Can Employers Legally Deduct 5% for Late PF Payments from Contractors? Let's Discuss!

Can the Principal Employer deduct 5% as penal charges from the Contractor's bill amount for delayed payment of provident fund contribution under the Employees' Provident Funds and Miscellaneous Provisions Act, 1952, when the Contractor has an independent code number and registration? Besides this, the contractor himself has to bear interest and damages as specified under the act.

The Principal Employer's action is based on invoking an agreement clause, signed by both parties, which reads as follows:

“The contractor will deposit the Employee and employer share of contribution along with applicable admin charges in respect of P.F. to the concerned authority, and the requisite proof for the same would be furnished to us on a monthly basis ahead of due dates. The proof of payment of the previous month must be attached along with the current month's bill. In case of late deposit, 5% of monthly service charges will be levied as a penalty.”

Is it legally binding on the Contractor?

Dear Colleague, This is a very interesting question raised by you, which may invite a lot of discussions from other HR colleagues to participate and share their valuable expertise. I offer my humble view on this matter below, although other colleagues may have different perspectives, which we eagerly await to learn from further:

Definition of "Employer" under the Employees' Provident Fund & MP Act 1952

The Employees' Provident Fund & MP Act 1952 defines "Employer" under section 2(e) of the said Act, which includes Owner, Occupier, Manager, etc. (Kindly refer to the relevant provisions below).

Employer's Right to Recover Employee Contribution

Further, under Section 8A, the Act provides the right to the employer/contractor to recover the employee contribution payable and remit it to the EPFO organization.

Penalties for Delays in Payment

Further reading of Sections 7Q and 14D imposes fines (to the extent of 12%) and damages in case of delays in payment by the employer.

1. In the instant matter of discussion, in the contract agreement between Employer and Contractor, there is a clearly agreed clause that in case of any delay in remitting the statutory dues, the employer will impose a penalty to the extent of 5% of the service charges only in those months where the contractor defaults by himself and on his own fault.

2. The intention and the clause of the contract reduced into writing between both parties is valid as the intent is good and only to ensure that the contractor is complying with legal provisions without any gaps or delay.

3. This penalty is entirely different from the penal provision under the PF Act, and the right of the employer arises out of the contract entered by mutual agreement between the parties. Independent of it, the contractor is liable to pay interest and damages to the Employees' Provident Fund Organization by facing due inquiries under relevant provisions of the Act, which is a separate process administered by the EPFO.

4. The penalty imposed by the Employer is an independent action and will not amount to double jeopardy in this case.

5. The employer needs to exercise controls in line with agreed contract clauses with the good intention of ensuring that the contractor is making timely PF contributions. Any violation here is a violation under the agreement clause.

6. In case the EPFO imposes interest and penalty, the violation arises under the EPF & MP Act 1952, and both actions are independent of each other.

7. Hence, in a nutshell, the employer may exercise the agreement clause or provision to impose such penalty or such other action on the defaulting contractor based on the signed agreement clause.

Reference:

2 [(e) "employer" means—
(i) in relation to an establishment which is a factory, the owner or occupier of the factory, including the agent of such owner or occupier, the legal representative of a deceased owner or occupier and, where a person has been named as a manager of the factory under clause (f) of sub-section (1) of section 7 of the Factories Act, 1948 (63 of 1948), the person so named; and
(ii) in relation to any other establishment, the person who, or the authority which, has the ultimate control over the affairs of the establishment, and where the said affairs are entrusted to a manager, managing director, or managing agent, such manager, managing director, or managing agent.

7Q. Interest payable by the employer.—The employer shall be liable to pay simple interest at the rate of twelve percent per annum or at such higher rate as may be specified in the Scheme on any amount due from him under this Act from the date on which the amount has become so due till the date of its actual payment: Provided that the higher rate of interest specified in the Scheme shall not exceed the lending rate of interest charged by any scheduled bank.

8A. Recovery of moneys by employers and contractors.—(1) The amount of contribution (that is to say the employer's contribution as well as the employee's contribution in pursuance of any Scheme and the employer's contribution in pursuance of the Insurance Scheme), and any charges for meeting the cost of administering the Fund paid or payable by an employer in respect of an employee employed by or through a contractor may be recovered by such employer from the contractor, either by deduction from any amount payable to the contractor, under any contract or as a debt payable by the contractor.

(2) A contractor from whom the amounts mentioned in sub-section (1) may be recovered in respect of any employee employed by or through him, may recover from such employee the employee's contribution [under any Scheme] by deduction from the basic wages, dearness allowance, and retaining allowance (if any) payable to such employee.

(3) Notwithstanding any contract to the contrary, no contractor shall be entitled to deduct the employer's contribution or the charges referred to in sub-section (1) from the basic wages, dearness allowance, and retaining allowance (if any) payable to an employee employed by or through him or otherwise to recover such contribution or charges from such employee.

14B. Power to recover damages.—Where an employer makes default in the payment of any contribution to the Fund, the Pension Fund, or the Insurance Fund or in the transfer of accumulations required to be transferred by him under sub-section (2) of section 15 or sub-section (5) of section 17 or in the payment of any charges payable under any other provision of this Act or of any Scheme or Insurance Scheme or under any of the conditions specified under section 17, the Central Provident Fund Commissioner or such other officer as may be authorized by the Central Government, by notification in the Official Gazette, in this behalf may recover from the employer by way of penalty such damages, not exceeding the amount of arrears, as may be specified in the Scheme: Provided that before levying and recovering such damages, the employer shall be given a reasonable opportunity of being heard.

All the best and God bless,
Dr. P. Sivakumar
DrSIVAGLOBALHR
Tamil Nadu

Dr. P. Sivakumar

Appreciate sharing your valuable views. I do agree, as the same is agreeable from the Principal Employer's point of view.

Look at the contractor

Admitting without accepting knowledge/vocabulary in English, some contractors, especially in the south, have learned only to sign in English. They have signed contract agreements, which they may or may not have fully understood, for survival in tough competition/serious negotiations. I am not denying the validity of the contract agreement clauses signed.

He, the contractor, as an Independent Contractor, sees his or her liabilities increase vis-à-vis the employees. Upon allotment of a code number, the Provident Fund Authorities recognize the contractor as an 'establishment' since he has complied with all the prescribed conditions. A principal employer cannot be held responsible for the omissions and commissions of the contractor's employees.

As agreed, the service charges that he could claim from the Principal Employer are after long negotiation. He survived/gained a contract for the placement of workmen, having struggled through tough competition. The service charges claimed are supposed to be for the service rendered, which includes his identifying/sourcing expenses, salary/wages for one or more supervisors depending on the number of manpower placed at the site, and administrative expenses, including stationery and maintenance of computer and printer charges. No doubt the payment/crediting of ESI, PF, GST, and so on can also be defined as part of services.

The services of payment/crediting by the Contractor as an establishment can also avail the benefit of payment of contributions in respect of his employees after the due date, with belated payments, interest, and penal charges as prescribed under the various welfare acts and rules framed thereunder, which are available both for the Principal Employer and the Contractor equally.

Further service charges are also part of the consideration payable for the services rendered, which includes wages, ESI, PF contributions, management contribution, and GST payable for the services rendered.

No contractor as an establishment would intentionally, understanding the interest and damages payable, which would be an amount close to double the contributions payable by him in time.

Judgement and implications

Especially after the judgment pronounced, "the contractors, who are registered with the Provident Fund Department, having the independent code number, are to be treated as independent employers. And therefore, cannot be treated to be 'principal employers for the purposes of those contractors." - Steel Authority of India Ltd. vs National Union Water Front Workers, 2001 LLR 961 (SC). 5th October 2019.

After the above judgment, of late, the enforcement authorities, in audit assessments, assess the Contractor establishment as follows:

The total calculated legal percentage under the act, from the bill received, against the heading wages, and actual contributions already paid as on date, and the difference (less some exemption eases as applicable for exempted employees) would be assessed as contributions payable, with interest payable, after the audit. Of course, the penal charges notice will certainly follow once you clear the payment, by voucher/E-challan, as per the assessment.

Further, as per the Amendment in Section 43B under the Indian Income Tax Act, 1961, the allowability of exemption of ESI and EPF contributions cannot be availed if the assessee paid the same after the due date, as applicable under the respective acts.

Imagine a contractor's liability. In these circumstances, which contractor would like to pay the contributions, even if he received it from the Principal Employer in time? In some cases, the contractor had to pay and claim reimbursement for having paid.

In the above predicament, I feel that the contractor is being punished too much. His act mostly may not be intentional and is beyond his capability, considering the business recession/exigencies he is facing.

Risk and remedy

Risk or disadvantage is incurred from two sources simultaneously. Why not the remedy could be availed by invoking the concept of Double Jeopardy/'audi alteram partem rule' with a crucial requirement for attracting the Article that the offenses should be the same, should be identical.

Kindly share your thoughts and views and if there are any legal citations in similar/allied circumstances.

Dear Colleague,

Quote
“In the instant matter, the action of imposing a penalty is like departmental action, and later when he faces proceedings under the EPF & MP Act 1952, he has to face the actions that are empowered by the Act to the officials of EPFO.”

My submission is why the contractor should alone be subjected to a penalty on the consideration received, inclusive of ESI & PF from the contractee factory?

When it is made amply clear that under both the ESI/PF laws, the principal employer is the contractor and not the contractee factory, the obligation and legal responsibility to remit the ESI/PF to the concerned department is on the contractor.

As per Sec 15 (1) of the CGST Act, the value of a supply of goods or services or both shall be the transaction value, which is the price actually paid or payable for the said supply of goods or services or both, where the supplier and the recipient of the supply are not related, and the price is the sole consideration for the supply.

If so, when the labor contractor is collecting the total amount as consideration for his supplies, and Sec 15 (1) does not explicitly speak about the inclusion of such elements as ESI/PF?

There’s also a question of whether it will be covered under the Pure Agent Principle and thus exempted in the hands of the contractor for the portion comprising ESI/PF in the consideration received from the contractee factory.

I am also inclined to look at the particular clause of the contract of agreement, as executed:

“The contractor will deposit Employee and employer share of contribution along with applicable admin charges in respect of P.F to the concerned authority and the requisite proof for the same would be furnished to us on a monthly basis ahead of due dates. The proof of payment of the previous month must be attached along with the current month bill. In case of late deposit, 5% of monthly service charges will be levied as penalty.”

As per the Contract Act, any consideration should be a new obligation. Performance of an existing legal duty is no consideration in the eyes of law. It should be something more than a person is already required to do.

The contract clause may also look as if it lacks consideration as one or more of the parties agreed to something he or she already was obligated to do.

Contract clause may also be considered as unconscionable. 'If there is a gross inequality of bargaining power, so the weaker party to the contract has no meaningful choice as to the terms, and the resulting contract is unreasonably favorable to the stronger party. A court will also look at whether one party is uneducated or illiterate, whether that party had the opportunity to ask questions or consult.'

Dear Colleague,

Excellent discussion and analysis by you, and thanks again.

There are a few additions:

Contract Clause and Penalties

The contract clause is clear, and we impose many such penalties in the contract clause. For example - Violation of Safety, Violation of Compliance, non-adherence to Environmental or EHS Compliance by the employees of the Contractor (of course, provided the Principal Employer (PE) provides all such amenities/aids as may be required, etc.). In case the Principal Employer is not remitting the payment for the bills on time, and the delay is due to the delay on the part of the PE, then in such a case, the PE does not have any moral or legal right to impose such a penalty. When the PE is adhering to all the requirements of the contract and the Contractor is still violating, then Departmental Action can be taken without any bar. Similarly, if there are delays from the PE in paying the cheque or any other payment, resulting in delays on the part of the contractor, then the PE has no right to impose any penalty.

Types of Situations in PE-Contractor Arrangements

1. PE-Contractor Arrangement

Where the contractors are petty in nature and lack professional management skills/local contractors of the location, here more close monitoring by the PE on the Contractor is required to run the show effectively without any risk of legal compliance. If there is loose monitoring and clauses in the contract are not departmentally administered, it might lead to not only a compliance gap but also IR challenges for which the PE will also become a party before any forum.

2. Principal to Principal Arrangement

These types of contracts (where the Contractor is professionally running their establishment, by having a structured setup/Code numbers/compliance/professional managers/managing all audits and inspections on their own/having internal audits within their organization and the payments are made as a whole sum without breaking up the cost into compliance cost, administrative cost, operating cost, etc.), then the Principal Employer need not impose any such penal provisions as things will always go right. There are leading outsourced agencies available who manage very perfect business and compliance. Here the PE need not have any worry or monitoring, but all things will go right.

In both cases, unless the clauses are balanced between both parties in the contract and it is not one-sided to Party A or Party B, then there are no challenges foreseen in invoking the clause of the agreement for a good cause and good intent to make compliance go right to protect the interests of Contract Workers in line with the spirit of the Act and in line with Provisions of the Act.

All the best and God Bless,

Dr. P. Sivakumar
Dr. SIVAGLOBALHR
Tamil Nadu

Dear Colleague,

Admitting without accepting your argument, I feel the Principal Employer cannot levy or impose penalties or fines on the bill or consideration claimed, except in the case of willful damage to any of the Principal Employer's property or products.

GST and Its Implications

Let us look into another component of consideration, payable to the Contractor by the Principal Employer. GST is required to be paid by the Service Provider (Contractor) on services rendered by the Contractor. The Principal Employer (Recipient) cannot levy penal charges or withhold the GST payable to the Contractor as the same is a tax payable to the Government under the CGST Act, 2017.

When the Service Provider raises a bill, they simultaneously file GSTR-1. This would get reflected in GSTR-2A and GSTR-2B of the Recipient of Services. When the Service Provider does not remit the tax collected to the Government, the Recipient cannot withhold or levy penal charges on the subsequent month's GST or bill amount claimed by the Service Provider, claiming the Service Provider has not filed GSTR-3B for claiming credit. The remedy for the Service Provider is available in the Act, where if the Service Provider has not remitted the tax collected on services rendered, apart from payment of interest and penalty, the Registration Certificate could be canceled. They will also not be allowed to generate E-Way.

Whereas the Recipient can always claim credit on the GST already paid to the Service Provider and is not a loser. The judiciary, including the Madras High Court, in the case of Woolworths Wholesale Limited Vs The Assistant Commissioner (CT), Koyambedu Assessment Circle, dated 06.11.2014, held that ITC cannot be disallowed to the Recipient on grounds that the Service Provider had not remitted the tax to the Government. However, this remedy would be available before the judicature of respective Higher Courts.

ESI & PF Considerations

Similarly, ESI & PF are also part of the consideration on which GST is payable. The Labor contractor is collecting the total amount as consideration of his supplies as per Sec 15 (1), which does not explicitly speak about the inclusion of such elements as ESI/PF.

I appreciate and am happy to note a colleague, Dr. P. Sivakumar, from my own state is sharing his knowledge and ideas.

I am at the age of 72, very happy to learn and share knowledge, having put in 35 years of HR experience in the Textiles, Cement, and Engineering industries, and retired. I am also waiting and expecting some input from Seniors and the HR Fraternity.

I am finding, of late, the vibrancy of the forum is getting diminished. I am confident and have read and learned to appreciate some of the regular active members' contributions to this forum.

Penal Provisions in Contracts

There is nothing wrong with including a penal provision in a contract. However, when it is linked to a legal provision under any specific Act, the question arises as to whether the principal employer has the right to demand it or not.

Responsibilities of the Principal Employer

The principal employer is liable to ensure that the contributions in respect of workers deployed in his plant are paid on time by the contractor. If the contractor fails to pay, the principal employer should act proactively, pay the contributions, and then recover it from the contractor. If that has happened, then the principal employer can demand charges as he wishes. However, if he had not paid the amount before the due date and then demands penal charges, it will not be fair. The principal employer has no right to recover any penal charges for non-compliance with a provision of the PF Act, but he can make the contractor liable to pay any amount as a penal charge on an amount paid by the principal employer on a cut-off date.

Contractor's Obligations

As such, you can say that the contractor should pay the contributions on the 15th of every month and produce the challan as proof. Failing this, the principal employer will pay and recover the amount along with a penal charge of 5% of the paid sum.

Once the clause is in a contract, it is enforceable as per law. The question of morality does not arise in this case. If the contractor does not agree, he should not sign the agreement, and if he does, he accepts the condition and should work within the parameters. If he fails, he will be liable to pay the penalty.

Logic Behind the Clause

There must be a logic in the clause, one of which is probably that if they don't pay, the risk of the company rises and stays for 3 years. So a penalty clause will make them obey and do things on time.

Power Imbalance Concerns

If someone says that this is a misuse of the imbalance in power between the company and contractor, then that is there in every field, from the supply of raw materials to the purchase of power. You need to live within that imbalance or find a different field of work.

I agree, and that is why I have very specifically said that the penalty clause begins to operate only when you pay it on behalf of the other party. You cannot punish the other party for an offense or non-compliance as per a particular act which is common to all and for which there are specific rules framed. First, you pay the amount and then recover the amount paid along with whatever interest or penalty that you want to impose from the defaulter.

Dear Mr. Babu Alexander,

Your reply to Dr. Sivakumar's response highlights the difficulties experienced by a contractor due to certain restrictions incidental to fulfilling his contract. It is purely from the contractor's perspective. Once you admit that there is no illegality in such restrictions, the arguments from the point of the doctrine of double jeopardy and lack of consideration in a clause of the contract compelling due statutory compliance on the part of the contractor pale into insignificance.

Levy of interest on belated remittance of PF contributions by the employer is an administrative act only. Therefore, it seems far-fetched and out of context to apply the doctrine of double jeopardy in this case. A clause in the contract enabling the principal employer to impose a certain penalty on the administrative charges payable to the contractor is only to require the contractor to remit the amounts of contribution to EPF, ESI, etc., on time from the charges already received by him. I cannot find any illegality in such a clause, for the consideration in this case is only statutory compliance.

Moreover, I am sure that your long and rich experience in the field would recognize the problems created by the practice of subcontracting by contractors in certain activities like construction. Hence, such a clause has to be appreciated in the interest of the ultimate beneficiary of the CLTA Act, 1970, i.e., the poor contract labor.

Dear Mr. Umakanthan.M and Mr. Madhu.T.K, Thanks for sharing your valuable information.

I fully accept and agree with your point about the alleged misuse by some contractors and the sufferings faced by the poor contractor workmen.

Rights and obligations of the contractor

However, I still have a doubt about the rights and obligations on the other side of the coin. Why is the contractor subjected to penal deductions by the principal employer when the contractor has to face different punishments, has an independent code number, and when their liabilities increase vis-à-vis the employees?

I agree and appreciate the concern the principal employer (PE) has, having paid the management contribution to the contractor along with their bill/payment for the service rendered. This concern is addressed under the Act and Rules by levying interest and penal charges for late payments from the due date when the contributions become payable.

Further, the late payment of contributions is denied any exemption under Section 43B of the Income Tax Act.

Supreme Court verdict and its implications

I understand that after the Supreme Court verdict, when the onus to make provident fund contributions is not on the principal employer, nor will a principal employer be held liable in case of noncompliance, inspections by the enforcement authority to the contractor are based on the actual amount received as wages. The percentage is calculated under the Act, less the contribution already paid, and the difference is assessed (unless justified reasons as exempted employees) as arrears of contributions payable, as I understand.

Recent control measures

There are still more control measures being enforced by the recent change in Section 142 of the Code of Social Security 2020. It has made it mandatory to link the Aadhaar card with the Employees Provident Fund (EPF) account. Once the linking is established, the employer will need to remit PF contributions for past periods, which could trigger interest and penalties on the employer.

When so many control and enforcement measures are being imposed, I feel no service provider can have the access or opportunity to use or rotate the contributions received for other business funds. Further, no principal employer will leave the contractor without the production of documents regarding contributions paid and the resultant challan, whether paid on time or late, by imposing a threat of non-release of bill amounts.

Impact of CGST Amendment Act, 2018

Another view is that after the CGST Amendment Act, 2018, the concept of service recipient, service provider, and the consideration for the service rendered has evolved with a different scope and meaning to the service consideration, which has become a total package.

Any party to an agreement can put whatever terms they want and offer whatever price they wish for a product or service, and it is for the other party to accept or reject it. Once accepted, it has to be adhered to whether it is fair or unfair.

The only exception is that an illegal term cannot be included.

So, if the contractor signs the agreement, they must pay on time or pay the penalty to the Principal Employer. If they do not want to agree to the clause, they are free to refuse it and not enter into the contract.