Why it is beneficial to change CTC structure with the changes in tax laws?
Both the employer as well as the employee can save money by rejigging the salary.
There have been many changes in the tax laws in recent years. However, most taxpayers as well as employers are working with the same mindset and an archaic CTC structure. In this new section, CA Sudhir Kaushik, our Co-Founder & CFO, will analyse the tax changes in the salary components and suggest ways to restructure CTC to optimize employee’s tax outgo and improve employee retention for companies.
Every employer wants to retain good employees to save money, time and effort but also wants to keep costs under control. Similarly, every employee wants a higher take home pay and lower tax outgo. Often, these two expectations are at odds with each other. However, if the CTC structure is made more tax efficient and flexible, it can be a win-win situation for both parties.
Indians are paying too much in tax, and not because our tax rate is high. Compared to other countries, the tax rate in India is quite reasonable. In fact, some deft investment planning can reduce the tax on an annual income of Rs 10 lakh to barely Rs 35,000. Yet, a lot of Indians end up paying a much higher tax rate. Tax filing data from last year shows that the average taxpayer doles out 30-35% more in tax compared to a taxpayer who has optimized his liability.
Employee’s retention can be increased by including the long-term incentives in the compensation structure. These components not only provide tax efficiency i.e. more money to employees but also make their financial life better by helping them in achieving long term goals systematically. These tax efficient components include provident fund, gratuity, leave encashment, superannuation, stock options and the latest one is NPS which is less availed so far. In next few paragraphs we bring more clarity and reason to change the CTC structure as per tax laws and include NPS. Specially, after tax changes in budget 2016, which has increased the tax benefit further.
National Pension Scheme: In 2012, the government allowed employers’ contributions to the NPS to be deducted as a business expense. These would be voluntary contributions and not be included under Section 80C. Till then, only the contribution towards a recognised provident fund, approved superannuation fund or gratuity fund was allowed as a business expense. It is the employer who needs to deposit the amount on employee behalf. For this, the company has to include the NPS benefit in its emolument package. Despite the enormous tax-saving potential of the provision, very few corporate houses have offered the benefit to their employees. There is little awareness about this clause. Not many people believe that their employees can save more tax through this avenue.
NPS is a voluntary, defined contribution retirement savings scheme. It is an attempt towards finding a sustainable solution to the problem of providing adequate retirement income to every citizen of India. The corporate houses are contemplating the inclusion of Section 80CCD(2) investment in its pay structure.
Increases income by 3% of basic salary: If your company does not offer employees this benefit yet, it’s time to think for it in forthcoming appraisal. In the highest 30% tax bracket, it will enhance your increment by 3% of your basic salary. The employer needs to rejig the salary structure by reducing any of the fully taxable emoluments (special allowance) and adding this new head in total CTC. So, if basic annual salary is Rs 8 lakh, employer will be contribute up to Rs 80,000 in NPS thus tax saving of Rs 24000/- i.e. 3% of basic salary.
Flexible– NPS offers a range of investment options and choice of Pension Fund Manager (PFMs) for planning the growth of your investments in a reasonable manner and see your money grow. Individuals can switch over from one investment option to another or from one fund manager to another subject, of course, to certain regulatory restrictions. The returns are market-linked and definitely higher than those offered by the fully debt oriented EPF.
Simple – Opening an account with NPS account is very simple. Every investor gets a Permanent Retirement Account Number (PRAN), which is a unique number and remains with the subscriber throughout his lifetime. The scheme is structured into two tiers:
Tier-I account: This is the non-withdrawable permanent retirement account into which the accumulations are deposited and invested as per the option of the subscriber.
Tier-II account: This is a voluntary withdrawable account which is allowed only when there is an active Tier I account in the name of the subscriber.
Tax Treatment before retirement:
The tax benefits under Section 80CCD(2) are available only on investments in tier-I account and open to anyone between 18 and 55 years.
Employer contributing to the NPS on behalf of an employee will get deduction from his income (i.e. employer’s income) an amount equivalent to the amount contributed or 10% of BASIC SALARY + DA of the employee, whichever is less. (Section 36 (1) (iv a) of the Income Tax Act 1961).
Employer’s contribution to NPS on behalf of the employee is treated as perquisite in the hands of the employees, but is deductible u/s80CCD(2) of the Income tax Act,1961 to the extent of 10% of basic salary. This deduction is over and above the limit of Rs.1 lakh u/s 80C of the Income tax Act,1961. This will lessen the tax burden of the employee to the extent of amount deductible u/s80CCD(2) of the Income tax Act,1961.
Tax treatment on the retirement age
NPS is currently subject to Exempt Exempt Tax (EET) tax structure. Once employee completes the 60 years of age, he has to compulsorily purchase an annuity for an amount equal to minimum of 40% of the accumulated balance in NPS account. The investor can withdraw the balance 60% of the corpus but the amount will be taxable. However, Budget 2016 has proposed that up to 40% of the total corpus be made tax free on withdrawal. Only 20% will be subject to tax. Any withdrawal before 60 years requires the utilisation of 80% of the corpus for purchasing annuity.
Tax treatment on the death
Any amount received by the nominee, on the death of the employee at the time of closure of account under National Pension System referred to in section 80CCD of the Income-tax Act is proposed to be exempt
A safe retirement fund: Introduced by the Government of India and regulated by the Pension Fund Regulatory & Development Authority (PFRDA).
Dual benefit of Low Cost and Power of compounding – The account maintenance costs under NPS are the lowest as compared to similar pension products. Over 35-40 years, the lower charges allows more funds for compounding.
Flexible in contribution: NPS offers flexibility in contribution as mentioned below
1) Equal contribution from Corporate and Employee
2) Un – equal contribution from Corporate and Employee
3) Contribution either from Corporate or from Employee
Flexible in investment:
Employees also have control on the choice of investment made and the fund manager who manages the investments. Subscribers can switch over from one investment option to another or from one fund manager to another subject, of course, to certain regulatory restrictions. There are three asset choices within a NPS:
- Asset Class E: Equity
- Asset Class C: Corporate Debt
- Asset Class G: Government Debt
You can choose to invest your entire pension wealth in C or G asset classes and upto a maximum of 50% in equity (Asset class E).. There is one automated option as well based on the age.
Portable- NPS provides seamless portability across jobs and across locations,
Flexibilities to corporate: NPS can be roll out for all on voluntary basis / for select group of employees. Corporate can select a Pension Fund Manager, Asset Allocation and Investment option on behalf of employees, Corporate can fix the percentage / frequency of contribution.
How to start NPS? In order to offer NPS to its employee corporate needs to register itself through a POP by submitting Corporate Registration Form and KYC documents as prescribed by the regulator. POP sends these documents to CRA which creates a Corporate Registration Number called CHO / CBO number.
Upon receiving the CHO / CBO number, Corporate can implement NPS in the system. POP helps create awareness about NPS to all the employees and organize NPS helpdesks where employees can deposit individual NPS registration form and KYC documents for NPS account opening.
Once the NPS account of employee is opened, Corporate can start deducting the contribution from monthly salary of the employee and sends the same to POP for further processing.
(As published in monthly newsletter of Allsec Technologies ‘Allsec SmartConnect’, May 2016 issue.)