India - A slumbering giant no more?
India, the world's largest democracy, has been seeing a shift in its
political structures in the past few years. In the last three general
elections, no single political party has been able to get sufficient
popular support to secure a majority in Parliament. Coalition
governments seem to be here to stay. Politics then, like the economy,
is becoming market driven. India has seen phenomenal growth in
'New Economy' companies associated with knowledge-based
industries and information technology. It is regarded as the hub of the
worldwide IT solutions development and many multinational
companies have chosen it as a centre for setting up back office
operations, call centres, transcription and translation services within
the country.
The changes in context
Against this background, a battle is raging to
attract and retain high quality talent.
Historically, employers have worked with a
very complex compensation and benefits
structure. This year's budget statement,
however, contained proposals to reduce
tax-sheltered benefits which have formed the
bedrock of compensation for so many years.
If the proposals are translated into law, the
way should have been set for a simplification
of structures and a reinforcement of the new
approach of 'cost the company' in
determining overall compensation and
benefits. To appreciate the importance of
these changes, however, it is important to
look at their historical context in the
provision of compensation and benefits.
Senior executives
Reforms began as long ago as 1991. Prior to
then, governments had followed a socialist
economic policy that justified restrictions on
pay and benefits to top level executives. At
that time, the maximum monthly salary that
could be provided to a senior executive was
Rps 15,000. This policy was relaxed in 1993
and again in 1994. Now companies with
adequate net profits are free to work out a
suitable remuneration package for managing
directors and directors within
the limit of 5% or 10% of net
profits. Companies have taken
advantage of this greater
freedom and salaries and
perquisites of top
management have increased
considerably.
Other employees
For ordinary employees,
compensation structures have
been driven by the various different types
of tax shelters relating to items such as,
housing, car, telephone, mobile phone,
interest subsidy on loans, a chauffeur's
allowance, a helper's allowance,
a gardener's allowance, allowances for
furniture and soft furnishings, work
clothing allowances, professional
education allowances, commuting
allowance and holiday allowance. To
name just a few! Consequently base pay
forms a comparatively low percentage of
an employee's total remuneration.
Managing these complex structures of
allowances has created a considerable
administrative burden for companies.
As far as employees are concerned,
however, benefits available to those
below managerial level remain
government controlled. In the retirement
benefit area, there are two statutory
regimes that must apply to all employees.
Statutory schemes
The Employees Provident Funds and
Miscellaneous Provisions Act of 1952
provides for a compulsory
contributory fund for
employees in a specified list
of industries. As the original
scheme did not provide
wholly effective protection
against premature death, a
family pension scheme was
added in 1971. In 1976,
another scheme was added
to provide a link between
Provident Fund and life
insurance cover.
The Act thus had three elements:
- provident fund
- family pension
- deposit-linked insurance.
In November 1995, the Government
introduced a comprehensive pension
scheme for employees, replacing the
family pension scheme of 1971.
These schemes apply automatically
to most undertakings with 20 or more
employees. Companies with a hundred
or more employees may set up and
administer a private provident fund
subject to obtaining government
authorisation. It has become
increasingly difficult to get such
approval, so most privately managed
schemes are those of older businesses.
The scheme is financed by employee
and the employer contributions.
Employees normally contribute 12% of
their basic salary and 'dearness'
allowance (given to compensate for cost
of living increases and linked to a
consumer price index). Employers
match those contributions paid by
employees. The Act also allows the
Government to specify some industries
where contributions are limited to 10%
from the employee and employer.
One such is the banking industry,
although there are currently moves to
bring this sector within the full
requirements of the Provident
Fund Act.
8.33% of the employee contribution
to the Provident Fund is diverted to the
Employees' Pension Scheme. The
monthly salary limit on which the
contribution is payable is Rps 5,000. All
money belonging to the pension fund is
kept on deposit in a public interest
earning government account.
• In addition to those of the Provident
Fund, employees receive retirement
benefits under the Payment of Gratuity
Act 1972. The minimum benefit under
the Act requires payment of 15 days'
salary, on last salary drawn, for every
completed year of service or part
thereof in excess of 6 months, subject
to a ceiling of Rps 15,000, although
benefits better than the minimum
prescribed by law are allowed. Five
years' continuous service is required for
the payment of the gratuity, but this is
waived in the event of death or
disability. The gratuity must now be
externally funded and the maximum
contribution that the employer may pay
and receive tax deduction is 8.33% of
employee's basic salary and dearness
allowance.
Supplementary retirement provision
Many companies provide an
additional retirement pension
arrangement on top of the
statutory schemes. These are
set up as trust funds and
under income tax rules the
maximum employer
contribution is 15% of the
employee's salary. The trust
must also effect a policy with the state
owned Life Insurance Corporation to
provide employees' retirement pensions
and to protect their families in the
event of earlier death or disability.
Companies have a free hand in
determining the scheme's rules, the
classes of employees covered, the level
of contribution, the vesting period,
transferability, retirement age and
benefits. Most schemes are of a defined
contribution nature, but a number of
the more established companies,
typically subsidiaries or associated
companies of multinationals, have
previously provided defined benefit
arrangements. Retirement age is
typically between 55 and 60 with the
majority being at 58 which is in line
with government rules.
Income tax rules specify how
contributions to a recognised provident
fund or pension fund run by a company
established trust are to be invested.
Under the rules, 15% of the funds must
be in government securities issued by
any state government, or in any other
negotiable securities, with
principal and interest fully
guaranteed by the central
government or any state
government. Another 40%
must be invested in bonds
and securities issued by a
public financial institution,
public sector company or
public sector bank. 55% can
be invested in mutual funds
which invest in gilt
securities for the Government. The
balance of 20% must be kept in the
central government special deposit
scheme and 10% of new contributions
can be invested in infrastructure related
securities.
Most provident, gratuity and
pension fund benefits are determined
by reference to base salary which as
stated before, forms a relatively low
proportion of the total employment cost
for an individual. It is this that presents
the greatest challenge for companies in
integrating the old tax-sheltered
allowances as anticipated by the
Government changes.
Going forward?
The announcement in this
year's budget, therefore, that
the Government is to reduce
the number of tax-sheltered
benefits to only four;
housing, car, retirement and
medical, whilst reducing the
number of tax efficient
allowances does open up the
opportunity for companies to simplify
their overall compensation and benefit
structures.
A significant problem arises,
however, as companies address the
simplification of remuneration
structures. Rolling all these allowances
into basic salary automatically increases
the pensionable pay of individuals and
so significantly increased personal
contributions will be made by
employees into the provident funds
matched by increased company
contributions. Furthermore, where
companies have operated more generous
gratuity schemes than the statutory
minimum, typically granting one
month's salary for each year of service,
without application of the statutory
ceiling of Rps 350,000, a significant
increase in past service liabilities can
arise and also an increase in future
service contributions, as benefits are
based on uplifted salaries. Finally, for
those companies that have operated
defined benefit pension plans, again
significant increases in past service
liabilities will occur as allowances are
made pensionable.
In consequence,
companies face the difficult
management issue of
simplifying and converting
allowances into basic salary,
plus at the same time
adjusting the current level of
retirement provision for
employees in order to retain
costs within acceptable levels.
Other current issues
Reduction in interest rates
As part of their budgetary reforms, the
Government has also announced
changes in interest rates. A year ago the
assured return for provident, gratuity
and superannuation was 12%. The
Government is now proposing to
reduce the assured returns to 9.5%
which will increase the cost to
companies of providing for defined
benefit retirement plans. At the same
time the maximum tax deductible
contribution of 15% to such schemes is
not being changed. The reduction in
interest rates will have an impact on the
annuity rates offered by the Life
Insurance Corporation when employees
convert their pension fund balances or
purchase benefits with the state
insurance company.
Introduction of 401(k) plans
The Government has been toying with
the introduction of a US 401(k) type of
plan which will improve the availability
of retirement funds to the investment
markets, but their budgetary action is
determined to tie returns to the
economic climate of the country.
Deregulation of the insurance sector
In 2000, the Government deregulated
the insurance sector so that a number
of private, local and multinational
insurance joint ventures have been
granted licences to operate in India.
These companies have recently started
launching their products in the market
and are likely to start providing
competition to the state owned Life
Insurance Corporation.
Conclusion
All these changes are heralding a
revolution in the way employees are
rewarded and their benefits are
computed. In moving to the new
'cost to company' approach to
remuneration, there are plenty of
opportunities to incur increased costs.
The restructuring of the remuneration
package will therefore require a careful
balance and demand clear
communication with the employees and
their representatives.
|
Contact Us 