospective applicability of the SC judgement so as to avoid possible gaps in interpretation in the future.
  • Provide a suitable transition period to allow the industry to implement the new rules.

It is important that the clarification mention in (1) above is issued at the earliest as firms would soon be finalising their books of accounts for the financial year 2018-19 and the auditors are already raising queries to the industry on the line of treatment being taken for the purposes crystalising the liability.

We are tracking the developments in relation to this issue.

 

Illustration of impact of SC ruing on scope of basic wages for the purpose of PF contribution

Case 1: Domestic Worker (assuming monthly CTC of Rs. 20,000)

Emoluments Existing Scenario (A) Revised  Scenario (B)
Basic salary- 40% of CTC 8,000 8,000
HRA@40% of basic 3,200 3,200
Other allowances 7,840 7,000
ER contribution to PF* 960 1,800
Total monthly CTC 20,000 20,000
Take home salary 18,080 16,400
Reduction in employee’s take home pay (=1680/18080) NA 1,680
9.29%
Impact on employer for retro payment (55 months)** NA 92,400
Interest on above NA 24,925
Employer’s Cash outflow per employee NA 1,17,325
Impact on employer’s Cash outflow per employee (times of monthly CTC)   5.87
Impact for 500 employees NA 5,86,62,500
* 12% of Basic Wage in (A) and 12% of Basic Wage + Other allowances except HRA in (B)

**The statutory wage ceiling under the PF Act was enhanced to Rs. 15000 pm effective 1 September 2014.

Case 2:  International Worker (assuming monthly CTC of Rs. 200,000)

Emoluments Existing Scenario (A) Revised Scenario (B)
Basic salary- 40% of CTC 80,000 80,000
HRA@40% of basic 32,000 32,000
Other allowances 59,150 52,812
Reimbursement 19,250 19,250
ER contribution to PF* 9600 15,937
Total monthly CTC 2,00,000 2,00,000
Take home salary 1,80,800 1,68,126
Reduction in employee’s take home pay (=168126/180800) NA 12,675
7.01%
Impact on employer for retro payment (125 months) NA 15,84,360
Interest on above NA 9,82,295
Employer’s Cash outflow per employee NA 25,66,655
Impact on employer’s Cash outflow per employee (times of monthly CTC)   12.83
Impact for 15 employees NA 3,84,99,825
* 12% of Basic Wage in (A) and 12% of Basic Wage + Other allowances except HRA and Reimbursement in (B)

The illustrations above do not take into account past changes in wages in computation of impact as that would bring in too many assumptions. The purpose is only to highlight the broad impact.

 

[1] Regional Provident Fund Vs Vivekananda Vidyamandir and Others (Supreme Court of India), Civil Appeal No(s). 6221 of 2011, Date of Judgement : 28-02-2019, see: https://www.supremecourtofindia.nic.in/supremecourt/2008/2232/2232_2008_Judgement_28-Feb-2019.pdf

 

[2] As per the withdrawn PF Circular, all allowances which were ordinarily, necessarily, and uniformly being paid to employees were to be treated as part of the ‘basic wages’.

[3] The PF Act does not permit recovery of contributions from employees for past periods.

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