Organizations pay salaries to their employees in exchange of the services obtained. These salaries often have different components, such as basic salary, allowances, perquisites, etc. It is important to understand how salaries are structured and the various methodologies associated with it while processing payroll.
A salary structure is the basic framework to work out the compensation plan of an employee. While structuring salaries is a crucial task for human resource (HR) and payroll personnel, many aren’t adept with the technical expertise required to create a salary structure with strong fundamentals. We thought of addressing the gap by curating a detailed guide on how to structure a salary in India.
Salary structure in India: Key terms
A salary structure aims to lay out the anatomy of the salary being offered in terms of the different components constituting the compensation plan. From the employee’s perspective, it is imperative to have basic knowledge of the different components of their salary to plan their finances with an aim to maximize their claims on the various tax exemptions available to them.
Let us understand a few important terms before proceeding further.
This is the salary that you get in your hands and is also called the ‘in-hand’ salary. This is the amount you get (or pay) after deduction, such as Provident Fund (PF), Employee State Insurance (ESI), Professional Tax (PT), Tax Deducted at Source (TDS), loss of pay and other deductions, as applicable by the company.
This is the total earning of an employee, excluding statutory and non-statutory deductions. It also includes loss of pay based on employee’s attendance.
CTC or cost-to-company is the total monetary benefit provided by the employer for the complete financial year. This will include components, such as the PF contribution from the employer, gratuity provision, any insurance that is being provided, or any other benefits.
Fixed pay and variable pay
Fixed pay is the fixed amount of money paid by an employer to its employees in exchange for services rendered by them, in the form of a fixed salary. Fixed pay is the accrual salary mentioned in the salary slip with basic and multiple allowances. It is the fixed amount received every month by the employees.
Sometimes, a salary structure of an employee has both fixed and variable elements. The variables and incentives might or might not be credited every month, depending on the company’s policy. Fixed pay includes basic pay, dearness allowance (DA), house rent allowance (HRA), conveyance allowance, and other special allowances, etc.
A good example of variable pay is the portion of compensation determined by an employee’s performance. When employees meet their revenue targets, variable pay is provided as an additional incentive, or commission. Variable pay is often based on two major factors: employee’s performance and company’s performance. So, most of such schemes designed by companies tie their variable components to targets and the actual pay-out is based on that combination.
Some common components of a salary structure
Basic salary is the base income of an employee, comprising of approximately 50 percent of the CTC. It is a fixed amount that is paid prior to any reductions or increases due to bonus, overtime, or allowances. Basic salary is determined based on the designation of the employee and the industry in which they are working in. Most of the other components, like allowances, are based on the basic salary. This amount is fully taxable.
Allowance is an amount payable to employees during their regular employment. It can be partially or fully taxable, depending upon the type of allowance. The allowances provided and their respective limits will differ from one company to another, as per their respective policies.
Types of allowances
1) Dearness allowance (DA): Dearness allowance is a certain percentage of the basic salary paid to employees, aimed at mitigating the impact of inflation. It is paid by the government to employees of the public sector and pensioners of the same. Dearness allowance is fully taxable whether it is “in terms” or “not in terms”.
Note: DA in terms means DA that constitutes a part of the retirement benefit calculation.
2) House rent allowance (HRA): House rent allowance is paid to employees to meet their monthly rental expenses for housing/ accommodation. It offers tax benefits to employees for the sum that they pay towards their housing/ accommodation every year. Salaried individuals residing in rented homes can claim this exemption and reduce their tax liability either fully or partially. If an employee doesn’t live in a rented accommodation, this allowance is fully taxable.
Least of the following amount will be exempt u/s 10(13A):
- 40%/50%* of basic salary and dearness allowance (DA)
- Actual amount received
- Rent paid – 10 percent of basic salary and dearness allowance (DA)
Note: Tax exemption of house rent allowance is not available in case you opt for the new tax regime from FY 2020-21 (AY 2021-22).
3) Conveyance allowance: Conveyance allowance, also known as transportation allowance, is an incentive offered to employees to compensate for their travel expenses to and from their residence and workplace.
Note: In the Union Budget 2018, a standard deduction of INR. 40,000 (currently INR 50,000) was introduced in lieu of transport (INR 19,200) and medical (INR 15,000) allowances.
4) Leave travel allowance (LTA): Leave travel allowance is eligible for tax exemption. It is offered to employees to cover their travel expense when the travel occurs during a leave of absence from work. The amount paid as leave travel allowance is exempted from tax only on the actual travel costs under Section 10(5) of Income Tax Act, 1961. Leave travel allowance only covers domestic travel and the mode of travel needs to be air, railway, or public transport. The exemption is also limited to LTA provided by the employer.
5) Medical allowance: Medical allowance is a fixed allowance paid to the employees of an organization to meet their medical expenditure.
Note: In Union Budget 2018, a standard deduction of INR. 40,000 (Currently it is INR 50,000) has been introduced in lieu of transport (INR 19,200) and medical (INR 15,000) allowances.
6) Books and periodicals allowance: Books and periodicals allowance is a type of allowance provided to employees for helping them meet the expenses associated with the purchase of books, periodicals, and newspapers. It is exempted from tax to the extent of actual expenditure incurred towards purchases of books and periodicals.
Perquisites, also referred to as fringe benefits, are the benefits that some employees enjoy because of their official position. These are generally non-cash benefits given in addition to the cash salary. Some examples of perquisites include provision of car for personal use, rent-free accommodation, payment of premium on personal accident policy, etc. The monetary value of perquisites gets added to the salary and tax is paid on them by the employee.
Bonus is a type of compensation an employer gives to an employee that complements their base pay or salary. A company may use bonuses to reward achievements, to show gratitude to employees who meet longevity milestones, or to entice prospective employees to join a company’s ranks. Bonus received by an employee is chargeable to tax in the year of receipt.
Gratuity is a lump sum benefit paid by employers to employees who are retiring from the organization. This is only payable to employees who have completed five or more years with the company. The gratuity amount is paid in gratitude for the services rendered by the individual during the period of employment. Most firms with a workforce of 10 or more employees fall under the purview of the Indian Law.
Gratuity received during the employment is fully taxable whereas gratuity received at the time of retirement is exempted u/s 10(10) in the following cases:
For government employees: Amount of gratuity is fully exempted
For non-government employees: For private sector employees covered under the Payment of Gratuity Act, 1972, the exempted amount will be the lowest amongst the following:
- 15/26 x salary per month x number of completed years of service
- Actual amount received
- Maximum INR 2 million
For employees not covered under Payment of Gratuity Act, 1972, the exempted amount will be the lowest among the following:
- 1/2 x average salary per month x number of completed years of service
- Actual amount received
- Maximum INR 2 million
Professional tax is a tax levied on the income earned by salaried employees and professionals, including chartered accountants, doctors, and lawyers, etc. to the state government. Different states have varying methods of calculating professional tax. The maximum amount that is payable in a year is INR 2,500. Employers deduct professional tax at prescribed rates, from the salary paid to employees, and pay it on their behalf to the State Government. The revenue collected is used towards the Employment Guarantee Scheme and the Employment Guarantee Fund.
If a company has 10 or more employees (20 in case of Maharashtra and Chandigarh) whose gross salary is below INR 21,000 per month, then the employer is required to avail ESIC scheme for such employees. The employer’s contribution will be 4.75 percent of gross salary, whereas the employee’s contribution will be 1.75 percent of gross salary.
This article has been produced in collaboration with Dezan Shira & Associates, a professional services advisory firm. Dezan Shira & Associates’ India offices can help foreign invested companies focus on their core strategic goals by obtaining better benefits for their employees, implementing stress-free payroll, and granting administrative relief.
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ponents, types of allowances, and their taxable scope.