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Policy Update: Supreme Court ruling on Basic Wage for the purpose of PF Contribution

  1. Ruling: The SC has in its judgement dated February 28, 2019 ruled that only allowances which are variable in nature or which are not paid to workers across the board or category, could be excluded from the definition of ‘basic wages’ for the purpose of PF contribution. Merely separating the allowances into different names and keeping them out of the basic wage and dearness allowance in the wage breakup, would not result in exclusion of such wages for the purpose of determining the amount of PF contribution. The ruling sets aside the ambiguities in the law to now give certainty to what qualifies as basic wages for the purpose of deducting PF contribution. The present ruling is on cases going back to 2011.
  2. New: The ruling is not completely new. It in-fact reiterates some of the rulings of a 1963 judgement [Bridge and Roof Co. (India) Ltd. vs. Union of India, (1963) 3 SCR 978].
  3. Impact: The impact is applicable across sectors and is not specific to the IT industry. The magnitude of the impact is likely to be huge if the ruling is applied by the EPFO retrospectively.
  4. Next steps: NASSCOM plans to work with other industry associations  and the Government to stress that the ruling is applied prospectively to the industry at large.

The court has ruled that “In order that the amount goes beyond the basic wages, it has to be shown that the workman concerned had become eligible to get this extra amount beyond the normal work which he was otherwise required to put in.”  Applying the above principle in the instant case, the court noted: “The wage structure and the components of salary have been examined on facts, both by the authority and the appellate authority under the Act, who have arrived at a factual conclusion that the allowances in question were essentially a part of the basic wage camouflaged as part of an allowance so as to avoid deduction and contribution accordingly to the provident fund account of the employees.” Based on this finding, the SC ruled that, “There is no occasion for us to interfere with the concurrent conclusions of facts. The appeals by the establishments therefore merit no interference.” [para 14, pg. 19-20]

In summary, it appears that only the real variable pay based on level of output or payments which are not applicable to workers across the board or to a particular category of workers, can be excluded from the definition of wages for the purpose of deduction of PF contribution, unless the allowance has already been excluded based on the definition of ‘basic wages’.

From an industry perspective, this might lead to an increase in the staffing CTC for companies who have been interpreting the basic wages differently. The impact would, however, vary based on employer specific policies on PF contribution (Refer to the various contribution options under EPFO here)

Case 1: The impact could be limited for employers who are applying the wage ceiling for the purpose of PF contribution i.e. Rs 15,000/- pm. To illustrate, if eligible wage i.e. Basic + DA  is equal to Rs 15,000 pm as per current policy and based on SC order if the eligible wage i.e. Basic + DA + other qualifying fixed allowances = Rs. 30,000 pm, then PF contribution would still be capped at wage ceiling of Rs 15,000 and there would be no financial impact. The impact would be limited for employers who do not offer PF to employees who join at Basic + DA above Rs 15,000 pm and do not have a PF account.

Case 2: The impact could be significant for employers who choose to pay contribution on higher wage. To illustrate, , if eligible wage i.e. Basic + DA  is equal to Rs 15,000 pm as per current policy and based on SC order , if eligible wage i.e. Basic + DA + other qualifying fixed allowances = Rs. 30,000 pm, then PF contribution would now apply at Rs 30,000 and the financial impact would be high. Similarly, the impact would be high for employers with International Workers, who are covered under the PF as the wage ceiling for PF contribution is not applicable for them.

The impact on employees would correspond to the employer policies. The impact would also depend upon treatment of annual increment, CTC structure etc. The CTC could go up due to higher contribution to PF but take home pay could reduce as the employee share of PF contribution would also increase.

Member companies are advised to take a legal opinion to arrive at conclusions relating to provident fund contributions for their domestic and international workers, basis their specific wage policies and structures.

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