Payment of Gratuity and Gratuity Qualifying Salary

Having clarified by the Apex Court of India that PF qualifying salary is the amount of salary that the employer has agreed to give to the employee in return for the labour the latter gives, the next question that arises into the minds of all employees is that what will be the salary for the purpose of calculating Gratuity?

Section 2 (s) of the Payment of Gratuity Act, 1972, defines the term “wages” as  “ all emoluments which are earned by an employee while on duty or on leave in accordance with the terms and conditions of his employment and which are paid or are payable to him in cash and includes dearness allowance but does not include any bonus, commission, house rent allowance, overtime wages and any other allowance”.

The above definition of wages is almost similar to the one given for wages under the Employees Provident Fund and Miscellaneous Provisions Act, 1952, which provides under section 2 (b) as follows:

Basic wages means 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 employees 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.

Under both these Acts the meaning of basic Salary is same, ie, the total or gross emolument payable as per terms and conditions of employment or, simply, the contract of employment. It is true that an employee joins an organisation after accepting the terms and conditions of employment which will include a salary structure with a basic pay and other components. It is also common now a days to show how much will be the contribution by the employer towards Provident Fund and even the gratuity payable at the time of exit of the employee. For an employee, whatever is offered as salary is the salary on which he has agreed to work with the employer, and he is not concerned with the heads under which he is paid the same. As such, even if the agreement contains a break up of salary, the total should be regarded as the remuneration for his labour.

In the case of most of the private companies who treat Provident Fund and other social security schemes as a mandatory requirements or obligation rather than employee welfare schemes, it is obvious that they would keep the salary on which these contributions are to be made at a very low level. The history which induced the Supreme Court of India to clarify the meaning of Basic Wages to include all allowances is known to all. It is nothing but a dispute raised by the Employees Provident Fund Organisation against those employers who bifurcated the salary payable into small compartments with distinguishing headings leaving only a small fraction as under “Basic Salary” to attract Provident Fund deduction. This was done by following section 6 of the EPF and MP Act, which says that contribution is payable on Basic Wages and Dearness Allowances only. (in the case where there is no work and the employees are retained and as such instead of salary, if an allowance is paid to retain them, viz, retaining allowance, the same will also attract PF contribution) But the employers did not go to the scope of the meaning of Basic Wages as total wages but took it as the basic wages that they fix. Now having clarified that Basic Wages means the total salary payable as per agreement with an exception of house rent allowance (HRA) many have also restructured the salary with huge amounts shown as HRA.

What is House Rent Allowance?

This is an allowance paid or payable to an employee who stays in and around the place of office/ factory as mandated by the employer for the purpose of his occupation. It is not payable to all employees uniformly but is payable only to those who stay in leased houses. The basic feature of this allowance like any other allowance which are exempted from the scope of Basic Wages is that it will be payable even if the employee is on leave without pay. For example, the salary agreed is Rs 30000 per month. But the employee is given an additional amount of Rs 5000 as house rent allowance so that he can take a house on lease near the establishment and stay there. If the employee takes three days’ leave when is short of any paid leave, his salary will be subjected to deduction of three days’ salary at the rate of Rs 1000 per day on a calculation that monthly wages divided by 30 would be the average daily wage. But he will be paid HRA of Rs 5000 in full. HRA will not be subjected to proportionate deduction. If he is given telephone allowance of Rs 300, the same will be paid in full and no deduction proportionate to the days that he remained on leave will be made.

HRA is part of Salary

Let us take the same example with a difference that HRA is part of salary. The salary will be Rs 35000 and of this HRA as a component will be Rs 5000. In this case, if the employee takes three days’ leave without pay, it will be Rs 1166 per day which will be deducted from the salary. In this case HRA becomes part of Salary and in the former case, of course, it is a perquisite not falling under the scope of Salary. The same test applies to other allowances also. Most of the private establishments follow this pattern of salary structure. They would even consider the employers’ contributions towards PF, ESI, Gratuity etc as part of personnel cost and add it to the salary (commonly referred to as Cost to Company or CTC)  so that the total amount would lure the job seeker.

Special Allowances

The issue of treatment of Special Allowance is no exemption.  It is to be noted that Special Allowance is something that is paid only to a particular employee or particular category of employees in return for a special skill that they contribute to perform their task. Special Allowance in such cases can be excluded from the scope of definition of wages. But if special allowance is paid to all the employees, it will be considered as an allowance universally applicable to all the employees and in such cases,  it will become part of Wages/ Salary for any purpose.  

In the current system or custom of pay fixation, whatever left after allocating to segments like Basic Pay, HRA, Conveyance allowance etc is taken as Special Allowance. Obviously, it will have nothing to do with special skill nor is given only to a few employees who require special skill to do the work. Right from the decision of the Supreme Court in Bridges and Roofs (India) Ltd Vs Union of India (1963 (2)LLJ 490) there have been directions from the appropriate authorities that (Special) Allowance paid to all the employees would be part of Basic Salary and only those allowances which  are paid to some employees considering the nature of their duties or purely out of management's own interests or pleasure, can be excluded from the scope of Basic Wages.

A variant of Special Allowance is “other allowance”. Obviously, this is another head which will also form part of Wages or Salary or all purposes including payment of EPF, Bonus and Gratuity.

Meaning of Gross Wages/ Salary

Gross wage is the total wage paid or payable as per contract of employment. It is the amount of wage that one gets if he works on a day or takes an authorised leave. On the other hand, it is from the same gross wage that one’s salary for the day on which he remained leave without pay is deducted. For example, let us say that the gross salary of an employee is Rs 30000 per month. The salary is bifurcated as follows:

Basic Salary                           :   7000

HRA                                       :   5000

Conveyance                            :   3000

Special Allowance                  : 15000

Total                                        : 30000

Let us assume that the above employee has taken one day leave without pay. For the purpose of deduction, it is 30000 taken as base and it will account for Rs 1000 for a day, assuming that there are 30 days in the month. Accordingly, he will get Rs 29000 as salary for that month.

Why deduction is made from the base of 30000? It is because the salary as per contract of employment is Rs 30000 and the average salary per day is Rs 1000 and if you do not work on a day, you will lose Rs 1000 for that day.

In order to treat House Rent Allowance, Conveyances Allowances, Special Allowance, Telephone allowance etc as allowances not forming part of salary or basic salary, we should deduct the day’s salary in respect of the leave taken on without pay basis from the Basic Pay alone, and give the other allowances in full without subjecting them for deduction. But what is the practice? We deduct it from the total.

Gratuity qualifying Salary

Now coming to the calculation of Gratuity we have to take average salary. What the Act says?  The Payment of Gratuity Act, 1972, by its section 4(2) says that “……..the employer shall pay gratuity to an employee at the rate of fifteen days wages based on the rate of wages last drawn by the employee….”

We have seen the definition of wages under section 2(s) of the Act as total emoluments which are earned by the employee. As such it is the gross salary that should be taken as the base for the calculation of gratuity. But the practice is to take the Basic Pay alone. In companies that pay dearness allowance, naturally, they consider DA also as part of Gratuity Qualifying salary. This is also a custom followed at par with the treatment of Wages for Provident Fund contribution.

The payment of Gratuity Act has further said how to arrive at the average rate of wages. The average rate of wages is the monthly wages divided by 26 and not 30.

In respect of piece rated workers, it is the average of the total wages received by him for a period of

three months immediately preceding the termination of his employment. In respect of an employee who has been disabled but has been reemployed on reduced wages is to be calculated prorate for the period preceding his disablement and for the period subsequent to his disablement on average wages of the respective periods.

In the above cases, including wages of seasonal employees and daily rated workers, you cannot bifurcate the piece rated wages into basic, HRA, Special Allowance etc but whatever is paid is the wages. Only those amounts which can be excluded from it are any overtime wages, commission or incentive though it is also paid along with the wages.  It is only in respect of employees who receive monthly salary,  the bifurcation of gross salary normally happens. As such when two employees with the same length of service leave the establishment, one with a higher salary but on monthly basis may get lesser gratuity when compared to another employee with daily rated salary. Since the Provident Fund is also contributed on the daily wages without any bifurcation as to HRA, Conveyance allowance etc, the latter may get more PF and may also be eligible to more Pension!

The issue of Basic Wages regarding Provident Fund has been clarified by the Apex Court. Now everybody is looking to find a solution for payment of Gratuity, and he base for calculating amount of Gratuity. As the definition of wages given under both the Acts are the same, I am of the impression that Gratuity is to be calculated on the gross salary and not alone on Basic salary and Dearness Allowance. Simply, gross salary is:

·         The salary as per contract of employment

·         The salary paid to the employee on duty or on (authorised) leave

·         The salary which is deducted for any leave without pay

Therefore, the gross salary should qualify for calculating the amount payable as Gratuity.

Pension Based on Actual PF Contributing Salary- Who will get the benefit of higher pension as per Supreme Court Verdict?

Yesterday, ie, on 1st April, 2019, the Supreme Court of India has pronounced a landmark judgement on Provident Fund Pension by holding the decision by the Hon. High Court of Kerala of October 2018 and rejecting the appeal by the Employees Provident Fund Organisation (EPFO). The verdict directs the EPFO to pay pension based on the actual salary of the member. There are a few points which require attention.

Background 

1. The Employees’ Pension Scheme 1995 provided for payment of 8.33% of the PF qualifying wages to the Pension Fund. The basic scheme  also provided that if the PF qualifying salary of any employee exceeds Rs 6500 the contribution payable to the Pension Fund could be restricted to Rs 6500. However, the Scheme was amended in 1996 which provided that if both the employee and the employer jointly agree, a higher amount equal to the amount contributed to Provident Fund could be contributed and, in such cases, that higher amount would qualify for pension calculation. Following this, many organisation (who later became parties to the case against the EPFO before the Kerala High Court) contributed to Pension Fund on higher salary. But the EPFO, with an administrative order, stopped this option with effect from 1st December 2004.  

2. In September 2014 when the PF threshold limit of wages was revised from Rs 6500 to Rs 15000, the contribution limit prescribed in the principal Scheme of Pension Fund was also revised from Rs 6500 to Rs 15000. Since a dispute was already in force about the higher contribution to pension fund and higher pension treating that as the pensionable salary, the EPFO restricted the Pension qualifying salary to Rs 15000 without any scope for the employer to pay contribution to pension fund on salary higher than Rs 15000. Moreover, the amended Scheme provided that the Pensionable Salary would be average of the 60 months’ salary. Owing to this many persons who retired in 2014 received Pension based on a maximum salary of Rs 6500 only. 

3. This was also challenged in the court. The Kerala High Court in October 2018 found that the order of the EPFO putting a cutoff date (1st December 2004) for giving option as unconstitutional. The court also scrapped the provision in the Act which limited the Pension Fund qualifying salary to Rs 15000. The High Court of Kerala viewed that when an employee is contributing to the Provident Fund on a salary higher than Rs 15000, he should be paid pension considering the same salary as the Pensionable Salary. 

4. The above order was challenged by the Employees Provident Fund Organisation before the Supreme Court of India. The Apex Court also found that a member of the EPF must be paid pension based on his actual contribution to the Provident Fund. The Court also directed that the pensionable salary should be the average of the salary for the preceding 12 months as against 60 months. The Court also upheld the decision of the Kerala High Court scrapping the provision in the Scheme which capped the pension fund qualifying salary to Rs 15000 and said that “the employees, who have been making contributions on the basis of their actual salaries after submitting a joint option with their employers as required by the Pension Scheme, are denied the benefits of their contributions by the said amendments without any justification. Apart from the above, to cap the salary at Rs. 15,000/- for quantifying pension is absolutely unrealistic. A monthly salary of Rs.15,000/- works out only to about Rs.500/- per day. It is common knowledge that, even a manual labourer is paid more than the said amounts as daily wages. Therefore, to limit the maximum salary at Rs.15,000/- for pension would deprive most of the employees of a decent pension in their old age. Since the pension scheme is intended to provide succour to the retired employees, the said object would be defeated by capping the salary."

Who will get the benefit? 

Really, the employees who are members of the Pension Fund Scheme of the Employees Provident Fund Organisation are overwhelmed by the verdict from the Supreme Court which upheld the decision of the  Kerala High. It gives them a relief that they are on the right track with regard to savings, investment and retirement planning. All the apprehensions spinned around the value of a 1000 rupees pension per month in 2030 or 2040 have gone. If this is the way in which pension will be calculated, then no one would think of investing in any other form of retirement plan. But things would not be so simple as many thinks. This is because many organisations take EPF as a STATUTORY BURDEN rather than a welfare scheme to their own employees.  It is true that for employees of an employer who  contributes his share of contribution without capping it at Rs 15000, but for an employee whose PF qualifying salary is limited to the mandatory amount of 12% of Rs 15000, there is nothing to cheer up. 

Those who contribute to PF on a salary higher than Rs 15000, say, Rs 50,000, that higher amount, ie, Rs 50000, will be the Pensionable Salary. Since the average pensionable salary for the 12 months preceding the date of retirement is the base salary for calculation of pension, he will get pension based on Rs 50000. At the same time, if his PF is capped to Rs 15000, only Rs 15000 will be taken as base for Pension calculation. In order to get higher pension, he should have contributed to PF on higher salary. Since the Pensionable salary is the average of 12 months’ pay preceding the date of retirement, any increase in PF contributing salary during this period would also benefit the employee.  

Is it possible to increase the PF contributing Salary? 

If the employer agrees that the contribution can be made on the actual salary, then there is nothing wrong in increasing the PF contributing salary. At the same time, neither the employee nor the EPFO can direct the employer to increase the PF contributing salary beyond Rs 15000. 

Will the verdict of Supreme Court on PF contribution on allowances help the employees to increase their PF and Pension qualifying salary?

It is true that PF is payable on allowances as well. The recent Supreme Court Verdict on contribution on allowances also substantiate that  allowances other than HRA will attract PF and as such your actual pay should be the base for PF contribution. But this does not apply in the case of salary above Rs 15000. The decision of Marathwada Gramin Bank Karmachari Sanghatana Vs Management of Marathwada Gramin Bank by the Supreme Court also says that EPFO cannot demand a contribution on a salary above Rs 15000. As such, it is entirely left to the employer whether to increase the PF contributing salary above Rs 15000 or not. 

It costs nothing to an employer if he decides to remove the capping of Rs 15000 from his payroll because whatever he contributes is accounted as part of remuneration in the present style of salary structure, viz, Cost To Company or CTC. Therefore, if he contributes more to PF it will be reflected in the CTC. At the same time the employees get the benefit of higher pension when they retire. As rightly observed by Justice Surendra Mohan and Justice AM Babu, you cannot get a labourer for Rs 500 per day then what is Rs 15000 all about? 

Madhu T K

Provident Fund Qualifying Salary and the recent Apex Court Judgement.

Section 2(b) of the Provident Fund and Miscellaneous Provisions Act, 1952, defines basic wages as all emoluments which are earned by an employee while on duty or on leave as per contract of employment. It also provides that cash value of any food concession, any dearness allowance which is paid to compensate 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 shall not form part of Basic Wages.

Section 6 of the Act instructs that every employer should pay contributions towards Provident Fund at the prescribed rates calculated on the Basic Wages, dearness allowances and retaining allowances, if any. Retaining allowance is the amount paid to employees of such organisation which are not presently running and is paid to retain the manpower and make them available when the establishment resumes its work. The definition  of basic wages given in section 2(b)  clearly says that wages is nothing but the amount earned by an employee while on duty or on leave. As such retaining allowance will not form part of wages per say.

What constitutes PF qualifying salary, therefore, is very clear and is nothing but basic wages and dearness allowance in the case of employees receiving salaries and retaining allowance in the case of employees retained by temporarily closed establishments. But various employers misinterpreted the term basic wages as that basic wages that they fix in their organisation and started deducting or paying the contribution on that basic wages alone which is only a component of the total remuneration agreed to be paid to their employees. It is also pertinent to note that many have kept the basic salary at a very low level so that their contribution towards provident fund could be reduced. But the Act had envisaged the meaning of Salary or Wages in its authentic meaning to mean and include the amount required for an employee to apportion to food, shelter and clothing which in normal months would be 80%, 15% and 5% respectively. Of these, you cannot have a compromise on 80% which is the amount required for the basic things, ie, all the direct costs of your family budgets, probably, cost of food items, cooking gas, electricity, water, education, medicine and like things. This is the way in which basic wages is designed in government departments, public sector undertakings and other organized sectors. It is to be welcomed that about 90% of the establishments which have collective bargaining practices and  trade unions  follow the pattern of Basic wages, dearness Allowances and other allowances. It is also pathetic in new generation companies who are not heard of what dearness allowance is and how the same is fixed according to changes in the cost of living index!

On account of misinterpretation or even by unscrupulous interpretation of law by the employers the basic wages were taken as the base for deciding the contribution towards PF. This was challenged by the Employees Provident Fund Organisation initially by means of administrative instructions requiring the employers to pay PF at least on the wages as per the notified statutory minimum wages. They even inspected the companies and directed the employers to comply with the Minimum Wages Act. This resulted in a back fire since the Employees Provident Fund Organisation had nothing to do with enforcement of minimum wages which is to be done by the State Labour Department. When their efforts in that direction failed, they filed cases against the employers. Various High Courts have ruled the issue in different manner and finally the issue came for the consideration of the Supreme Court. There were four appeal cases and one transfer case on the same subject before the Apex Court. The landmark judgement  (it is a landmark judgement because there has been a law made by practice and once it is pointed out as wrong practice then it will be become a sensation) directs that PF should be paid on all the emoluments that an employee gets, and it should not be restricted only to basic wages fixed as a component of wages of your company. It provides that only HRA is an exempted allowance and all other allowances will form part of basic wages.

The Practice of Compensation Fixation

As against fixing the basic wages and building up the salary by adding Dearness Allowance based on CPI, HRA as a percentage of the basic wages and city of residence, conveyance allowance according to the grades or city of residence and other allowances as per eligibility of the respective employees, in private sector concerns we have a system of first deciding what is the Personnel Cost to the Company and then cutting the same into small compartments and giving some title to each component. There will not be any grade wise pay structure,  but the remuneration is fixed by the concerned officer giving weightage to the candidate’s present salary, experience etc and in this pursuit, occasionally, the bargaining power of the candidate and the bias of the HR Manager will be decisive factors.  Everything is discussed on the CTC and once it is decided the same is put in an excel template which will give you a break up like Basic pay, HRA, Conveyance, performance pay, medical allowance and finally Special Allowance. This special allowance is the amount left after putting the percentages are put on each cell representing the amount demanded by the employee and the amount payable by the Personnel policy  of the organisation. Eventually, this component will be common for all employees and whenever salary hikes are declared, often this is the component of salary to which the increase in the salary will be absorbed. This is because any addition to basic pay will increase the burden of the employer towards PF, Bonus, Gratuity, leave encahment etc!

It is to be noted that, whatever is paid to all the employees commonly should form part of basic wages. At the same time, if any particular employee or a class of employees having special skills or requiring special skills to do a particular work is paid any additional amount, that can only be excluded from basic wages as special allowance. This was decided very long before in Bridges and Roofs India Ltd Vs Union of India (1963(2)LLJ 490) and a few other cases like R Ramanathan Chettiar Jewelers,Madurai Vs Regional PF Commissioner, Madurai, (1988(ii)LLJ 045) and Associated Cement Company Ltd, and Ors Vs RM Gandhi, Regional PF Commissioner, Gujarat (1995-III-LLJ(suppl.) 368)

The system of pay fixation based on Cost to Company and making it more and more employer friendly only has put them under trouble. With the new decision the employers are now thinking of increasing of share of CTC to HRA because HRA is in the exclusion part of the definition of basic wages and as such no contribution is payable on HRA. But the EPF Organisation is ready with a calculation of HRA in tune with the Income Tax Act preventing the employers to pay more for the shelter rather than for their basic requirements.

Take Home Salary

Though the Supreme Court has ruled that provident fund should be contributed on your Gross Fixed Salary (less HRA), the amount of contribution of those whose basic salary was more than Rs 15000 will not change. This is because the EPFO cannot demand a contribution on a salary above Rs 15000. In Maratwada Gramin Bank Karmachari Sanghatana and Another Vs Management of Maratwada Gramin Bank and others (SC 2011 LLR 1130) it was held that the EPFO has no right to demand a contribution on a salary above Rs 6500. (Please note that the mandatory salary was Rs 6500 when this verdict came and now it has become Rs 15000). Therefore, the employer’s liability to pay PF shall be restricted to 12% of Rs 15000. As such those whose salary are subjected to PF deduction at this figure will continue to get the same take home salary.

For those whose contributions were worked out on amounts less than Rs 15000, the take home salary would certainly come down. But the reduction of take home pay should not be taken as a negatively because of various reasons. First, whatever you contribute will be a saving. Second, the same amount is put by the employer also. This will increase your take home at the time of your retirement. Since 8.33% of the PF qualifying salary is posted in Pension Fund, your pension qualifying salary will also be high and this will, obviously, result in higher pension through out the rest of your life. If you wish to take a loan, say for construction of a residence, the amount available to you will be 36 times of your PF qualifying salary. An increased PF qualifying salary will result in increased amount available as loan from PF.

Provident Fund is an investment and is considered to be the best available retirement benefit available in India. Besides its beauty of income tax savings, insurance under the Employees Deposit Linked Insurance and easiness of getting advances for construction or purchase of residential plots, education of children, marriage etc, it is the only form of investment which gives the nominee of the deceased member monthly pension without reference to the service. Therefore, I would recommend that the ruling of the Supreme Court should be welcomed.

Apprehensions

The ruling only gives a direction that basic wages means total salary and you should include special allowances, conveyance allowance and other allowances to wages which qualifies to PF contribution. However, the EPFO can demand the arrears of contribution by sending notices to all the establishments who have not complied with the statutory requirements. Therefore, from now onwards it will be a period of enquiries under section 7A of the EPF & MP Act. If so, from which dates the employers will have to pay the contributions? Is it from the date on which the Employees provident Fund and Misc. Provisions Act was enacted or the date on which the Act was made applicable to the establishment whichever is later or whether the EPFO will give a cut of date for this? If they take the former, the employers will have to provide for a huge amount in their next year budget and this will include the employees’ share  because they cannot recover a single paisa from the employee in respect of their old dues. For the EPFO, it is benefited because there are huge amounts which are remaining unclaimed by members who have either not bothered to get it or died without claiming the amounts. Under the Payment of Gratuity Act there is a provision that it is the responsibility of the employer to pay the gratuity to an eligible employee within 30 days of his leaving service even if he has not claimed it. Similarly, the EPFO should be mandated that it is their responsibility to pay the PF amounts and pension as soon as an employee leaves or communication of his exit is given to them by the employer.

Madhu T K