While an increased CTC is always a wonderful thing, it can also mean increase tax liability. Fortunately, there are ways to reduce your taxes
After two years of hard work, Atul Agnihotri got a much-deserved raise and a promotion. He was so overjoyed that he threw a party. There, a friend asked him about his increased Cost to Company (CTC). When Atul detailed his CTC break-up, the friend pointed out that the raise, in effect, was hardly a raise. That is because the increment had increased his tax liability. This meant that the tax would, in effect, eat up much of the raise. Atul was shocked. The friend then explained that certain components of his CTC could help save taxes, too.
Atul is not an exception. Many employees rejoice when their CTC increases, but rarely pay attention to the various components. It is important to know that these can save taxes and increase your take-home pay. Each component invites a different tax treatment. Let us understand these components in detail.
Components of CTC
Basic Pay: This is the primary component of your CTC, also called ‘Basic Salary’. It makes up a major part of your CTC. The basic pay is fully taxable in the tax slab in which your income falls. The higher the basic pay, the higher your tax liability.
Allowances: If you study your CTC, you will find a mention of ‘Allowances’ and a limit against it. Your employer offers various allowances, some of which are tax-free. Popular tax-free allowances include the following:
• House Rent Allowance (HRA): The taxes on HRA are applicable if you live in a rented house. According to prevalent tax laws, the amount of HRA exempted must be lower than:
- The actual HRA received
- 50% of your basic pay if you live in a metro city; otherwise, 40% of your basic pay
- (Rent paid) – (10% of basic pay)
• Conveyance allowance: This pays the costs you incur when conveying to and from office. The highest amount you can claim as the exemption is Rs. 1,600 per month.
• Leave Travel Allowance (LTA): LTA allows your employer to cover your travelling expenses when on leave from work. LTA is exempt from tax under Section 10(5). At the most, an employee can claim it twice in a block of four continuous years. However, remember that LTA covers only domestic travel, and you must submit actual bills to claim this exemption.
• Children’s education and hostel allowance: The limit of exemption is Rs. 100 per month for two children. For hostel allowance, your children should be staying in a hostel. Here, the allowance exempted from tax is Rs. 300 per month for two children.
Perquisites: Perquisites are some fringe benefits that employers offer. These are usually taxable, but some are tax-exempt.
• Taxable pre-requisites: This includes rent free accommodation, supply of gas, water and electricity, employee professional tax, reimbursement of medical expense, and salary of servant. Fringe benefits provided to employees such as free meals, gifts above Rs. 5000, club and gym facilities etc. are also part of this.
• Tax exempted perquisites: Travel allowance, computer or laptop provided by companies for official use, refreshments given during working hours, medical aid provision, use of health club or sports club (if any), telephone facilities, interest fee salary loan, contribution to provident fund, free medical and recreational facilities, etc.
Some lesser-known perquisites offered to employees that are taxable include:
• Company owned car used by an employee
• Education facilities provided to an employee’s children
• Accommodation facilities and domestic help
Contributions: These are tax-free payments your employer makes towards your social security schemes. Some popular tax-free contributions include:
• Employee Provident Fund (EPF): Both, you and your employer contribute towards the EPF scheme. Your contribution can be claimed as a deduction under section 80C, when filing tax returns. The limit for claiming exemptions is 12% of your basic pay.
• Employee State Insurance Corporation (ESIC): If your monthly gross income is below Rs. 15,000, your employer will contribute 4.75% of it towards ESIC. This scheme provides insurance coverage. Your employer’s contribution is part of your CTC, and is tax-free.
• National Pension Scheme (NPS) contributions: Your employer’s contribution towards the NPS is exempt from tax up to 10% of your salary.
Understanding how these CTC components work, can help you save taxes. So, the next time you negotiate your CTC, do not make the same mistake Atul made. Keep an eye out for the tax-free components. You can also talk to a financial expert to help you negotiate a CTC that ensures you optimum benefits.
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or insurance or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.