Labour legislations in India are more comprehensive and vast as compared to other countries and the Indian judiciary has contributed tremendously towards development of laws regulating labour. The development of labour jurisprudence is the outcome of a need for social and economic justice for the working class. These legislations consist of certain enactments, sanctioned with an aim to provide adequate social security and to safeguard the future of the employees and their dependants. Apart from social security these benefits also provide tax incentives to the employer and the employee. Every employer, who falls within the ambit of certain enactments, is under an obligation to provide statutory benefits for instance, provident fund, gratuity, pension etc.
With industrialization gaining momentum during the new millennium, India has become a preferred destination for investors. As a consequence, it is increasingly important to be conscious of the applicability of these social legislations and their tax implications on an organization. The present bulletin aims to highlight the applicability of various legislations, which provide statutory benefits to employees and their tax treatment in the hand of employer and employee.
1. The Employee Provident Fund and Miscellaneous Provisions Act, 1952 (“EPF Act”)
The EPF Act is a social security legislation which covers three schemes i.e. Provident Fund, Family Pension Fund, and Employees Deposit Linked Insurance, details of which are below:
1.1 EPF Act and Provident Fund Scheme: The EPF Act is applicable to all establishments, enumerated under Schedule I,1 or any other class of establishments notified by the government employing 20 or more employees. It further allows establishments (on an approval by central provident fund commissioner) to be voluntarily covered under the provisions of the act2 even where the number of employees are less than 20. For the purpose of provident fund, the central government has framed an employee’s provident fund scheme. The employer and the employee contribute at least 12% of the wages, which includes basic wages,3 dearness allowance,4 and retaining allowance.5 Contributions collected from the employer, employee and interest thereon are accumulated in accounts maintained by the employer, known as “Employee Provident Fund Account.”
In order to facilitate EPF Scheme to encourage employee savings, the Income Tax Act, 1961 (“IT Act”) provides certain exemptions and deductions. The IT Act recognizes various types of provident funds;
for instance, statutory, recognized, un-recognized, and public provident funds for granting exemptions. EPF Act applies to recognized provident fund.6
An employee can claim deduction for the contribution made by him towards EPF.7 Contribution made by the employer is fully exempt in the hands of the employee up to the statutory limit of 12%8 of the salary.9 Any contribution made above the statutory limit forms part of the salary and, therefore, becomes taxable. The interest accrued on the contribution is also exempt.10 Further, where lump-sum payment is received by an employee on retirement or termination of service it is exempt from tax, provided the employee has continuously been employed with the employer for a period of at least five years.
Contribution by employer towards provident fund is a business expense in the hands of the employer and, therefore, the employer can claim deduction for it as expenditure.11 In a matter before Calcutta High Court it was held that a employer can claim deduction under the IT Act for the contribution made towards EPF provided (a) the sum paid by the assesse is in the capacity of an employer (b) the sum paid is by way of contribution towards a recognized provident fund and (c) the contribution does not exceed the statutory limit.12
1.2 Family Pension Fund Scheme, 1995: Every employee, who is entitled to benefits under the provident fund scheme, is entitled to avail benefits under the Family Pension Scheme. An employee can claim either superannuation pension if he has been in employment for at least 20 years and retires at the age of 58; or retirement pension if he has worked for 20 years or more but however, retires before attaining the age of 58 years; or short service pension if he has been in service for 10-20 years. The employer’s contribution of 8.33% to the provident fund is diverted to the pension fund. Employees do not have to make any contribution to this fund.
The IT Act imposes a tax on pension in the hands of an employee depending upon the mode of receipt. Pension may be disbursed in two ways – as uncommuted pension (i.e. periodical payment of pension) or as commuted pension (i.e. lump-sum payment in lieu of periodical payment). An uncommuted pension forms part of the salary13 and, therefore, is taxable. Where an employee receives commuted pension as well as gratuity on retirement or termination of service then in such cases, one-third of the pension received is exempt from tax.14 However, where only pension is received, half of the pension becomes taxable. Further where a family member receives pension after the death of an employee it becomes taxable15
2. Payment of Gratuity Act, 1972 (“PG Act”)
Gratuity is a reward paid by the employer on retirement or termination to an employee as a gratitude for his longstanding commitment to his employment. The PG Act applies to every establishment where ten or more employees are employed on any given day in the last twelve months. The employer contributes, as gratuity, fifteen days salary of the employee based on the rate of wages18 last drawn for every completed year of service. In order to be eligible for gratuity, an employee must complete a minimum of five years of continuous service.
An employee who is entitled to receive gratuity is exempted from tax to the extent of either 15 days salary (7 days in case of employees of a seasonal establishment) based on salary last drawn for each year of completed service or INR 350,000 (US$ 8,750) or gratuity actually received whichever is less.19 Any amount received above the statutory limit is taxable in the hands of the employee.20 However, an employee can claim relief under section 8921 of the IT Act.
It is noteworthy, that interpretation of the term “completed service” has been a contentious issue and has been dealt by various courts and tribunals. In a matter before the Bombay High Court the income tax authorities had refused to include the previous year of service as completed service for granting
exemption on receipt of gratuity. It was held, that for purposes of IT Act, completed service would mean an employee’s total service under different employers including the employer from whose services the employee has last retired.22
An employer can also claim deduction23 in respect of the contribution made by him in an approved gratuity fund24 created for the benefit of employees. However, it is pertinent to note that deduction is allowed only where the contribution is made in an approved gratuity fund.25 In a matter before the Delhi High Court a similar question arose. It was held, that an assessee cannot claim deduction where the contribution has been made in an unapproved gratuity fund.26
2. The Employees’ State Insurance Act, 1948 (“ESI Act”)
The ESI Act was enacted to provide certain benefits to an employee in case of sickness, maternity or injury at work. In order to supervise the scheme, Employees State Insurance Corporation (“ESIC”) has been formed which administers the employee’s state insurance fund. The ESI Act applies to all the establishments where ten or more persons are employed or were employed for wages27 on any day of the preceding twelve months. Both the employer and employee contribute to the fund. The employer contributes 4.75% while the employee puts in 1.75% of the wages. The claim can be made either by the injured employee or by the family members of the deceased within three months of injury or death, as the case may be.
Contributions made to the fund are utilized in payment of cash benefit in cases of medical treatment or attendance of insured employee. Therefore, such contributions are exempt from tax in the hands of the employee.28
An employer can also claim deduction for the contribution paid by him for insurance of the health of an employee.29 However, the deduction is disallowed30 where the contribution is made after the due date31 prescribed under the act. In a matter before Delhi High Court assessee had made the contribution after the due date but within the grace period allowed to the assessee. The court held that the assessee was entitled to avail deduction.32
4. The Payment of Bonus Act, 1965 (“Bonus Act”)
Bonus is a reward, which may be in the form of an incentive to an employee for good performance or share of profit. The Bonus Act is applicable to (a) any establishment employing 10 or more persons where any processing is carried out with aid of power; (b) any other establishments employing 20 or more persons. Minimum bonus payable is 8.33% whereas it extends to a maximum of 20% of the annual wages. It is payable annually within 8 months from close of accounting year extendable up to 2 years in special circumstances.33 All employees whose salary or wages do not exceed INR 10,00034 (US$ 250) per month are entitled for bonus, provided they have been employed for at least 30 days in the accounting year.
Bonus is fully taxable in the hand of an employee in the year of receipt unless it has not been taxed earlier on accrual basis. In case bonus is received in arrears, the employee can claim relief under section 89 of the IT Act.
An employer can also claim deduction35 for the bonus paid to the employees, provided that such bonus is not payable as profit or dividend. The intent of legislators behind enacting the above exception was to ensure that the employer does not evade his tax liability by distributing profits earned by way of bonus among employees rather than distributing such profits as dividend to the members of the company.
5. Maternity Benefit Act, 1961
The Act was passed with an object to provide maintenance and benefit while nurturing motherhood to the women employees working in the establishment. The Act is applicable where 10 or more persons are employed during any day of the preceding 12 months. However, the act does not apply where ESI Act governs the establishment. A woman employee is entitled to maternity benefit provided she has worked in the organization for more than 80 days in 12 months immediately preceding the date of the expected delivery. The employer is liable to pay maternity benefit at the rate of the average daily wage36 during maternity leave.
Maternity benefit is treated like normal salary under the IT Act. It is a benefit which an employee can avail and, therefore, its tax treatment is meted out in the similar fashion as salary in the hands of an employee.
An employer can claim deduction37 in the same manner as salary under the provisions of the IT Act.
Statutory labour legislations have been enacted for the benefit of both the employer as well the employee. These legislations help in regulating the employee-employer relationship by providing adequate security to the employees as well as tax incentives to both. The benefit arising out of these legislations motivates the employer and employee to contribute towards the funds created under various legislations. Therefore, every establishment for smooth functioning must ensure that all the enactments are complied with.