Making Every Rupee Count

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Making Every Rupee CountHow to strike the right balance between in-hand salary and long-term

savingsChandralekha Mukerji Edition:February 2013

A 25 per cent jump over your present salary Is this sentence enticing enough to

convince you to join a new company? Before deciding anything, it's better to wait for the

'offer letter'.

In thesetimes of tight budgetsand cost control, companies do not hire on the basis of

what they will credit to your bank account but your cost to company (CTC), that is, the

money they will spend on you. But what constitutes CTC? That, unfortunately, has no

standard definition and varies from company to company.

"The government does not recognise the concept ofCTC in computing wages. So,

there are no rules, and the structuring is mostly the company's prerogative," says E

Balaji, CEO and MD of Randstad India, a division of Randstad Holding NV, a leading

global human resource services company.

CTC can include both monetary and non-monetary items. Apart from the basic salary, all

fixed allowances and cash reimbursements are part of the package. Defined

contributions towards long-term and retirement benefits such as provident fund,superannuation fund and gratuity, along with benefits given in kind, for instance house,

furniture and car, are also included. Some companies even include variable payouts

such as performance bonus and gratuity in the 'total target remuneration'.

Group benefits such as health and accident insurance that are either contingent or for

which no specific value can be attributed to a single employee may also be included on

the basis of derived or ascertained value.

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COST STRUCTURE

Except for statutory heads such asEmployee Provident Fund (EPF), Employees' StateInsurance, gratuity and bonus, where the rules prescribe minimum contributions, thereare no set rules on structuring the cost to company.

However, there are some practices that all companies follow. For instance, the basic payis generally 35-50 per cent of the CTC and house rent and dearness allowances are apercentage of the basic pay. Contributions for retirement funds such as EPF andsuperannuation fund are also linked to the basic pay. Other benefits such as leavetravel, medical and conveyance allowances serve two aims. One, they increase the nettakehome salary. Two, they make the salary structure more tax-efficient. For instance,medical reimbursement up to Rs 15,000 a year increases the salary in hand withoutadding to the tax burden.

So, unless you seethe salary break-upand do the math, you cannot be sure about

what you'll get in hand. For example, suppose the company has offered you a goodsalary increase but has made variable pay a big part of the CTC. In such a case, thecompensation may be less than expected and the deal may not turn out to be as goodas it seems.

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The key, therefore, lies in finding outwhat makes up the CTC. Here wediscuss some common elements ofthe CTC and how they fit into thetotal package.

BASE SPLIT

The base pay has threecomponents- basic, house rentallowance or HRA and dearnessallowance. The basic is the biggestchunk, usually 35-50 per cent ofCTC. Senior employees get muchless basic pay as a proportion ofCTC than mid- and junior-level staff.This is because basic pay is fullytaxable and so for people in highertax brackets it makes sense to keepthat to the minimum and get paidthrough allowances that attract nil orlower tax.

"The industry norm is another factorthat influences your basic pay," saysKuldip Kumar, executive director,Tax & Regulatory Services, PwCIndia. "For instance, in the

information technology industry,where staff turnover is high,employees prefer more take-homesalary, while manufacturingcompanies give more fringe benefits," he says.

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A higher basic pay means higher house rent allowance, dearness allowance andcontribution towards provident and superannuation funds.

"Generally, a higher basic pay enhances the tax exemption limit for HRA. It alsoincreases contribution towards retirement benefits like provident fund (usually 12 percent of the basic pay) and superannuation fund, which means a lower take-homesalary," says Parizad Sirwalla, partner, Tax, KPMG.

Dearness allowance (given mostly to government employees) is a percentage of basicpay and is paid to lower the impact of inflation. The HRA is usually 40-50 per cent ofbasic pay depending upon where you live.

REIMBURSEMENTS AND ALLOWANCES

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Allowances and reimbursements areguided by two things-the pay scaleand the tax rules that apply to thesecomponents.

Allowances are sometimes paidirrespective of whether the employeehas incurred the expense. These arefully taxable if bills are not provided.However, if the expenses areincurred and bills submitted, theallowances are either not taxable ortaxed only after a limit. For instance,phone bills and allowances to buybooks and periodicals are not taxedif the bills are submitted. However,fixed allowances, for example forentertainment, which are credited toyour bank account every month withthe salary are taxable if bills are notprovided.

But this rule is different for mostgovernment employees. For them,entertainment allowance up to 20per cent of salary (exclusive of allowances, benefit and perquisite) or Rs 5,000,whichever is less, is exempt from tax.

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Since the tax-free limit for conveyance allowance for commuting to work is Rs 800 amonth, it is usually capped at Rs 9,600 a year. For medical allowance, the tax-exemptlimit is Rs 15,000 a year, provided the bills are submitted.

The bills can be in the name of self, spouse, children, parents or siblings, provided theyare your dependents.

The Leave Travel Allowance (LTA) is also exempt to the extent of the expense incurred.However, it is limited to two trips in a block year of four calendar years (the current block

is calendar years 2010 to 2013) and travel within India.

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The list of allowances andreimbursements is quite long.

PERKS AND PRIVILEGES

Perquisites provided by theemployer such as a house with zeroor concessional rent, vehicle,insurance, medical and club facilitiesare also part of the totalcompensation. Each has a differentvaluation rule. The tax treatmentalso varies from situation tosituation.

Accommodation: The rules dependon whether it is a company-leased ora company-owned property. If theaccommodation has been taken onrent by the employer, the taxablevalue is 15 per cent salary or therent paid, whichever is lower.

If it is owned by the employer, thevaluation is based on the populationof the city (as per the 2001 census).According to the tax rules, theperquisite valuation should be 15 per

cent of salary in cities with apopulation of more than 25 lakh, 10per cent in cities with 10-25 lakhpeople and 7.5 per cent of salary inother areas.

"In case of furnished accommodation, the value of the housing benefit is first calculatedaccording to perquisite valuation rules and then 10 per cent of the actual cost of furnitureowned and provided by the employer, or in case of hired furniture, actual charges paidby the employer is added to it," says Kuldip Kumar of PwC India.

Car: Here also, the tax treatment depends on how the vehicle is used.

If the car is used only for official work, there is no tax.

If the car is for personal use and running and maintenance expenses are paid by theemployer, the actual expenditure incurred by the employer, including the remunerationof the chauffeur along with an amount representing normal wear and tear of the car (10per cent cost of the car or hire charges if the car is hired) is taxable as a perquisite.

If the car is partly used for official and partly for personal purposes and maintenanceexpenses are paid by the employer, Rs 1,800 per month is taxable as a perquisite where

the cubic capacity (cc) of the engine does not exceed 1.6 litres. For vehicles with enginecapacity exceeding 1.6 litres, the amount is Rs 2,400 per month. The rules apply even if

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the vehicle belongs to the employee but the running cost is paid by the employer.

"If the employer provides a chauffeur, Rs 900 per month is added to the abovementioned taxable values of Rs 1,800 and Rs 2,400. If a recovery is made from theemployee, it is deducted from the perquisite value," says Kumar.

If the running and maintenance costs are borne by the employee, Rs 600 per month istaxable in case of vehicles with engine capacity up to 1.6 litres. If the engine capacity isabove 1.6 litres, the taxable amount is Rs 900 per month.

Medical Insurance: Provision of medical insurance for the employee or his family is nottaxable. Reimbursement for medical treatment in specified hospitals for prescribeddiseases is also not taxable, subject to certain limits and conditions.

Club Membership: The perquisite value of expenditure (including the fee) in a club borneor reimbursed by the employer is included in the taxable income. However, if thisexpense is for business purposes or a group benefit, it will not be taxed.

"Where the employer has membership of a club and the facility is enjoyed by theemployee, the value of the perquisite will not include the initial fee paid for acquiring the

membership. Further, the reimbursement of expenditure for, say, a health club facility,provided to all employees will also not qualify as a perquisite," says Kumar.

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Interest-free or concessional loan: The valuation of such a benefit is done on the basisof the interest that the employee otherwise would have paid, which is taken as the ratecharged by State Bank of India on a yearly basis for similar loans and computed on themaximum outstanding monthly balance.

There is an exception for loans taken for specified medical treatments. "The amount ofsuch loans is reduced by the reimbursement from the medical cover," says Kumar.Loans worth less than Rs 20,000 are also exempt.

Food and Gifts: The perquisite value of food and non-alcoholic beverages provided bythe employer during work hours at business premises or non-transferable foodcoupons/vouchers such as Sodexo meal passes for purchasing food items andredeemable at specific stores is not taxable to the extent of Rs 50 per meal per workingday. Anything above this is added to the taxable income.

Gifts and vouchers in lieu of gifts are not taxable up to Rs 5,000 a year. Anything more istaxed by adding an amount equal to the value of the gift to the taxable salary.

Movable assets: Companies at times provide employees expensive equipment. Forexample, a photographer may be given a camera. The valuation of such benefits is 10per cent per annum of the actual cost of the asset or the rent/charge paid by theemployer. In case some of it is recovered from the employee, the value is reduced bythe same amount. Computers are not included in this.

Stock Options: ESOPs, or, Employee Stock Options is another popular perquisiteoffered. Here, the company provides you with option to purchase a limited number ofcompany's stock at a fixed price (also called exercise price) on a future date.

Why CTC structure and components vary from company to company

There are no rules to set salary components and, therefore, the cost to company, or

CTC, structure varies. However, there are some standard practices considering the taximpact. The variations may occur due to the following factors:

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1. Industry norms or company-specific policies: Some CTC components, such as

uniform allowance, may be specific to industries. Ways of calculating CTC also differ.

For instance, company A may pay 50% of the CTC as basic while company B may

give only 30%. Or, one bank may include interest subsidies to employees in the CTCwhile the other may not.

2. Type of organisation: Small organisations usually dont have too many

components or reimbursements to avoid administrative hassles. Similarly,

accommodation and medical benefits are taken for granted in a government job while

they may not be part of the CTC if you are working in a private organisation.

3. Salary bands and average age of employees: Employees with lower salary may

want a chunk of their CTC as take-home so that they can meet their daily expenses.

Those who are paid more may want to focus on long-term savings.

4. Location of work: Whether you are posted in a metro or a non-metro city also

influences certain salary components depending upon the cost of living in different

cities as well as working hours. You may even get a special allowance in locations

where working conditions are not very conducive. Also, certain components such as

House Rent Allowance and the perquisite value of the private employer-owned Rent

Free Accommodation vary based on the location of the employee.

- PARIZAD SIRWALLA Partner, Tax, KPMG

BONUS

Everyone likes to get something extra. Many employers pay bonus based on several

factors, including the employee's performance (also known as ex-gratia), years spent in

the company and the company's growth.

Bonus is fully taxable in employees' hands, whether part of salary or not.

At present, employees drawing a monthly salary or wage (including basic and dearness

allowance) up to Rs 10,000 are entitled to an annual bonus. According to the Payment

of Bonus Act, 1965, an employee is eligible for a bonus of 8.33-20 per cent annual

salary if he has worked for at least 30 days in an accounting year. For computing the

payout, the salary or Rs 3,500, whichever is lower, is taken.

The law applies to all establishments with at least 20 employees or factories with 10 or

more workers. An amendment to the Act seeking higher eligibility limit and minimum

bonus is under consideration.

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Bonuses other than those covered by the law are agreements between you and your

employer. As most establishments follow the concept of CTC, your job contract will

include a detailed clause on bonus if it is part of your pay package.

All bonuses, including ad-hoc ones such as retention bonus, are part of your taxable

income.

LONG-TERM BENEFITS

While allowances and perquisites provide immediate gratification, your CTC has

components that will benefit you in the long run.

All retirement benefits-provident fund, contribution to an approved superannuation fund

or the National Pension Scheme (NPS) and gratuity-come in this category

The employer's contribution towards provident fund is exempt up to 12 per cent of basic

pay while your contribution is eligible for deduction under Section 80C of the Income Tax

Act 1961.

In NPS, employees' contribution, up to 10 per cent of the basic pay (basic plus dearness

allowance), is deductible under Section 80CCD and the employers' contribution, up to 10

per cent of the basic, is deductible under Section 80CCE over the Rs 1 lakh deduction

limit for Sections 80C, 80CCC and 80CCD.

Contribution by the employer to an approved superannuation fund is exempt up to Rs 1lakh in the year of contribution.

Gratuity is payable to all those employed for at least five years. The amount is broadly

calculated as half-month's salary for every year of service. So, if your annual basic pay

is Rs 4 lakh, the gratuity due after five years of service will be Rs 10 lakh.

"In case of death or disablement of the employee, the nominees are entitled to gratuity

even if the employee has served for less than five years," says Parizad Sirwalla of

KPMG.

Apart from gratuity, other components are usually a part of your CTC.

Now that you know the rules, go ahead and grill the human resource executive about the

nitty-gritty of your pay package. You may end up doing yourself a favour.