Are you sure your salary package is tax efficient?

By Vineet Agarwal

The charm of earning high salaries gets overshadowed when an employee realizes the tax outflow. It may be a good idea to look at the salary components and discuss it with the employer in order to make the salary more tax efficient. The salary package (also known as CTC or cost to company) is generally divided into 4 parts:

Basic salary

Allowances

Perquisites

Retirement benefits

The Income-tax Act, 1961 (‘IT Act’) provides for taxability of the components, and companies adapt a compensation structure basis the tax benefits, cash flows and other HR considerations. This article discusses the taxability of various allowances, perquisites and retirement benefits, which are part of the salary package.

Allowances : Allowances are a fixed amount paid on a monthly basis. It generally comprises of House Rent Allowance (HRA), Conveyance Allowance, Education Allowance, etc.

HRA: Most employees take a house on rent and it is generally a good option to avail of HRA as part of the package. The IT Act provides for an exemption for least of the following i.e. (1) 50 percent of salary if residence is in a metro and 40 percent otherwise (2) the actual HRA received or (3) the excess of rent paid over 10 percent of salary. Basis the above, at times, the entire amount of HRA may be claimed as tax-exempt.

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Leave Travel Allowance : Leave travel concession is provided by the employer to meet employees’ travel costs on vacation. The IT Act provides for an exemption to the extent of ticket cost actually incurred by the employee and the dependent family members, subject to certain conditions.

Other tax exempt allowances : The IT Act provides for few other allowances, which are fully exempt from tax viz., Transport allowance up to Rs. 9,600 pa for commute between one’s residence and office; Children’s education allowance up to Rs.1,200 pa per child, for a maximum of two children and Hostel expenditure allowance of Rs. 3,600 pa per child, for a maximum of two children. Though these allowances are nominal, any tax saving would surely be a welcome addition to the income.

[caption id=“attachment_484126” align=“alignleft” width=“380”]  Like in case of allowances, there are certain benefits, which have a perquisites value prescribed under the IT Act or are considered as non-taxable benefits.[/caption]

Perquisites : or benefits provided by the company usually have a concessional tax cost associated with it.

Car and driver: Many companies provide a car and driver to those employees who are required to travel extensively. Under this facility, the repair, running and maintenance costs of the car are also met by the employer. The taxable value attributable to the personal use of a car is Rs. 28,800 pa, where the cubic capacity of the car exceeds 1.6 liters and at Rs. 21,600 pa otherwise. The perquisite value of a driver is Rs. 10,800 pa. This can be a good tax saving tool.

Medical reimbursement : Medical reimbursement up to Rs. 15,000 pa for medical expenditure on self and dependent family members is exempt from tax. This could include doctor’s fees, cost of medicines, medical tests, etc.

Other benefits: Like in case of allowances, there are certain benefits, which have a perquisites value prescribed under the IT Act or are considered as non-taxable benefits. Ex. health club facilities, sports facilities provided to employees, corporate membership fees. The value of any gift voucher, if less than Rs. 5,000 pa, is also considered exempt from tax.

Retirement benefits

Provident fund (PF): An employee contributes 12% of basic salary and the employer makes a matching contribution. The main tax advantage in case of PF contribution is that the employer contribution is considered tax exempt and the interest earned on the employee and employer contribution is also tax exempt, subject to certain conditions. The employee’s contribution is eligible for deduction under section 80C of the IT Act up to Rs.1,00,000.

Superannuation contribution : Some employers make annual contributions towards superannuation funds for their employees. Depending on the terms of the policy, the employees could be eligible for an annuity or a lump sum payment on retirement.

Gratuity : The IT Act provides a tax exemption of Rs. 10 lakhs on gratuity received, subject to certain conditions. Hence, it is good if employers contribute to gratuity regularly.

Point of caution: There is still uncertainly on whether the Direct taxes code will come into effect from April 2013 or later. The DTC will have an impact on the salary components, which would need to be analyzed carefully. Additionally, the above list is only illustrative and other components can also be explored.

To sum up: A combination of the above allowances, perquisites, retirement benefits put together, determines the tax outflow on your salary. It will be a good idea to have a re-look on the compensation structure and see if any benefits can be availed. After all, every penny saved, is a penny earned!

[caption id=“attachment_484123” align=“alignleft” width=“200”]  Vineet Agarwal[/caption]

The author is a Director in KPMG. The views expressed are personal.