The Supreme Court recently examined whether certain components of an employee's overall salary are subject to provident fund (PF) contributions. The court ruled that special allowances which form part of an employee's basic wages are subject to such contributions.
In Regional Provident Fund Commissioner (II) West Bengal v Vivekananda Vidyamandir, the Supreme Court opined on five different appeals arising from the High Courts of Calcutta, Madhya Pradesh and Madras. The appeals concerned the same question of law – namely, whether the special allowances paid by an employer to its employees form part of their basic wages and are thus subject to PF contributions.
One of the appeals concerned an unaided school which had paid a special allowance by way of an incentive to teaching and non-teaching staff. This allowance was reviewed occasionally when the tuition fee was increased. In the other appeals, the appellants had excluded all allowances (eg, housing allowances, special allowances, management allowances, conveyance allowances, education allowances, food concessions and medical allowances) which were not specifically included in their employees' basic wages from their determination of PF liability. It was argued in the appeals that only those emoluments that are earned by an employee in accordance with their terms of employment qualify as basic wages. Therefore, discretionary allowances which are not earned in accordance with an employee's terms of employment are not deemed to be basic wages.
The Employees' Provident Funds and Miscellaneous Provisions Act 1952 (EPF Act) – which applies to establishments with at least 20 employees – along with the schemes thereunder, govern employers' PF contributions on behalf of their eligible employees. The EPF Act applies to all employees, including contract workers, who:
- earn a basic wage of up to Rs15,000; and
- have never been members of the statutory fund or have been members but have withdrawn all of their accumulations in accordance with the act.
In addition, the EPF Act applies to 'international workers' as defined under the EPF Act. Employees and employers must contribute to the PF at the rate of 12% of an employee's basic wage.
Under Section 6 of the EPF Act, read with Paragraph 29 of the Employees' Provident Funds Scheme 1952, PF contributions are calculated based on the basic wages, dearness allowance (including the cash value of any food concession) and retaining allowance (if any) payable to each employee.
The term 'basic wages' is defined under Section 2(b) of the EPF Act as:
all emoluments which are earned by an employee while on duty or on leave or on holidays with wages in either case in accordance with the terms of the contract of employment and which are paid or payable in cash to him, but does not include (i) the cash value of any food concession; (ii) any dearness allowance that is to say, all cash payments by whatever name called paid to an employee on account of a rise in the cost of living, house-rent allowance, overtime allowance, bonus, commission or any other similar allowance payable to the employee in respect of his employment or of work done in such employment; (iii) any presents made by the employer.
In general, all emoluments are included in an employee's basic wages, except those specifically excluded in the above definition. In order to determine the components of an employee's basic wages, all emoluments earned by the employee must be considered. Thus, basic wages are different from the basic pay or salary which forms part of the pay structure of employees in most companies.
The issue before the Supreme Court was whether the special allowances paid by an employer to its employees constitute basic wages in accordance with Section 2(b)(ii) read with Section 6 of the EPF Act for the purposes of deducting PF contributions.
The Supreme Court reiterated the principle of universality set out in its previous judgments in Manipal Academy of Higher Education v Provident Fund Commissioner and Bridge and Roof Co (India) Ltd v Union of India. In these cases, the court had set out the following guidelines for establishing what constitutes basic wages:
- Where a payment is universally, necessarily and ordinarily paid to all employees across the board, it constitutes basic wages.
- Where a payment is available only to those who avail of the opportunity, it does not constitute basic wages.
- Where a payment is linked to a special incentive or extra work, it does not constitute basic wages.
Based on the above guidelines, the Supreme Court ruled that the special allowances in the case at hand, which formed part of the employees' basic wages, were subject to PF contributions on the basis that they:
- were not variable in nature;
- were not linked to an incentive to perform extra work; and
- were paid across the board to all employees in a particular category.
The petitioners were unable to prove that the allowances were variable or linked to an incentive to perform extra work. Thus, this judgment has clarified that:
- special allowances (and other similar allowances) which form part of an employee's wages are considered basic wages and are thus subject to PF contributions; and
- special incentive or production bonuses which have a direct link with an employee's output fall outside the scope of basic wages.
The principle set out in this case will apply only where:
- an employee's salary is less than Rs15,000; or
- the PF contribution is calculated based on a salary or basic wages of less than Rs15,000.
As the Supreme Court has clarified that special allowances paid to employees must be included in the calculation of PF contributions, employers should review and analyse their current salary structures to determine any increase in PF liabilities.
Pursuant to this judgment, there might be an increase in inspections by the PF authorities to ascertain whether PF contributions are being calculated correctly.
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