How Can We Structure Salary Payments to Potentially Exempt Allowances from ESI?

Dear Sir/Madam,

In July 2016, the firm I am working for obtained PF registration, and now all employees are covered under PF. For PF contribution purposes, we have restructured the salary split for each employee (previously, it was only Basic + Sales commission). The current salary structure is as follows:

1. Basic
2. DA
3. HRA
4. CCA

Total 1 - Gross Salary

5. Other Allowances
6. Sales Commission

Total 2 - Allowance + Commission

The monthly salary of an employee is equal to Total 1 + Total 2.

This salary structure was developed at the request of management to keep the Gross salary as low as possible to reduce the burden of ESI and PF. To achieve this, the basic salary was set at the minimum as per the minimum wages act applicable to us (in our case - Kerala Shops & Commercial Establishments Act), and the remaining balance after the gross salary was designated as "Other Allowances."

Let me illustrate with an example of an employee in our firm - a marketing executive with a monthly salary of ₹30,000/- plus sales commission. His breakdown is as follows:

1. Basic - ₹9330
2. DA - ₹1300
3. HRA - ₹3500
4. CCA - ₹200

Gross Salary total - ₹14,330

Other Allowance (total salary ₹30,000 - gross salary total ₹14,330) = ₹15,670

Sales Commission (varies with sales volume)

Total salary = ₹14,330 + ₹15,670 + sales commission

According to my understanding, ESI is applicable to the "Other Allowance" amount of ₹15,670 and the sales commission amount.

However, the ESI wages document states that if certain allowances are booked and paid quarterly, they won't attract ESI. The issue arises as employees prefer monthly payments due to these allowances forming a significant part of their salary.

A co-worker proposed a solution - treating the "other allowance" as an advance payment of salary for two months, then booking the full amount in the last month of the quarter and paying the balance.

To provide a clearer example based on the above scenario, assuming the sales commission is Rs. 1000:

1st-month payment = Gross salary ₹14,330 + Advance amount ₹16,670 (₹15,670 other allowance + sales commission ₹1000) = Total ₹31,000

2nd-month payment = Gross salary ₹14,330 + Advance amount ₹16,670 (₹15,670 other allowance + sales commission ₹1000) = Total ₹31,000

3rd-month payment:

1. Add: Gross salary ₹14,330
2. Add: quarterly payment of incentive + allowance - ₹50,010
{ [3 months x ₹15,670 = ₹47,010] + commission for 3 months [₹1000 x 3 = ₹3,000] }
3. Less: advance deduction for previous 2 months = (₹16,670 x 2) = ₹33,340

Net payment: ₹31,000

By implementing this method, the employee won't notice any change in the payment amount monthly, but the booking is done quarterly, which could be argued as quarterly payment as the first two months are considered advances.

I welcome your comments and suggestions on this approach, and if this method could exempt the "other allowance" and commission amounts from ESI. Additionally, any other suggestions to aid in claiming exemption from ESI would be greatly appreciated.

Thanks and Regards

Dear John, this is not news or new; many employers (employees) adopt this method to reduce ESI contribution. I equate this sales commission to incentive and vice versa, and the discussion on this can be seen here in this link: https://www.citehr.com/273844-pf-esi...incentive.html

Definition of Wages

As per the Act, wages mean all remuneration paid or payable in cash to an employee according to the terms of the contract of employment. This includes any payment made to an employee in respect of a period of authorized leave, lock-out, lay-off, or strike which is not illegal, and other additional remuneration paid at intervals not exceeding two months. It does not include contributions paid by the employer to any pension fund or provident fund, traveling allowance, or reimbursement of expenses made by the nature of employment of the employee.

Thus, wages include basic pay, dearness allowance, city compensatory allowance, payment of day of rest, overtime wages, house rent allowance, incentive allowance, attendance bonus, meal allowance, and incentive bonus. However, wages do not include annual bonus, unilateral rewards scheme (inam), ex gratia payments made every quarter or every year, traveling allowance, retrenchment compensation, encashment of leave, and gratuity.

Also, please see more from the attached notes on 'wages'.

Therefore, your sales commission, when not paid as allowances on a monthly basis, can escape. But when it comes to EPF, you have to rethink as the more they contribute, the more savings for their future, which includes employers' equivalent contribution also with added interest thereon. But you cannot have the cake and eat it too.

Your salary structure should comply with the law regarding EPF and ESI. This restructuring follows coverage under EPF and ESI. Remember, a little knowledge can be dangerous. Please refrain from considering restructuring that lacks rationale.

ESI is applicable to employees whose gross salary is Rs 21,000/- per month. Employees whose gross salary is above Rs 21,000/- are excluded from the purview of the ESI Act.

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