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Big Story | Decode your payslip to get more from your salary

Anand Kalyanaraman | Updated on October 04, 2020 Published on October 03, 2020

Pay heed to the components of your salary to make it tax-efficient, especially in tough times like these

It’s been a tough year for many with job losses and pay-cuts. Especially in times like these, every rupee counts — and it will pay to pay closer attention to your payslip.

Understanding the components of the payslip could help you get a better deal from your employer and negotiate better with prospective employers. A tax-efficient pay-package — to the extent possible — will mean more money in your pocket.

The pain of pay-cuts can also be reduced if some pay components are left untouched.

Also, having clarity about the various components and knowing the difference between pay and CTC (cost-to-company) can help you bargain well while applying for new jobs.

Besides, payslips often have to be given when you apply for loans, credit cards or visas. They can also come handy as proof of employment and while filing tax returns. So, here’s decoding the payslip and ways to optimise it.

A payslip essentially comprises cash earnings (incomes) and deductions (cuts). Total earnings minus total deductions is net pay, also known as take-home pay (see sample). The payslip also has some details about the employee (name, department, designation, PAN, etc) and the employer (name, address, etc).

See sample below

 

Earnings

The earnings in a payslip can have many cash components. These include:

Basic Salary: This is a payslip’s basic building block and a key component. Basic salary is the starting point of most payslips, accounting for the chunk — about a quarter or much more — of the total earnings.

It also has an influence on other components. For instance, HRA (House Rent Allowance) that is part of the payslip is usually a percentage (up to 50 per cent at times) of the basic.

Besides, basic has a bearing on benefits that form part of the CTC such as EPF (Employees’ Provident Fund) and gratuity.

For instance, both the employer and employee contribution to the EPF is calculated at 12 per cent of the Basic plus Dearness Allowance (DA).

So, having a healthy basic salary will help. It follows that pay-cuts should ideally not happen through reduction in the basic salary, as this will also hurt other salary components, besides your long-term and retirement benefits.

On the flip side, you do not get tax breaks on basic salary — so, the entire amount is taxable.

Dearness Allowance: Many employers give DA to employees to provide for the rising cost of living. DA is often adjusted periodically, taking into account inflation indices. But employers can pay DA as a fixed amount, too. DA can form a good part — about 10 per cent or more — of the total earnings, and along with the Basic, it, too, has a bearing on CTC components such as EPF and gratuity.

DA is taxable, without tax breaks. Even so, reducing the DA as part of pay-cuts is not advisable since this will impact other benefits, too.

House Rent Allowance: Similar to Basic and DA, HRA is also often a good portion — 10-15 per cent — of the total earnings. But unlike the Basic and DA, HRA is a tax-efficient income for employees who live in a rented house.

The tax break on HRA can be significant (up to 40 - 50 per cent of Basic plus DA) depending on the amount of HRA received, the Basic and DA of the employee, the rent paid, and the location of the rented house (metro or non-metro). There is a tax break even for those who don’t get HRA but pay house rent; this is a smaller amount though.

Reducing HRA as part of pay-cuts may not be a good idea as it could reduce tax breaks. But note that the tax break on HRA is available for those who opt for the old tax regime, not for those who choose the new one. In the old tax regime, tax rates are higher but tax deductions and exemptions are allowed. In the new tax regime, tax rates are lower, but most tax deductions and exemptions are not allowed. Some number-crunching may be needed to make an optimal choice between the two tax regimes .

With work-from-home (WFH) becoming common now due to the pandemic and many employees moving away from rented houses, the impact on HRA tax benefits needs to be assessed.

Leave Travel Allowance (LTA): This tax-efficient allowance is often given to defray travel costs on domestic vacations incurred by the employee and family. It can be paid by the employer annually or monthly. On expenses incurred, a tax break is allowed, but it comes with some strings attached.

Given its tax benefit, it is best not to touch this allowance in case of pay-cuts. The tax break on LTA is allowed only for those who opt for the old tax regime.

Leave encashment: Many employers allow employees to encash a portion, say 15 days, of their unutilised privilege leave (earned leave) every year. This payment will reflect in the payslip when it is made. Such encashment of leave, while in service, is taxable. Leave encashment at retirement, though, gets a tax break under both the old and new tax regimes.

Bonus/Variable pay: The employer may have agreed to pay bonus or variable pay depending on the performance of the employee and also that of the business. As and when such payment is made, in part or in full, it will be reflected as earnings.

This is fully taxable.

Other allowances without tax breaks: There could be many other allowances, too, in the payslip, some without tax breaks. These include:

Medical allowance: This is given to help employees meet regular medical expenditure.

Earlier, medical allowance of up to ₹15,000 a year was tax-exempt on submission of bills.

But this tax break has now been removed and clubbed along with the standard deduction benefit of ₹50,000 a year for salaried employees; the standard deduction benefit, though, is only for those who choose the old tax regime.

Transport allowance: Employers often give their employees transport or conveyance allowance for travel to and fro their residence and office. Earlier, this allowance was tax-exempt up to ₹19,200 a year.

But now, this benefit has been clubbed along with the standard deduction benefit of ₹50,000 a year for salaried employees, again only for those going for the old tax regime.

Vehicle allowance: This allowance is often given to employees to meet vehicle running and operating costs. It could be a good part of the total earnings, depending on the policy of the employer. The allowance is taxable and does not get you any tax breaks.

Personal/Special/Other allowance: Employers may also pay employees through other allowances, by any name — personal (to cover personal expenses), special (to meet special expenses), or just ‘other’ (for general purposes). A chunk of the total earnings could be housed under such allowances that are fully taxable. Pay-cuts, if any, are best effected through reduction of such allowances as these do not get tax -breaks and also do not have a bearing on other parts of the earnings and the CTC.

Other allowances with tax breaks: Then, there could also be allowances on which tax breaks are available. These include:

Children’s education allowance: This allowance could be given to provide for the education cost of the employee’s children. It comes with a tax break that is rather small — ₹100 per month per child for a maximum of two children.

So, if you have two children and get education allowance, your taxable income will reduce by ₹2,400 a year.

Hostel expenditure allowance: This allowance, provided to meet the hostel expenditure of children, is tax-exempt up to ₹300 per month per child for a maximum of two children. So, the taxable income can reduce by a maximum of ₹7,200 a year.

Besides, some special allowances for employees working in specified hilly, border, disturbed and tribal areas and such are tax-exempt to the extent specified by the tax rules.

Also, special allowances given to members of the armed forces for working in challenging areas are tax-exempt to the extent specified by the tax rules. The tax breaks on the above-mentioned special allowances and also children’s education and hostel expenditure allowances are only for those opting for the old tax regime.

In addition to the above, on some allowances, tax-exemption is given under both the old and the new tax regime. These are allowances towards cost of travel on tour or transfer, daily charges incurred on tour or transfer, and conveyance expenditure incurred in performance of duties. Also, transport allowance granted to specified physically challenged employees to commute between residence and place of duty is exempt up to ₹3,200 a month.

The details of these other allowances and related tax breaks are specified in Rule-2BB of the Income Tax Rules. Employees who are eligible for these benefits could check with their employers whether the salary could be structured to include such allowances.

Reimbursements: The payslip could also include reimbursements that employers may provide employees for specified expenses incurred for official purposes — for instance, telephone expense reimbursement.

Such reimbursements are tax-exempt, if allowed by the tax laws. Employees could check with their employers to include such reimbursements as part of the pay package.

That said, not all reimbursements will be tax-exempt. For instance, in the recent WFH scenario, many employers are providing allowance/reimbursements to employees to buy ergonomic furniture and other equipment at home. Tax experts opine that such allowances/reimbursements are not eligible for tax breaks as there is no specific provision in the law, yet.

Perquisites: Besides the above-mentioned cash components, the employer may provide non-cash perquisites (perks) such as concessional accommodation and vehicle for usage. These are not reflected in the payslip, but will form part of the CTC provided by the employer.

The valuation and taxation of such perquisites will be as provided in the tax laws (Rule 3). Among the tax-efficient perquisites are paid food vouchers that are tax-exempt up to ₹50 per meal, but this tax break is only for those in the old tax regime. Also, gift/voucher provided by employer to employee is tax-exempt if its value is below ₹5,000 a year (available under both the old and the new tax regime).

Another tax-efficient perquisite is contribution made by employer to the National Pension Scheme (NPS) account, or other notified pension schemes under Section 80CCD (2). A deduction of up to 10 per cent of salary (Basic plus DA) is allowed on such contributions in both the old and new tax regimes. Having such perquisites as part of your CTC can reduce your tax outgo.

Deductions

Among the key deductions from the total earnings are income tax, employee contribution to the EPF and professional tax.

Income tax: The employer deducts income tax at source (TDS) before paying the salary to the employee. This tax deduction is based on the estimated taxable earnings (including taxable perquisites) of the employee for the year, taking into account planned tax-saving investments. These include deployments/spends under Section 80C (up to ₹1.5 lakh a year), Section 80D (health insurance premium), Section 80CCD (1B) — additional NPS investment of up to ₹50,000 a year — and Section 24 (interest on home loan).

EPF contribution: Both the employee and the employer usually contribute 12 per cent of the Basic plus DA to the EPF on a monthly basis.

The employee’s contribution to the EPF is deducted from the payslip, while the employer’s contribution is shown as part of the CTC.

An employee can contribute over and above the 12 per cent to the EPF account; this is known as VPF (Voluntary Provident Fund) and is also shown as a deduction in the payslip; the employer need not contribute to the VPF.

Professional tax: This tax levied by certain States can be up to a few hundred rupees each month.

Other deductions: Besides the above, there may be some other deductions such as insurance premia, loan instalments and canteen payment, depending on the arrangement between the employer and the employee.

 

Pay versus CTC

There is often confusion about why the net-pay (take-home pay) in the payslip is different from the CTC mentioned in the offer letter. There are many reasons for this.

CTC is the sum your employer spends on you. It includes the sum the company pays you, and more. The take-home pay is often lower than the CTC — the latter has a broader scope and includes benefits such as the employer contribution to the EPF and NPS, perquisites, gratuity, insurance premia paid by the employer and full variable pay.

Besides, CTC is a pre-tax amount while the take-home pay is a post-tax amount.

Negotiate with a prospective employer on the basis of both the CTC your current employer gives you and the pay mentioned in your payslip. Ask for more fixed, and less variable, components. This could help you get more than before.

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Published on October 03, 2020
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