How you can rejig compensation structure to make your salary more tax-efficient
February, 16th 2015
The appraisal season is here, raising hopes of generous increments and higher incomes. Many people will be rewarded for the hard work.
Several others will be lured to switch with better offers. In either case, before you sign on the dotted line, pay attention to the compensation structure being offered. A higher package does not always mean that your take-home salary will increase by the same margin. Various components of the compensation package may not come to you immediately. Others may be fully taxable. If the compensation package is not structured properly, you might get a rude shock in your next pay cheque.
This week's cover story tells you what you can do to minimise the tax outgo and enhance your take-home income. A large number of companies give employees the option to design their compensation structures. "Many companies are flexible when it comes to structuring the pay package. An employee earning Rs 60,000-70,000 a month can save over Rs 20,000 in tax in a year by realigning the package appropriately," says Sudhir Kaushik, Co-founder and CFO, Taxspanner.
If your current or prospective employer lets you rejig the compensation structure, here are some tricks to make your pay more tax-efficient. How you can rejig compensation structure to make your salary more tax-efficient Opt for lower basic and variable pay
The basic pay, which is the primary component of the compensation package, is fully taxable. If the basic pay is too high, your tax liability will shoot up. However, you can't keep it too low because the other components of the package, such as the HRA and Provident Fund benefit, are linked to the basic pay. For those in the highest tax bracket, it makes sense to keep the basic pay low, but a higher basic will not have a big impact in the lowest 10% income tax slab.
How much basic pay you should have will depend on individual need. "Those who have to fund immediate goals would need a higher take-home pay. This can be done by lowering the basic pay component. Those focusing on building a corpus for retirement can opt for higher basic pay, as it leads to a higher contribution to the Provident Fund," says Kuldip Kumar, Executive Director, Tax & Regulatory Services, PwC.
Similarly, the variable pay and special allowance is also fully taxable. Any bonus will get the same tax treatment. Make sure that the employer has not loaded your CTC with these heads.
Make room for more allowances
Instead of a high basic pay, opt for more taxfriendly allowances and reimbursements, such as conveyance, medical, telephone, and newspaper/periodicals. Some companies even offer soft furnishing allowances to cover clothing and certain household items.
However, all these allowances become taxfree only if the individual submits bills as evidence of the expenses incurred. If no bills are submitted, these become fully taxable.
The medical bills can be for self, spouse, children, parents and dependent siblings. Though allowances can bring down the tax outgo significantly, choose the ones that you can avail of. The leave travel allowance (LTA), for instance, can be a big amount but you have to submit evidence of the journey.
Kaushik points out that a higher LTA only benefits people who travel extensively. "Since LTA covers only the cost of travel and no other expenses, such as food and hotel bills, utilising the entire benefit may not be possible for everyone," he says.
Similarly, if you do not pay rent, the HRA becomes fully taxable. Even if you pay rent, the exemption is linked to your basic pay. It is the least of the following three options: the actual HRA received, 50% of basic pay (40% in non-metros), and actual rent paid minus 10% basic. If you pay a high rent and can claim exemption, include it in the package. If you live in your own house or the rent is very low, replace it with some other allowance. "It would unnecessarily impact your take home pay. Instead, you should go for benefits you can avail of," advises Kaushik.
When you sit down to reconfigure your pay package, keep in mind that the allowances are allocated reasonable amounts. There is no upper limit to how much a company can pay under one head. However, someone with a monthly CTC of Rs 80,000 cannot get Rs 40,000 a month for conveyance and Rs 10,000 for books and periodicals. If this component is unreasonably high, the taxman may raise an objection. "Even though the law has not defined any quantum under these heads, there has to be some rationale behind the amount so claimed," says Neeraj Chauhan, CEO, Financial Mall. How you can rejig compensation structure to make your salary more tax-efficient
Make use of perquisites
One smart way to avoid tax is to opt for a company leased car instead of buying one yourself. Instead of you paying the EMI out of your post-tax income, your employer pays the EMI and includes it in your CTC. This cuts the tax significantly because you are taxed only for the perk value of the car, which is between Rs 1,800 a month (for cars of up to 1600 cc) and Rs 2,400 a month (for cars bigger than 1600 cc). Yes, you don't own the car but it is available to you for all practical purposes. As our calculation shows, if you buy the car you will have a depreciated car valued at Rs 2 lakh at the end of five years, but if your company provides it, you would be able to save more than Rs 2 lakh in tax. "Another benefit of this arrangement is that if you lose your job, the company simply takes back the car. You are not burdened by EMI payments you can't afford," says financial planner Pankaaj Maalde.
The same arrangement can work for other benefits as well. Some companies also offer to fund the higher studies of their employees. If your employer is willing to fund a professional course, the taxable value of such a perk will only be at 10% of the course fee. This means, for a benefit of, say Rs 70,000, you will be taxed for only Rs 7,000. Check if your employer can provide you a laptop or tablet for professional as well as personal use. You will have to pay tax on the perk value of the gadget, which is only 10% of the price of the gadget.
Other tax-efficient perks include food coupons, which can be used at various outlets and departmental stores to buy food items. Most of big grocery chains, fast food outlets and departmental stores accept these coupons. One can take nearly Rs 30,000 worth of meal coupons and gift coupons of up to Rs 5,000 in a year. This has the potential to reduce the tax by almost Rs 10,000 for someone in the 30% tax slab.
Opt for more long-term benefits
Tax can be reduced further if you opt for certain long-term benefits. Every month, 12% of your basic pay flows into your PF account with a matching contribution by your employer. While your contribution fetches you tax benefits under Section 80C, you can opt for investments that give you additional tax benefits over and above the Rs 1.5 lakh deduction under Section 80C. Under Section 80CCD(2), up to 10% of your basic salary is fully deductible if invested in the national Pension System (NPS). Additionally, the employer's contribution, which is up to 10% of the basic, is deductible under Section 80CCE over and above the Rs 1.5 lakh deduction limit for Sections 80C, 80CCC and 80CCD. If your company does not offer you this benefit yet, it's time to ask for it in your forthcoming appraisal. In the highest 30% tax bracket, it will enhance your increment by 3% of your basic salary. All your employer needs to do is rejig the salary structure by reducing any of the fully taxable emoluments (special allowance, performance-linked bonus, etc) and diverting it to this new head in your CTC. How you can rejig compensation structure to make your salary more tax-efficient Become a consultant
Another way to ensure a higher take-home salary and lower tax is by becoming a consultant. Consultants can claim deduction for work-related expenses. As a consultant, your income is taxed under the head 'income from business or profession' and accordingly you can claim deduction of all expenses incurred, including telephone bills, travel, entertainment, stationery and depreciation of assets. This can go a long way in reducing the taxable income for the individual.
However, there are several hassles you need to go through as a consultant. You will have to maintain proper books of accounts and get an audit report in case the gross receipts exceed Rs 15 lakh in a year. A consultant is also liable to pay service tax if his income exceeds Rs 10 lakh. "It is wrong to assume that the tax burden will lessen if one becomes a consultant. It will depends on how much expenditure one has incurred against receipts," cautions Kirit Sanghvi, senior partner, K.S. Sanghvi & Co.
Besides, you stand to forego some benefits you would have otherwise enjoyed as a salaried individual. For instance, HRA, LTA and medical allowance are some key benefits that consultants are not eligible for.
Kumar advises taxpayers to think about the long-term benefits of continuing as an employee rather than becoming fixated with the short-term tax benefits of a consultant.
"In the absence of a robust social security system in the country, professionals should continue working as salaried employees.
They stand to reap certain incidental benefits that help build long-term savings in the form of Provident Fund, as well as certain terminal benefits like gratuity and superannuation."
This should help you design a more taxfriendly compensation package for yourself.