Decoding the components of Salary.

Dear Friends,

When we are about to join a company, we all have those butterflies in stomach about the new company, new work environment, new manager, new colleagues, etc. With all these we also have some dreams about our salary and how much we will earn and how we will save/spend it.

Today you will know what all components are there in our salary and how we can tweak it to get the maximum salary and least tax that too in completely legal way.

In our offer letter , the total cost to company (CTC) is divided under various heads like Basic salary, Dearness Allowance (DA), House rent allowance (HRA), Leave travel allowance (LTA), Medical Allowance, Conveyance Allowance, Personal allowance, etc.

First of all what is Salary? Salary is the payment of money that a person receives in lieu of the services rendered to another person/organization. In this case the person earning salary is called Employee and the person who gives salary is Employer.

Salary word is derived from a Latin word "Salrium".

A sample Salary structure with components

	Annual		Monthly
Basic Salary	180,000		15,000
House Rent Allowance	90,000		7,500
Conveyance Allowance	19,200		1,600
Medical Reimbursement Entitlement	15,000		1,250
Personal Allowance	240,000		20,000
Leave Travel Allowance	24,000		2,000
Subtotal	568,200		47,350
Retirals
Gratuity	12,000		1,000
Provident Fund (employers contribution)	21,600		1,800
Cost to Company	601,800		50,150

Let’s discuss all the components in detail:

1.    Basic salary: Basic salary is the base income before any deduction. It is a fixed amount which does not include any bonus, benefit or other allowances. Amount depends on the designation of employee. It is generally around 40% of the total Cost to Company. This constitutes the core of the salary on which other allowances are calculated.

2.    Dearness Allowance: DA is a cost of living adjustment allowance for Government Employees, PSU employee, etc. Cost living adjustment means its value varies as per the prevailing inflation in the country. This is not paid in many Private sector companies. So don’t get shocked if you don’t see this component in your offer letter.

Some companies’ offer fixed DA to its employee which is not changed based on inflation rate.

3.    House Rent Allowance (HRA): HRA is paid to employees to meet the cost of renting a home. This is a tax-free income upto a maximum limit. The maximum limit is calculated based on the three conditions :

a)    Actual House rent allowance received as part of salary.

b)   Actual rent paid – 10% of Basic salary + Dearness Allowance.

c)    50% of Basic + DA for the 4 Metro cities and for all other places 40% of Basic + DA.

The least amount of all these 3 is considered to be the tax free part of HRA, any amount above that is taxable.

For example suppose your Basic Salary is Rs. 20000 per month, there is no DA component; you get Rs 7000 as a HRA component in your total salary and the rent you pay for your flat is Rs. 8000 and live in a tier II city like Pune. Then your non-taxable HRA eligibility will be the minimum of the 3 as calculated by the formulas mentioned above.

a)    Actual HRA received = Rs. 7000/-

b)    Actual rent paid – 10% of basic + DA = 8000 – 10% of 20000

= 8000 – 2000 = Rs 6000/-

c)    40% of Basic +DA = 40% of 20000 = Rs. 8000/-

So your tax free HRA eligibility will be minimum of the 3 amounts mentioned above i.e. Rs 6000/-

4.    Conveyance Allowance:  Also called Transport allowance. This allowance is paid to Employees of a company for their travel from residence to and from their Work place.

Currently the maximum tax free limit decided by Government of India is Rs. 1600 per month.

5.    Leave Travel Allowance: LTA is paid to employees to compensate them when the employee is travelling alone or with their family. This component is tax-free based on the proofs submitted by employee.

The exemption is restricted only to the travel cost incurred by the employee. The tax exemption is not valid for the costs incurred during the entire trip which might include expenses such as food expenses, shopping expense and other expense. The exemption is not available for more than two children of the individual born after October 01, 1998. Exemption is allowed for only two travels within a block of four years. The current block is from 2014-2017. If the individual doesn’t take advantage of the exemption within this block, they can carry it over to the next block.

List of expenses that is exempted under Leave Travel Allowance

·         Travel by air- Economic air fare by the shortest route or amount spent will be exempted depending on whichever is lesser.

·         Travel by rail- A.C. first class fare by the shortest route or the amount spent on travel will be exempted depending on whichever is lesser.

·         Place of origin and destination place of journey connected by rail but journey performed by other mode of transport

·         Place of origin & destination not connected by rail(partly/fully) but connected by other recognized Public transport system

·         Place of origin & destination not connected by rail (partly/fully) and not connected by other recognized Public transport system also.

For example, suppose an employee gets a LTA component of Rs 2000 per month then his yearly eligibility for tax exemption is Rs. 24000. He submits proofs of Rs. 20000/- in a year. Then only Rs. 20000 will be considered as tax free, rest Rs. 4000 will be fully taxable.

6.    Medical Allowance: Medical allowance is a fixed pay provided by an employer every month, which is fully taxable. Employees can claim a tax benefit of up to Rs. 15,000 under medical reimbursement (payments for bills or supporting documents).

7.    Personal Allowance:  The entire balance amount is clubbed under this head which is fully taxable.

Some other components

1.    Gratuity: Gratuity is a sum of money paid by an employer to an employee for services rendered in the company. However, gratuity is paid only to employees who complete 5 or more years with the company. It can be understood as a form of tip paid by employer to the employee for services offered in the company.

Following are the few instances when you will be eligible to receive gratuity.

1.    An employee should be eligible for superannuation

2.    An employee retires

3.    An employee resigns after working for 5 years with a single employer

4.    An employee passes away or suffers disability due to illness or accident

  

Formula for Calculation of Gratuity Amount:

The Gratuity amount paid to an employee is dependent upon the number of years served in the company and the last drawn salary.

If,

N = number of years of service in a company

B = last drawn basic salary plus DA

Then, Gratuity will be calculated as

Gratuity = N*B*15/26

For example, if Gaurav is an engineer who has worked with some XYZ Company for 5 years of service and had Rs.20,000 as his last drawn basic plus DA amount, then,

Gratuity Amount for Gaurav = 5*20,000*15/26 = Rs.57692/-

2.    Provident Fund or Employee Provident Fund: EPF is a retirement benefit scheme which is available to almost all salaried employees.

When you start working, you and your employer both pool in 12% of your basic + DA into your EPF account. Your entire contribution goes to EPF account where as in case employer 3.67 of its contribution goes to your EPF account where as the rest 8.33% goes to Employee Pension Scheme (EPS). The maximum amount permissible in EPS account is Rs. 541. Any amount above this should be contributed to EPF account.

These accounts earn interest amount as decided by the Government of India. Current interest rate is 8.75% for this financial year.

The amount which we invest in EPF account is tax-free under the Section 80-C of IT act.

Please Note: The only time you have option to opt out of the EPF program is at the start of your career, when you tell your first company that you don’t want to be a part of it and fill out Form 11. If you’ve contributed towards EPF even once and have an account created in your name, you cannot opt out of this scheme.