Salary structure has huge impact on taxation. Companies can rejig their salary structures or allow customisation for optimisation of taxes. We will talk about this in a series of articles. In this article, we are going to discuss about basic pay and its impact on taxes and various other benefits.
Salary structure has various components. Basic Pay is one of the most important component. Percentage of Basic pay in overall salary might vary among organisations. Some organisations keep 60% of their total salary as Basic Pay, while for others it might be lower. Please check your salary slip to know your ratio.
In India, your basic pay plays a significant role in determining your taxes because it forms the foundation for various allowances and deductions. Various benefits are also dependent on basic Pay. Let’s understand how your basic pay impacts your taxes:
Deductions: Retirement Savings
- Employer’s contribution to Provident Fund : Both employer’s as well as employee’s contribution to Provident Fund is 12% of the basic pay. Employer’s contribution to Provident Fund is reduced from taxable salary, so bigger is better. However there are few organisations which only deduct 1800/- as employer’s contribution and limit use of this feature whatever be the Basic Pay Percentage.
- NPS Contribution under Section 80CCD(2): This contribution to NPS Tier-1 account could be up-to 10% of Basic Pay. This NPS contribution also goes up if basic salary ratio is high.
This is important for those who wish to build retirement corpus along with saving taxes. However, it might not be useful for those who want to have more in-hand salary.
Allowances:
HRA and LTA components are also dependent on Basic Pay.
Higher HRA component can help in annual tax savings if rent in accordance with HRA component is being paid. Please note that HRA exemption could come down as well due to high HRA component if rent paid is low.
Benefits: Gratuity and Leave encashment benefits are also dependent on Basic Pay.
Summary:
There is another angle as well to above discussion. Sometimes, high basic pay can limit the scope for other tax free perks which could be tax-free on submission of bills. Though companies usually don’t change their salary, evaluate impact of Basic Pay percentage on your taxes and benefits. Explore the possibility of increasing the basic pay if it can cut your annual taxes.