One could take an ideological (or rather Historical!!!) standpoint on the matter. Basic pay is a measure of how much the person’s skills are worth in the market. But then again, this is an idea which has outlived it’s time for reasons beyond my understanding. In the current market scenario, where employees decide to switch careers based on a few thousand rupees, Basic Pay will not count for much. Frankly, how many of us find ourselves taking pride at how high our Basic Pay is?
I will take a shot at explaining the process of structuring pay in an organisation. I will assume that there is adequate knowledge of existing compensation levels. So you know how much Mr Ganesh is being paid. You also know how (the compensation structure!) he is being paid?
If the company is in the process of carrying out a compensation review, it would be ideal to decide the strategic market positioning initially. This would give you a fair idea of how much Mr. Ganesh is to be paid.
Tax Saving Components
The Indian government has given the C&B Manager a slew of compensation components to choose from with regards to compensation structure. More popular among these being Telephone Expenses, Medicals, Conveyance, LTA, etc
The first step would be add to the potpourri all components for maximum tax saving. Most of them would have an upper limit, which is exempt from tax. More than this and the employer/employee would be liable to pay tax, IT or FBT.
There are certain components which are calculated as a percentage of the Basic Pay, as per existing legal statutes. These would include the House Rent Allowance, Provident Fund and Gratuity. The next step thus, would be to fix the Basic Pay.
Now things get interesting. Say we fix the basic at about 40% of Cash to Company. Atleast everyone in the industry seems to. Time to take a different path.
Why can’t the basic be lower?
Lesser the Basic, Lesser the HRA. Lesser the HRA, Lesser the tax savings. Again, this being contingent on the actual rent being paid by the employee. For the purpose of this discussion, we will assume that the employee utilizes his full HRA.
Why can’t the basic be as high as possible then?
More the Basic, More the Retirals. More savings, but also a smaller pay cheque. It is possible for an employee to increase the statutory 12% contribution to the Provident Fund. In which case he would greatly reduce the taxable salary and increase his savings. It must be highlighted here, that the basic impacts both tax and savings. But the savings would take the spotlight, for the simple fact that the employee has freedom to increase his contribution to PF. Now if I were a newbie into the industry, I really would like a fat pay cheque at the end of the month. I would not be thinking about retirement now.
The employee exercises a lot of freedom regarding his PF contribution. He is allowed by law to apportion a larger percentage of his CTC to PF, though the company is not bound to match the employee’s contribution. Hence, an HR consultant has another reason to lower the Basic.
An employee is eligible for gratuity only on completion of 5 years in his company. Again considering the amount of employee turnover witnessed by companies these days. This component becomes almost ineffectual.
So now, we have two balancing forces. In comes a third player, Special Allowance. Special Allowance is usually the balancing figure in the CTC. It plays the role of rounding out the final CTC. Apart from Basic, Special Allowance is the only taxable amount. The consultant then faces the dilemma of structuring compensation based on future savings for the employee. In which case, he would increase the Basic.
Coming back to the Rent
Now we have more arguments in favour of lowering the Basic. The only factor coming in the way of relegating the Basic to a measly 2% of CTC would be the HRA. The Basic should be high enough to just accommodate the Rent the employee pays.
There are grades in the organisation which witness a higher turnover. The gratuity would not make a difference for these employees. If the organisation has the HR Payroll processing department to carry out the operation, it is imperative that they enquire about each employee’s house rent!!! This would enable them to fix the basic and hence the entire compensation structure.
If we are looking at employees going for the long haul, the gratuity would make a huge difference. But then again, 5 years in the current job market is a lifetime!