How To Optimise Your Cost To Company (CTC) To Save Income Tax
Broadly, the CTC can be divided into four components – basic, allowances, perquisites and retirement benefits/contributions. Tax treatment is different for each component and, hence, can impact your tax liability.
Basic salaryRead more ↓
Employees should take note of the fact that the basic salary is fully taxable. Therefore, it is paramount for them to decide what portion of CTC should be their basic salary. A higher basic pay means a higher tax liability. However, it does not imply that you go for a low basic pay because the other components of salary exemptions such as HRA (house rent allowance) and employee provident fund are linked to the basic pay. Essentially, designing an efficient tax pay structure is a trade-off between higher take-home pay and maximum tax benefits.
Junior-level employees need a higher take-home salary. They should add more fixed allowances to their salary structure such as food allowance, medical reimbursement, conveyance allowance, telephone etc. These allowances are fixed and payable monthly to the employee. However, employees get taxed on these to a certain extent but, at a lower rate.
Senior-level employees fall into a higher tax bracket. They are not only concerned about a higher take-home salary but, at the same time, they want to reduce their tax burden. It is in their best interest to add more benefits in their salary structure.
Another way to save tax is to include allowances in your pay structure. The Income Tax Act has prescribed certain allowances for all the salaried individuals that are exempt at source. Such allowances include HRA, medical reimbursement, transport allowance, LTA/LTC, uniform allowance/corporate attire, children education allowance, children hostel allowance, professional pursuit/research allowance and performance bonus (annual).
Again, the Income Tax Act allows an exemption for certain perquisites (additional benefits or amenities provided by an employer to an employee), which if included as a component of salary can result in tax savings. Important ones are meal voucher, health club, sports and similar facility, gift voucher, mobile/telephone reimbursement, books and periodicals and company leased car.
This component of salary is in the nature of long-term savings for an employee. Although it results in a lesser take-home pay, it is one of the most important components of any salary. To encourage individuals to save for a good retirement corpus, the income tax laws allow certain exemptions and deductions for these contributions.
These include provident fund contributions and contribution to NPS or National Pension Scheme. In provident fund, where an employer’s contribution is exempt up to 12 per cent of salary, the contribution made by an employee qualifies for tax deduction up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. In NPS, employer’s contribution is exempt up to 10 per cent of salary and that of employee qualifies for deduction up to Rs. 50,000 over and above the limit of Rs.1.5 lakh under Section 80C.
Hence, the goal of an employee should be to have a right mix of all the different components in the salary structure to save maximum tax and, at the same time, get a higher take-home pay.