Components forming part of Wages for deciding contribution under Provident Fund Act, effect of splitting salary into components/allowances and its effect on Contribution under Provident Fund Act

I. Components forming part of wages under the Provident Fund Act

Section 6 of the Provident Fund Act in India provides for “Contribution”. The Section reads as under;

‘The Contribution which shall be paid by the employer to the Fund shall be twelve per cent of the basic wages, dearness allowance and retaining allowance (if any) for the time being payable to each of the employees (whether employed by him directly or by or through a Service Provider) and the employee’s contribution shall be equal to the contribution payable by the employer in respect of him and may, if any employee so desires, be an amount exceeding twelve per cent of is basic wages, dearness allowance and retaining allowance (if any), subject to the condition that the employer shall not be under an obligation to pay any contribution over and above his contribution payable under this section:

Provided that in its application to any establishment which the Central Government, after making such inquiry as it deems fit, may, by notification in the Official Gazette specify, this section shall be subject to the modification that for the words ten per cent, at both the places where they occur, the words twelve per cent shall be substituted:

Provided further that where the amount of any contribution payable under this Act involves a fraction of a rupee, the Scheme may provide for the rounding off of such fraction to the nearest rupee, half of a rupee or quarter of a rupee.

(Explanation 1) – For the purposes of this section, dearness allowance shall be deemed to include also the cash value of any food concession allowed to the employee.

(Explanation 2) – For the purposes of this section, ‘retaining allowance’ means an allowance payable for the time being to an employee of any factory or other establishment during any period in which the establishment is not working, for retaining his services.’

Therefore, reading of the section it is clear that contributions under Provident Fund Act have been paid on Basic, DA and retention allowance.

II. Effect of splitting of salary into various components/allowances and consequent developments

In 1999, the Supreme Court, in Air Freight Ltd. v. State of Karnataka & Ors.(C.A. No. 4259 of 1999 and decided on 04.08.1999) laid down that, in cases where employer is paying wages to the workers under various heads, if the total sum is higher than the minimum rates of wages fixed under the Minimum Wages Act, 1948 including the Dearness Allowance/Special Allowance (variable component linked to rise/fall in cost of living index), then the employer is not required to pay Dearness Allowance/Special Allowance separately. This judgement allowed employers to split worker’s salaries in a manner that was convenient to them, taking into account various statutory obligations vis-à-vis monetary contribution to be paid therein.
However, the employers, in order to reduce liability of the company in terms of contribution under Provident Fund Act  & Gratuity started reducing the component of basic wages and split the salary into various allowances such as education allowance, medical allowance etc. The lower basic wages resulted in reduction in contribution receivable from employers.

In the light of reduction in contribution receivable from employers, Employees Provident Fund Organisation (EPFO) brought out Circular no. Coord. /4(6)2003/Clarification/13633 dated 06.06.2008 was passed, followed by a new circular by the EPFO, namely, No. Coord/4(6)2003/Clarification/Vol-II/7394 dated 23.05.2011. The said circular, referred to the Karnataka High Court Judgement, in the matter of Group 4 Securities Guarding Ltd Vs. RPFC (Writ Appeal No. 6438 of 2000, decided on: 30.10.2003) and provided that, for the purposes of calculating contribution under Provident Fund Act, Basic Wages shall come to mean the quantum of minimum wages that is payable to the particular worker depending upon his skill set/ nature of industry/zone in which the industry falls.
The following is an illustration of the above Circular–

Suppose the rates of minimum wages as per Minimum Wages Act, 1948 for Engineering Industry in Maharashtra for a factory situated in Zone I for a skilled worker is:-

Basic D.A./Special Allowance Total

6000/- 1000/- 7000/-

In the above case Employer’s Contribution under Provident Fund Act would be = 13.61 % of 7000/- = 952/-

Employees Contribution = 12% of 7000/- = 840/-

A particular factory named ABC in Maharashtra classified under the category of ‘Engineering Industry’ pays its skilled worker salary under the following heads;

Basic = 3000/-

HRA = 4000/-

Conveyance Allowance = 1000/-

Washing Allowance = 500/-

Total = 8500/-

Since the definition of the ‘basic wages’ under the Provident Fund Act clearly excludes cash value of any food concession, any Dearness Allowance, House Rent Allowance, over time allowance, bonus, commission or any other similar allowance payable to an employee in respect of his employment or work done in such an employment.

In the above case Employer’s Contribution under Provident Fund Act would be = 13.61 % of 3000/- = 408/-

Employees Contribution = 12% of 3000/- = 360/-

However, by the virtue of the said Circular ABC factory shall be compelled to pay Provident Fund Contributions on Rs. 7000/- (i.e. the rate of minimum wages) as mentioned above thereby significantly increasing the Provident Fund Contribution liability of ABC.

III.Conflicting views of various High Courts

As seen above, the Karnataka High Court in the G4S case held that contribution under Provident Fund Act must be paid on Minimum wages. However a conflicting view is seen in the judgement of the High Court of Punjab and Haryana in Asstt. Provident Fund Commissioner v. G4S Security Services (India) Ltd. and Anr., as decided on01.02.2011. The said High Court had already completely refuted the claim of the Provident Fund Dept. regarding essentiality of considering rates of minimum wages for calculation of the Contribution under Provident Fund Act  (as contemplated under the said Circular). The Court has opined that the objects and reasons of the Minimum Wages Act (MWA) & Provident Funds Act are manifestly different and the definition of the ‘basic wages’ under both statutes are distinct.

But, the Gwalior Bench of MP High Court in Montage Enterprises Pvt. Ltd. v/s Employees Provident Fund Indore & Anr., WP/1857/2011 and the Madras High Court in Reynolds India Pvt. Ltd. & Ors. v. RPFC & Ors., WP 15283/2010 have further amplified the ambit of the ingredients to be included for calculation of Contribution under Provident Fund Act and have laid down that certain allowances like Conveyance/Transportation allowance, Special Allowance etc. must be included in “Basic Wages” for the purpose of Provident Fund liabilities if the same are being uniformly, necessarily and ordinarily to all employees across the Board. These judgements, however, have been referred to larger benches.

The A.P. High Court, however, on 29/09/2011 in M/s. Hyderabad Industries Limited v. Employees’ Provident Fund Organisation, W.P. 23478 of 2011, has stayed all further actions pursuant to the said Circular dated 23.05.2011. Delhi High Court as well in Central Association of Private Security Industries v. Ministry of Labour & Employment & Ors. WP No. 6333/2011on 30.08.2011 has ordered to keep the said Circular dated 23/05/2011 in abeyance till the date of next hearing. This shows that the legality of the said Notification is questionable.

IV. Our views on the issue -

Keeping in mind the divergent views of the Court & uncertainty of outcomes of Judgments, an employer is expected to take a call. It is quite likely that High Courts may not accept the contention of the Provident Fund Dept. But in the mean time if the employer decides to include allowances while calculating Contribution under Provident Fund Act, he may have to continue to pay similar Contribution even if the Judgment sets aside the circular. However, if the validity of the circular is accepted by the Courts the employer will be protected from payment of retrospective fines.

NOTE – In the event that the said impugned circular is held unlawful by the High Courts, employers must keep in mind that the Karnataka High Court judgement in Group 4 Securities Guarding Ltd Vs. RPFC shall still hold good and the RPFC can go into the terms and conditions of employment/employment contract to determine whether splitting/bifurcation of the wages into various allowances by the employer is with the intention to reduce the contribution under Provident Fund Act by subterfuge for the employee’s welfare.

It is therefore of utmost importance that employers ensure that the terms and conditions of the employment contract are drafted and followed in such a manner that no liability shall arise in the future.

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