Salary is the fixed amount of money paid to an employee by the employer in return for services rendered by the employee. The employer and or his/her HR teams have to put in their minds and arrive at the salary to be paid to each employee. They need to have a clear grasp of the working conditions, their importance, and the contributions towards social welfare schemes, taxation, allowance, and such other components.
How is salary structure determined?
For the employer and his/her HR teams, deciding on the right salary can be a very tedious task. A lot of factors have to be considered to determine the right salary for an employee. These factors are:
1. Educational Qualification and Experience
Educational Qualifications and Experience play an important role in not only the selection process but also in determining the salary structure for an employee. The higher the Educational qualification and experience the higher the pay.
2. The Industry
The industry is also an important determinant in fixing the salary. Two individuals employed in two different industries but with the same designation may draw different salaries. The reason for this is that one industry is much larger than the other and the job function may be more critical to a particular industry.
3. The Location of Employment
The location of employment is important because based on the location, the cost of living varies and this will naturally have an effect on the salary structure. The compensation in an urban location would be higher than the compensation in a rural location. However, due to the surge in work-from-home or remote work, the compensation may be more aligned with role-based rather than to location-based.
4. Skill sets that are in demand
Skill sets that are in demand are a key determinant in deciding the compensation to an employee. Any skill set that has a wider role within an organization commands higher value and this translates to higher compensation.
What are the common components of the Salary Structure?
- Cost To Company (CTC)
- Gross Pay
- Net Pay
I. What is Cost To Company (CTC)?
Cost to Company (CTC) is the annual expenditure that a company incurs on an employee. This would depend on the salary and other variable components. CTC is calculated by adding the components like Basic salary, and the additional statutory benefits that employees receive such as EPF, ESIC, HRA, Travel Allowance, Food allowance, Gratuity, Bonus, etc. In other words, CTC is the cost of hiring and sustaining an employee in the company. However, the CTC amount is not the actual amount that an employee takes home at the end of each month.
CTC = Gross salary + Benefits
Components of Benefits
- Employer EPF
- EPF Administrative Charges
- EPF EDLI Charges
- Employer ESI
- Food Coupon
- Mediclaim Premium
1. Employer EPF
The Employees’ Provident Fund is an employee welfare scheme administered by the Employees Provident Fund Organization (EPFO). Under the scheme, both the employees and the employers contribute towards the Fund every month. This is a platform that provides an opportunity for employees to save a part of their salary as a long-term investment. The employer contributes 12% of the basic salary every month towards the Fund. An equal contribution is made to the fund from the employees’ side also. From the employer contribution, 3.67% goes towards EPF, and a portion is contributed towards ESI and related funds.
2. EPF Administrative Charges
The EPF Administrative charges are made from the contributions from the employer’s end towards EPF. From the contribution of 12%, 0.50% is contributed towards EPF administrative charges with effect from June 2018.
3. EPF EDLI Charges
The Employees Deposit Linked Insurance (EDLI) scheme is a part of the EPF and EPS schemes. All employees who subscribe to the PF scheme are automatically enrolled in this scheme. The employee contribution towards this fund is 0.50% (subject to a maximum of ₹ 75.
4. Employer ESI
Employees State Insurance (ESI) is an insurance scheme administered by the Employees’ State Insurance Corporation (ESIC). From the employers contribution of 12% of salary, 3.75 % is contributed towards the ESI Fund. The scheme is applicable for all employees whose salary is ₹ 21,000 or less.
Gratuity is a benefit received by the employee from the employer for the services rendered by the employee at the time of leaving the job or on retirement. To be eligible to receive gratuity, an employee has to be in service for 5 or more years. The amount is deducted by the employer every year and hence will get deducted from the CTC.
The Formula for calculating Gratuity is as follows:
Gratuity = n x b x 15/26
Where n = number of years of service, b = basic salary + DA,
When companies adopted CTC concept, every cost was converted into percentage. Thus 15 days wages is approximately equal to 4.81% and this is indicated in the CTC sheet. The ratio 15/26 is fixed and its value is 0.577 for the year and when calculated for a month is 0.577/12 x 100 which works out to 4.81.
6. Food Coupon
Food Coupons are food vouchers provided by companies to their employees to purchase food items and non-alcoholic beverages from designated shops. The food coupons are tax-exempt vouchers up to a limit of ₹ 50 and are mostly used by salespeople and other employees who work in the field.
7. Mediclaim Premium
Mediclaim is a basic type of health insurance designed to provide policyholders with financial support during medical emergencies for self and family. They cover the cost of treatment when an employee is hospitalized. In Mediclaim the coverage amount is limited and based on the plan that is opted for. The Insurance company reimburses the expenses incurred by the policyholders for treatment. The premium has to be regularly paid to avail the benefits of Mediclaim
II. Gross Salary
Gross Salary is the amount calculated before the deduction of taxes or any other deductions. Gross salary includes the Basic salary, dividends or bonus, and overtime amounts.
Gross Salary = Fixed Earnings + Variable Earnings
Every allowance will be subject to taxation, which will have an impact on the company. The company would pay the tax out of the employee’s wage.
Components of Earnings
- Fixed Earnings
- Variable Earnings
I. Fixed Earnings
- Basic Salary
- Dearness Allowance (DA)
- House Rent Allowance (HRA)
- Leave Travel Allowance (LTA)
- Conveyance Allowance (CA)
- Medical Allowance
1. Basic Salary:
Basic Salary is the primary component of the salary structure and forms the largest component of the CTC. It is the fixed part of the salary package and constitutes between 40-50 percent of the CTC. As per the “New Code of Wages” that is to be implemented by the government, the minimum basic component should be 50% of the salary.
Basic salary is fully taxable, therefore, keeping it too high will not only increase the tax liability of your employee but will also increase the contribution towards EPF and ESI.
On the contrary, by keeping it too low, you may increase the risk of not following the Minimum Wages norms set by the respective state governments.
2. Dearness Allowance (DA):
Dearness Allowance can be defined as the cost of living adjustment allowance which the government offers to public sector employees as well as pensioners in the public sector.
DA is the component of the salary applicable across India. Since DA is related to the cost of living, it has been linked to the Consumer Price Index. Hence, the DA varies based on location implying that it is different for employees working in the urban sector, semi-urban sector, and rural sector.
3. House Rent Allowance (HRA):
House Rent Allowance is a benefit for employees who live away from their place of work and need to live in rented accommodation. The HRA depends on the cost of living in that particular location. The amount that can be claimed as a tax deduction under HRA cannot be more than 50% of your Basic salary in a Metro or 40% of your Basic salary in a non-metro.
4. Leave Travel Allowance (LTA):
Leave Travel Allowance is a benefit provided to employees to travel within the country. LTA is normally reimbursed to employees after they undertake their travel. An employee can claim tax benefits on the Fare expenses incurred by his-her family during the travel. The tax benefit applies to only Fare expenses and no stay or food expenses are covered.
Only travel within India is considered for the benefit. The benefit applies only to dependent family members of the employee.
5. Conveyance Allowance:
An employee is liable to receive travel expenses for travel from residence to workplace and back. The to and fro expenses are reimbursed as conveyance allowance. With the introduction of standard deductions, the exemption on Conveyance Allowance has been removed effectively from April 2018.
6. Medical Allowance:
Medical allowance is a fixed allowance that is paid to employees, regardless of whether they have submitted the bills to claim these expenses or not. These are offered every month with the view to promoting staff health and supporting their medical expenses incurred in a financial year. Similar to Conveyance Allowance, the exemption on Medical allowance has been removed with effect from April 2018.
The employee can also claim Medical Reimbursement, which is a tax-free component reimbursed by the employer as the employee’s portion of medical costs
II. Variable Earnings
- Extra Days
Gratuity is a part of the salary that is received by the employee from the employer for the services rendered by the employee at the time of leaving the job or on retirement.
To be eligible to receive gratuity, an employee has to be in service for 5 or more years. The amount is deducted by the employer every year and hence will get deducted from the CTC.
A bonus is an amount provided to an employee as a lump sum once a year based on the individual performance of the employee or the overall performance of the company. The Bonus percentage ranges from 8.33% to 20% of the Basic salary and is based on the decision arrived at between the Unions and the management.
An Incentive is a reward that an employer gives to employees for achieving better results for the company as a whole. The incentives can be in the form of monetary compensation that is given in addition to salary. Incentives can also be in the form of a gift, a free product, paid time off or an additional share of stock
4. Over time (OT):
Overtime is the extra hours that an employee works beyond the scheduled hours of work. It is also the pay that an employee receives for working those extra hours.
III. Net Salary or Take-home-salary
Net salary or the actual salary that you take home is the salary after deduction of tax (TDS) and other deductions as per the company’s policy.
Net Salary = Gross Pay – Deductions
- Employees Provident Fund
- Employees ESI
- Tax Deducted at Source (TDS)
- Professional Tax
- Labour Welfare Fund
- Loan or Salary Advance
1. Employees’ Provident Fund (EPF)
The Employees’ Provident Fund Orgnization administers the Employees Provident Fund scheme. Under the scheme, both the employees and the employers contribute towards the Fund every month. This is a platform that provides an opportunity for employees to save a part of their salary as a long-term investment. The employee contributes 12% of the basic salary every month towards the Fund. The entire contribution goes towards EPF. The amount accumulated in the fund can be withdrawn in an emergency or upon retirement.
2. Employees’ ESI
Employees State Insurance (ESI) is an insurance scheme administered by the Employees’ State Insurance Corporation (ESIC). From the employees’ contribution of 12% of salary, 0.75 % is contributed towards the ESI Fund. The scheme provides for during medical emergencies to the employee or his/her dependents. The scheme is applicable for all employees whose salary is ₹ 21,000 or less.
3. Tax Deducted at Source (TDS)
For salaried employees Income tax is deducted and remitted to the IT Department. This is known as Tax Deducted at Source (TDS) and the same is deducted every month from the salaries of the employees. The employer deducts and remits the amount to the department.
4. Professional Tax
Professional Tax is the tax levied by the state government on salaried employees and professionals like doctors, lawyers, and chartered accountants. The amount fixed for Professional Tax varies from state to state. The employer deducts this amount from the salaries and remits to the concerned department.
5. Labour Welfare Fund
Labour Welfare Fund is a contribution made by salaried employees for the benefit of the labor class. The fund amount that is deducted varies from state to state where they are applicable. Both the employee and the employer make contributions toward the fund. The employer’s contribution is twice that of the contribution of the employee. The payments are normally made every 6 months.
6. Loan or Salary Advance
Loan or Salary Advance is paying an employee a portion of his/her salary in advance to meet a medical emergency or other unforeseen emergencies. A portion of the salary that is due is paid in advance and the same is recovered in installments from the salary dues of the subsequent months. These loans are usually interest free.
For both the employee working in an organization and for the employer it is very important to clearly understand the salary structure. A proper understanding of the Salary Breakup and the Salary Structure will help you to clearly understand where your money is invested. This will help you to plan your financials better.
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