A Supreme Court judgment on provident funds provides a poignant reminder to employers to ensure they are complying with the law. By Amit Wadhwa and Puneet Gupta

To provide a social safety net to retired workers and to meet the obligations of ensuring social justice to all, as enshrined in India’s constitution, India has a mandatory Employees Provident Fund, into which both employers and employees are required to make contributions.

The scheme dates back to 1952 and the passing of the Employees Provident Fund and Miscellaneous Act (PF act), which had the objective of making provisions for the future, funded by contributions from both the employers and employees, as well as cultivating a spirit of saving among employees.

Provident funds (PF) have provided much-needed financial support to employees. However, the components of salary/remuneration and other allowances on which contributions are made has proved to be a bone of contention. A recent Supreme Court judgment – The Regional Provident Fund Commissioner (II) West Bengal v Vivekananda Vidyamandir and Ors (RPFC judgment) – which reiterates and follows the principles laid down in earlier judgments and does not lay down any fresh law, has nonetheless served to bring the issue into focus.

Legislative framework

While the Employees Provident Fund and Miscellaneous Act laid down the framework for PF, the details were delegated to the executive, which introduced the Employees’ Provident Fund Scheme, 1952. The scheme sets out details of the PF, its members, the ways of withdrawal of benefits by members, etc. Once an employee becomes a member of the PF, they continue to be its member, except as mentioned in the scheme.

Contributions from employees are compulsorily extracted with no option available to the employees to decide whether to join the fund or not, except for “excluded employees”. Thus, a stipulated percentage of an employee’s monthly wage is deducted and credited to the PF. The employer is required to contribute an equal amount to the fund and the employer’s contribution cannot be recovered from the employee.

The PF act has long faced resistance from employers, with some companies devising innovative ways of structuring salaries so as to minimize their contributions. Typically, an employer would decrease the basic wages of its employees and, instead, introduce different allowances, such as transport allowances or management allowances, thus reducing the employer’s contributions to PF, gratuity and leave encashment.

Paradoxical provisions

The confusion regarding what constitutes a basic wage and the components of salary for which PF contribution is required arises from the PF act itself. Section 2(b) of the act defines basic wages as all emoluments earned by an employee while on duty (or on paid leave or holidays), which are paid or payable in cash, but does not include the cash value of any food concession, dearness allowance (cash payments by whatever name 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 with respect to the employee’s work and any gifts given by the employer.

However, section 6 of the PF act stipulates that PF contribution is required to be paid on basic wages, dearness allowance, including the cash value of any food concession, and retaining allowance, if any. The phrase “or any other similar allowance” which was not defined either in the PF act or the scheme, is open to interpretation, and has been the cause of litigation over several decades. The inconsistency between section 2(b) and section 6 adds to the confusion.

This confusion provided a loophole and allowed employers to be innovative with salary structures. Several new components like fuel allowance, communication allowance, travel allowance, driver allowance, etc., found their way onto employees’ salary slips. The allowances were conveniently considered as falling outside basic wages by the employers and thus not considered for PF contributions.

Judicial interpretation

While the legislature made no efforts to bring any clarity to the matter, the issue first reached the Supreme Court in 1963 in the case of Bridge and Roof. The issue in Bridge and Roof was whether production bonus was to be counted as wages for the purpose of computing PF contributions. A bench of six judges laid down the principle that “all that is not earned in all concerns, or by all employees of a concern seems to be excluded,” in other words, anything fixed and paid across the board will not qualify for exemption. However, money earned by employees by way of their additional efforts can be exempted. It was held that “production bonus” was not to be included as wages for the purpose of computation of PF.

In the case of the RPFC judgment, one special leave petition (SLP) was filed by the regional provident fund commissioner, while all other SLPs were filed by employers against which demands had been raised by PF authorities for payment of PF contributions on different allowances that had been paid to employees.

The following key issues came before the Supreme Court:

  1. Whether the different allowances – special allowance (Vivekananda Vidyamandir); transport allowance, special allowance (Surya Roshni); conveyance allowance, education allowance (management of Saint-Gobain Glass India); house rent allowance, special allowance, management allowance (Montage Enterprises and U-Flex) – or any other similar allowances paid by an employer to its employees can be excluded from basic wages under section 2(b)(ii), and consequently not be considered for the computation of PF contributions made under section 6 of the PF act.
  2. Whether there was a contradiction on the issue of dearness allowance and house rent allowance being excluded in section 2(b), but included in section 6 of the PF act.

The Supreme Court discussed and relied upon the principles laid down in the landmark judgments of Bridge & Roof, Manipal Academy of Higher Education v Provident Fund Commissioner, Muir Mills Co Ltd Kanpur v Its Workmen, Kichha Sugar Company Limited through General Manager v Tarai Chini Mill Majdoor Union, Uttarakhand; and The Daily Partap v The Regional Provident Fund Commissioner, Punjab, Haryana, Himachal Pradesh and Union Territory, Chandigarh. It applied the principles laid down in the precedents and held that for an allowance to be excluded:

  1. it should be either variable or linked to any incentive for production resulting from greater output by an employee;
  2. it should not be paid across the board to all employees;
  3. it needs to be established that the extra amounts paid to the employees were in fact paid for their extra work.

The Supreme Court did not go into the facts of any of the petitions, but endorsed the factual position ascertained by the PF authority and the appellate authority under the PF act, and held that the allowances in question were essentially part of the basic wage but had been camouflaged as allowances so as to reduce employers’ PF contributions. The Supreme Court dismissed all the appeals filed by the employers and only upheld the appeal filed by the regional provident fund commissioner.

The judgment reaffirms and reiterates the principles and law laid down in earlier judgments, with special emphasis on the half-a-century-old Bridge and Roof judgment. However, the judgment does not widen the ambit of contribution to be made towards PF.

Some employers, in an attempt to justify the exclusion of different allowances, took a skewed interpretation of an 18 March 2014 circular, which stated that contributions under section 6 were not payable on cost to company (CTC). They argued that different allowances paid were not part of the basic wage and that the concept of CTC already stood approved by the Employees’ Provident Fund Organization. Therefore, it was argued that any restructuring of the CTC was not a violation of the PF act, even in instances where the employer’s contribution was borne by the employee, as long as the CTC was not reduced.

This interpretation, when pitted against the express prohibitions and safeguards mentioned in the circular and tested against the touchstone of judicial precedent, falls flat for a few simple reasons: 1) not all components of the CTC can be considered for contribution under the PF act, such as bonus, incentive, etc., which are expressly excluded in the PF act; 2) the circular was only a clarification showing that some components of CTC are not actually paid to an employee, and 3) the employer’s contribution cannot be recovered from an employee.

A significant risk that the RPFC judgment poses to employers is exposure to inquiry by PF authorities for past years when contributions were not paid on allowances, unless the employer is able to establish that the allowances paid were not to all employees and/or fulfilled other conditions for exclusion from contribution laid down in different judgments. Since there is no limitation period in the PF act, the threat of PF authorities seeking to recover contributions from past years looms large. However, it will not be easy for them to raise demands for unreasonably stale claims and there is also the onerous task of identifying the beneficiaries.

Additionally, there would be challenges with the recovery of contributions from employees, especially ex-employees, and huge complexities that could result from reopening of past years accounts, not least corporate tax implications.

Furthermore, the Supreme Court, by overlooking the facts of the cases and dismissing all the challenges made by the employers, has inadvertently directed house rent allowance to be considered for PF contribution. This is not only against the intention of the law, but also runs contrary to earlier decisions and circulars issued by the Employees’ Provident Fund Organization. A review application has already been filed by Surya Roshni, one of the employers, with regards to the inclusion of house rent allowance.

Bottom line

The RPFC judgment needs to be seen as an opportunity for companies to review their existing salary structures and align them with the statutory framework and judicial principles. Innovative allowances designed to sidestep the objectives of the PF act may attract penal action.

While the legislature is mulling the idea of increasing the statutory limit from ₹15,000 (US$215) to ₹21,000 per month, in line with other labour law legislations, such as the Payment of Statutory Bonus Act and the Employees State Insurance Act, it is incumbent that the PF act needs to be followed in both letter and spirit. Ensuring full compliance will protect companies from future business risks, including ballooning liabilities, rising interest and the constant threat of penal consequences. Therefore, the allure of short-term gains should not be entertained.

Amit Wadhwa is head of litigation and Puneet Gupta is head of contract at Max Life Insurance.