Key Topics Covered:

• International Taxation
• FEMA
• Audit
• Indirect Tax
• Companies Act, 2013
• Labour Laws

This article is contributed by Partners of SBS and Company LLP - Chartered Accountant Company. You can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

In the recent past there has been constant conflict between the employers and the Employees Provident Fund Organisation (EPFO)enforcement authorities on the issue of ‘basic wages’ on which contributions are required to be made. In this paper an attempt is made to collate the information on the subject based on the various judgements of the High Courts and Supreme Court to create a perspective on the subject for future guidance and to initiate corrective measures to avoid possible litigation with the EPFO.

Para 29 of the Employees’ Provident Funds Scheme, 1952 deals with the contributions payable by the employer. In accordance with the said para, the employer shall contribute twelve per cent of the basic wages, dearness allowance (including the cash value of any food concession) and retaining allowance (if any)payable to each employee to whom the Scheme applies.

The EPF&MP Act has defined ‘Basic Wages’ as all emoluments which are earned by an employee while on duty or on leave or on holiday with wages in either case in accordance with the terms of the contract of employment and which are paid or payable in cash to him, but does not include –

• The cash value of any food concession;

• Any dearness allowance ( that is to say, all cash payment by whatever name called 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 payable to the employee in respect of his employment or of work done in such employment;

• Any presents made by the employer.

Most of the new economy establishments are devising a salary structure with Basic Salary, HRA and other allowances without the component of Dearness Allowance and contributions towards provident fund are being paid on the basic salary only on the assumption that all other allowances fall under the exclusion category as per the above definition.

There has been conflict between the employers and EPF Organisation and hence these matters reached various Hon’ble High Courts in the country and some of the matters are pending before the Apex Court for its final verdict. Review of some important judgements are mentioned hereunder to understand the views of the judiciary in the matter.

The Hon’ble Madhya Pradesh High Court Division Bench in the matter of Montage Enterprises Pvt Ltd Vs EPFO, Indore [2011 LLR 867] held that the conveyance allowance and Special Allowance will fall within the definition of ‘Basic Wages’. The rationale taken by the Hon’ble bench is that the Conveyance Allowance and Special Allowance is paid to all non-executive category of employees and it is not a case that some of the employees are not getting the same. It is a settled law that if such wages are paid universally, necessarily and ordinarily to all across the board, the same will fall under the definition of basic wages.

In the year 2005,the Hon’ble Calcutta High Court Division Bench in the matter of RPFC (II), WB Vs.

Vivekanadnda Vidya Mandir [2005 LLR 339] held that contributions are payable on Special Allowance

when it is revised from time to time and the company has not adopted the system of payment of

Dearness Allowance. The detailed view of the court in the matter is as under:

In order to exclude any allowance from the purview of Section 6 which provides for liability to pay contribution based on basic wages, such allowance should fall under Clause (i), (ii) and (iii) of Section 2 (b) which enumerate allowances which are not included in the definition of ‘basic wages’. In the instant case the special allowance paid by the employer was not a retaining allowance, neither cash payment for food concession, nor over time allowance, house rent, bonus, commission, nor a present by employer and it did not satisfy any of the ingredients of Clauses (i) to (iii). Considering that the said allowance was paid in terms of contract of employment and was upwardly revised every 2 years and there is no system of payment of dearness allowance, it was held to be dearness allowance though described differently (Special Allowance) and therefore has to be treated as a part of pay and hence order passed by PF Authority that special allowance was subject to liability of contributions under section 6 of the Act is upheld.

In the year 2004, the Hon’ble High Court of Gujarat in the matter of Gujarat Cypromet Ltd Vs APFC [2004 III CLR 485] also held that the contribution to Provident Fund made on basic wages includes all emoluments earned by the employee and allowances like lunch allowance, medical allowance, conveyance allowance etc., except those which are specifically excluded by the legislature, such as house rent allowance which is clearly excluded from the definition of basic wages by virtue of Section 2(b).

It could be seen from the above the judiciary has interpreted the term ‘basic wages’ to include all allowances which are not specifically excluded. This interpretation has major cost implications to industry.

The establishments have been engaging employees through contractors and agencies to meet the non-core activities of the industry such as Security, House Keeping etc., In addition to this, during the last one decade, the establishments started engaging manpower through outsourcing agencies to meet the work requirements without having long term liability. The number of such employees have increased substantially in the recent past. Most of these employees are paid applicable minimum wages. The outsourcing agencies in general bifurcate the minimum wages as basic wages, house rent allowance and conveyance allowance etc.,

The E P F authorities have come to the view that the employers are bifurcating the minimum wages with a view to avoid payment of provident fund contributions and this led to litigation across India. The Hon’ble High Court of Andhra Pradesh issued a stay order on the circular issued by the PF Department on this issue. The Division Bench of Punjab & Haryana held that the definition of wages under Minimum Wages Act is inapplicable to that of basic wages under EPF Act.

The decisions of the Hon’ble High Courts, which are discussed above and similar other matters are pending before the Hon’ble Supreme Court of India for disposal. We have to await the decision of the Apex Court on these matters.

The courts have also held that certain category of payments does not fall under the ambit of basic wages and does not attract provident fund contributions. They are:-

The Supreme Court held that the Production Bonus / Incentive when paid in a sliding scale with due regard to the production made by each workman then no contribution is payable. Similarly if the production bonus is paid on an average to all workmen on the basis of extra production made by them, then also, no contribution need be paid. [Daily Pratap Vs RPFC 1999 I LLJ 1]

The Madras, Delhi and Gujarat High Courts held in various matters that the ad-hoc allowance and ad-hoc payments made to employees does not form part of ‘basic wages’ and hence no contributions are payable.

The Hon’ble High Court of Bombay held that payment made in lieu of notice for terminating the contract of employment of a permanent employee does not constitute ‘basic wages’ and hence no contributions are payable. The Gujarat High Court in the matter of Swastik Textile Engineers Vs V M Rathod [2008 II LLJ 533] held that the back wages awarded by Court cannot be regarded as ‘basic wages’ payable to the employee and it is in the form of damages or compensation and hence provident fund contributions are not required to be paid.

The Supreme Court held that Leave Encashment should not be taken as part of ‘basic wages’ and hence no provident fund contributions are payable.

The Hon’ble High Court of Madras in the matter of Wipro Ltd Vs PO Employees PFAT [[2007 LLR 624] held that the canteen subsidy is not equivalent to cash value of food concession and hence provident fund contributions are not payable on canteen subsidy.

With effect from 1.9.2014, employees drawing basic wages, dearness allowance and retaining allowance of Rs. 15,000/- or below are liable to be covered under the provident fund scheme. Once covered employee will continue to get covered even though his wages exceed Rs. 15,000/- per month. The Supreme Court in the matter of Marathwada Gramin Bank Karamchari Sanghatana Vs Management of Bank [2011 LLR 1130] held that employers need not pay provident fund contributions higher than the prescribed limited under the Act and Scheme that is now Rs. 15,000/-.

Most of the new generation organisations are following the concept of cost to the company of the employee and the compensation package is decided on annualised basis. As the organisations are deciding the cost to the company, it has all the freedom to bifurcate the mutually agreed compensation package. Say for example the annual CTC is Rs. 2.90 Lacs, the monthly wages can be defined as Basic: Rs. 15,000/-, HRA 40% of the Basic Salary ie Rs. 6000/- and the employer Provident Fund contribution as Rs. 1800/-. Thus the monthly cost to the company is Rs. 22,800/- and annual cost is Rs. 2, 73, 600/-. In view of the recent amendment to the Payment of Bonus Act, the employee with basic wages of Rs. 15,000/-will also be covered under the Act. Hence the employee will be entitled to at least 8.33% of the basic wages earned in the financial year which translates to one month basic wage of Rs. 15,000/-. Thus the annual cost to the company will be Rs. 2, 88, 600/-.

When the CTC offered to an employee is higher than the Rs. 2.9 lacs per annum, other allowances such as conveyance allowance, medical reimbursement etc., may be introduced.

In case of employees whose monthly wages are minimum wages, it would be advisable to bifurcate the minimum wage as basic wages and house rent allowance only. For example if the minimum wage is Rs. 10,010/- per month the same may be bifurcated as Rs. 7150/- as basic wage and 40 percent of basic wage as HRA ie Rs. 2860/-. The cost to the company per annum would be Rs. 1, 43, 272/- which includes statutory minimum bonus of 8.33%, 12% of PF and 4.75% of ESI contributions.

If the monthly wages are above minimum wage and below Rs. 22,800/- per month, that is the annual cost to the company is between Rs.1.45 lacs and Rs. 2.9 lacs, the applicable minimum may be taken as basic and the balance wage be bifurcated as HRA, Conveyance Allowance, Washing Allowance and Medical Reimbursement etc.,

In the above mentioned cost to the company, the liability that may arise on account of Payment of Gratuity Act is not included.

Of late the highly reputed and law abiding employers are also finding it difficult to convince the provident fund enforcement authorities the method followed by them in finalising the compensation package of the employees during the 7A proceedings and the matters are going against them. This has led to large scale litigation in the Tribunal and also depositing a part of the amount determined in the 7 A proceedings by the Qasi Judicial Authority by the company. The cost of litigation has also become substantial besides monitoring the maters under litigation which may become major liability on the company at a later date.

In view of the above analysis, it is suggested that organisations may consider to restructure the salaries of the employees, as suggested above, to ensure litigation free statutory compliance under Provident Fund Act, Payment of Bonus Act and the Minimum Wages Act.

Introduction:

Section 66B provides for levy of service tax on services provided or agreed to be provided. On the other hand, we have Rule 5 of the Point of Taxation Rules, 2011(POT Rules) which can extend its arms to tax even those services which are provided prior to effective date of levy but the amount is received afterwards. Swacch Bharat Cess (SBC) and Krishi Kalyan Cess(KKC) are two levies that are newly introduced in recent past. A lot of confusion is prevailing in the trade whether Rule 5 can extend its arms to tax services already provided. Recently a notification is issued to exempt KKC for all services provided and invoices issued on or before 31st May, 2016.Is it required to really exempt these services by Notification? What is the rationale in extending this exemption only for KKC and not so when SBC is introduced? In this backdrop, an attempt is made to really under the nature of levy under section 66B and validity of Rule 5 in light the said section.

Rule 5 of the POT Rules and its ramifications on literal interpretation:

Rule 5 of the POT Rules is reproduced as under;

“Where a service is taxed for the first time, then,-

• no tax shall be payable to the extent the invoice has been issued and the payment received against such invoice before such service became taxable;

• no tax shall be payable if the payment has been received before the service becomes taxable and invoice has been issued within fourteen days of the date when the service is taxed for the first time.

Explanation 1.- This rule shall apply mutatis mutandis in case of new levy on services.

Explanation 2.- New levy or tax shall be payable on all the cases other than specified above (inserted recently with effect from 01.03.2016)”

In terms of the above rule read with newly inserted explanation 2, new levy is applicable except in the two circumstances stated therein i.e.

1. invoice issued and payment received before the effective date of new levy and

1. Payment is received before the effective date of new levy and invoice is issued within 15 days after the levy became effective.

Let us consider the impact of this rule assuming a new levy is effective from 01st June, 2016 with the following examples;

2016. The service is completed by May 15th, 2016 and invoice is issued on June 01st 2016. Payment for the service is received on June 20th, 2016. In terms of Rule 5,new levy is applicable as payment and invoice are after the effective date of new levy.

2016. Advance received in the month of May 15th and invoice raised immediately on the same date. But service provision is started on 15th of June, 2016 and completed by 30th of June 2016. As first condition is satisfied, new levy is not applicable though the service is provided after the levy coming into force.

• Service is provided in December 2015 and invoice is raised in the same month. Payment is received on 16th June 2016. The service is provided and invoice issued at the time when the levy of service tax is never contemplated. On plain reading of Rule 5, as payment is not yet received, it can be interpreted that new levy is applicable on all outstanding debtors as on 31st May, 2016 which gets realized on or after 01.06.2016.

It is because of this reason, notification 35/2016-ST dated 23.06.2016 is issued to exempt from KKC all the services which are provided on or before 31.05.2016 and invoice is issued to that extent. But the whole issue raises the following questions;

1. What would be the position for cases, where invoices are not yet issued but services are provided before 31.05.2016?

2. Is it really required to exempt KKC by a notification on services provided upto 31.05.2016 i.e. services provided before the effective date of levy?

3. How logical/prudent it is in not demanding anytax on services provided after the effective date of levy just because payment is received in advance before the effective date of levy?

4. What would be the position in case of SBC which is introduced with effect from 15.11.2015?

In order to find solutions to the above posers, it is pertinent to understand the moot question i.e. what is the taxable event under Finance Act, 1994 to attract service tax?

Understanding Taxable Event under Finance Act, 1994:

Every taxing statute contains a section which provides for event upon satisfaction of which the respective tax becomes payable by authority of law. This is popularly called charging section and the event is said to be taxable event. The taxable event for excise duty is manufacture of goods and for VAT, it is sale of goods.

Thus in a case where taxable event is not satisfied or the charging section (Law) is not in force at the time when the taxable event occurred, then no tax is leviable as per the said taxing statute. In this regard, let us now examine the charging section under Finance Act, 1994. Under erstwhile positive based taxation, the charging section is section 65(105) of the Finance Act, 1994 and under the present negative list based taxation regime, it is section 66B. The same are reproduced as under;

On plain reading of the above two charging sections under Finance Act, 1994, both the sections are using more or less similar phrase ‘provided or agreed to be provided’ and ‘provided or to be provided’. Even upon strict interpretation of provisions, there is no difference between the two. Thus the judicial precedents on new levy of service tax under erstwhile regime can also be considered for determining the chargeable event under the current regime.

Coming to interpretation of charging section, there are two phrases in the charging section. One is ‘provided’ and the other one is ‘to be provided’ or ‘agreed to be provided’. The first phrase ‘service is provided’ which means that provision of service is completed. The second phrase ‘to be provided’ is added in levy section after the words ‘provided’ during the Finance Budget, 2005. It has been then clarified that the objective of the amendment is to collect service tax on the advances received for the services to be provided in future.

Though the charging section is amended to tax the advances received immediately without waiting for the services to be completed, it is just a conditional collection of tax amount and in case where service provider failed to provide the service, the same is required to be returned. Without the service being provided, question of collection of service tax do not arise. This legislative intent is clearly evident from provisions of Rule 6(3) of the Service Tax Rules, 2004 as reproduced below;

“Where an assessee has issued an invoice, or received any payment, against a service to be provided which is not so provided by him either wholly or partially for any reason, or where the amount of invoice is renegotiated due to deficient provision of service, or any terms contained in a contract, the assessee may take the credit of such excess service tax paid by him, if the assessee.-

• has refunded the payment or part thereof, so received for the service provided to the person from whom it was received; or

• has issued a credit note for the value of the service not so provided to the person to whom such an invoice had been issued”

In view of the above rule, assesse is entitled to take credit of service tax amount paid on advances received if the service is not provided either wholly or partly. In case where it is not practicable for him to take credit of service tax and adjust against future liabilities, he can claim refund also. The principle that when no service is provided eventually, Government is not entitled to retain service tax paid on advance receipts has been upheld by Mumbai tribunal in the case of Datamatics Software P Ltd vs. CST, 2014-35-CESTAT-Mum.

Thus upon plain reading of charging section and other provisions of Finance Act, 1994 and the rules made thereunder, it is very clear that the taxable event is the provision of service. Though service tax is collected by Government immediately upon receipt of advance, it is only a conditional collection. Only upon completion of service, the levy gets crystalised thereby Government gets the right to unconditionally retain such service tax. The question of taxable event and the issue relating to liability to pay service tax in case of new levy are considered in various judicial forums. Some of them are reproduced hereunder;

1. In the case of Association of Leasing & Financial Service Companies vs. UOI, 2010(20)S.T.R417(SC) wherein it was held by Supreme Court that the taxable event for service tax is the rendition of service.

2003. In the case of CCE vs. Krishna Coaching Institute, 2009(014)STR0018(Tri-Del) wherein payments were received in advance for the services yet to be rendered. Service tax levy was in force at the time when service is rendered. it was held “The respondent has no vested right to collect in advance the fees for conducting the training programme to be conducted after 1-7-2003. The main obligation to pay tax arises out of Finance Act, 2003 and the service has been brought into tax nets by Notification No. 7/2003-S.T. dated 20-6-03 with effect from 1-7-03. This main obligation cannot be altered by subsidiary obligation like taking registration as an assessee, issuing invoices, filing returns etc. Even if the amount is collected in advance, it is not impracticable to raise an invoice indicating the service charges (noting that the amount already stands paid) and indicating service tax payable.”

1. In the case of British Airways PLC vs. CST, 2013(29)STR177(Tri-Del) wherein the appellant contended that as levy was not in force at the time when tickets are sold, service tax payment do not arise though services are provided after the levy i.e. 01.05.2016. It was held that—“the levy of Service Tax has no connection with the receipt of payment and the service tax is required to be paid when the service is provided. Since all tickets though sold prior to 1-5-2006 journey was undertaken on and after 1-5-2006 and at the time of journey undertaken the levy of service tax on the amount of taxable service was in force and, therefore, the appellant is liable to pay the service tax on the air tickets sold by them prior to 1-5-2006 also.”

In view of the above analysis, in the opinion of paper writer the taxable event under Section 66B or Section 65(105) is the rendition of service. At the time when service is provided, if the levy is in force, service tax gets attracted. It is not relevant whether or not money is received before or after the levy is in force. The said principle is in complete contrast to Rule 5 of POT Rules which provides that levy is applicable and tax is payable in all cases except in cases where amounts for the services are received prior to the effective date of levy. No importance is given to rendition of service.

Is Rule 5 a case of excess utilisation of delegation power?

Point of Taxation Rules, 2011 is introduced with effect from 01.04.2011 with two fold purpose i.e. to determine the time when service tax is required to be paid as provided under Rule 6(1) of the Service Tax Rules, 1994 and also to provide for the rate at which such service tax is to be paid as provided under sub-section 2 of section 67A of Finance Act, 1994.

Thus the power extended to Central Government to frame the rules is to achieve the above stated objectives and not to make the levy applicable to services provided much before the charging section is introduced or to exempt services for which payment is made before levy but services are provided after the levy. Further no such express power is conferred in terms of section 94 of Finance Act, 1994 which provides the rule making power to Central Government. Thus in the opinion of paper writer Rule 5 of the POT Rules is clearly traversing the charging section and is excess utilisation of its delegated power under the guising prescribing the time when service tax is to be paid.

Conclusion:

Before parting, it is very clear from the fact of issuance of notification to exempt KKC that the rule is having a direct conflict with the charging section. Otherwise there is no reason to exempt them from KKC. Similar exemption is not provided with SBC is introduced. It seems that Government has identified the flaw but wanted to give just a temporary solution to the problem without thinking of amending or withdrawing the Rule 5. Further certain assesses who receives advances before the levy is introduced but services are provided subsequently would get unjust advantage as they need not have to pay service tax by virtue of Rule 5. Thus arbitrary and indifferent treatment prevails amongst the service providers and continues every time when a new levy is introduced. Let us hope that sooner or later the age-old canon(taxable event is rendition of service) is endured clearing the paradox on applicability of service tax in case of new levy.