Does Basic Salary need to be 60% of Total?

Meaning of Basic Salary

Terms like “Gross Pay”, “Cost to Company”, “Allowances”, “Deductions” etc get thrown around by folks in different circumstances during employment. Employees naturally get confused. In this blog, I will attempt to delineate the term “Basic Salary” and the legal provisions associated with the term in order to uncomplicate this unnecessarily complicated term.

Firstly, let’s understand the meaning of some terms used in the Labor Act and Bonus Act.

  • Labor Act 2074, Section 2(Ka): Basic Remuneration means the basic remuneration for employment received by the labor and the term shall also include annual increment in remuneration.
    The amount of increment in remuneration each year shall be equal to the half day’s remuneration of the concerned worker or employee. Meaning, with every passing year, a grade of Rs. (Basic Monthly Salary/30)×(1/2) is added to the monthly basic remuneration payment under Section 36 of the Labor Act 2074.
  • Labor Act 2074 Section 2(Jha): Remuneration means the basic remuneration received by the labor and the term shall also include allowance.
  • Bonus Act 2030 Section 2(gna): Salary or Wage means any kind of remuneration receivable by an employee in cash for the work done in an enterprise. Provided that, this term does not include any other amounts to be obtained by an employee for electricity, water supply, medicine, travel, bonus, provident fund or subsidies.
    As per the definition provided in Bonus Act, Salary or Wage means remuneration but it excludes any allowance, bonus, or social security contribution. Essentially, Salary or Wage simply means Remuneration other than allowances.

The above definition tries to provide a technical definition of the term “basic salary” but what exactly is the spirit and concept of basic salary? Let’s take an example to understand this better. There is one office that provides vehicle facility to employees to pick them up during the mornings and drop them to their places at the end of their workshifts. Traveling to the office is a minimum cost that every employee has to bear so when the office is providing this facility to employees, the employees get benefits in kind. In a pure economic sense the cost of picking and dropping employees nearer to the factory is low whereas some from rather long distance may be higher. But the facility is not seen as non-equitable just because some employees live closer or farther from their factories. Let’s say the entity decides to drop the inhouse pick and drop facility and rather compensate employees in monetary terms. Obviously the transportation allowance that is given in this form would mean that employees closer to the factory will receive a transportation allowance that is lower than the employees living farther from the factory – despite having the equal basic salaries. In the example, let’s assume that the entity also in the past provided factory quarters to the families of the workers which they decided to drop and provide monetary allowance instead. In this case the workers living closer to the factory may have to pay higher rents than the workers living farther from the factories and their rent/housing allowance could differ potentially. But what about the basic difficulties that are borne by the workers living farther from the factory have to face due to transportation cost, market unavailability, remoteness etc. This may require the workers living farther from the factory area may need an additional dearness allowance to be provided to them. Again, what about the basic medical checkups and bills that workers living closer to the factory need to face as a reason for the waste of the factory? It’s only fair that they receive some basic medical allowance against those. So as we can observe, setting salaries and allowance is a very complicated task and more often than not these differences will lead to employee dissatisfaction because everyone has their own expectations and assumptions. This complicates further when we are dealing with workers working in different designations, levels and seniority. Due to these complexities we have seen employers resort to a rather simple approach of determining the allowance amounts as a percentage of the total salary – which actually defeats the purpose and meaning of the term “allowance” but this is a quick solution to avoid any employee dissatisfaction. This is also one of the main reasons why modern companies and economies compensate employees on an hourly basis or work based compensation, altogether avoiding the need to allocate the total compensation into basic salaries and allowances in most cases.

So it’s quite complicated to equitability and logically break the total compensation into basic salary and allowances – so the allocation of total compensation into basic salary and allowances based on percentages is quite common as it is an easy way out to avoid these human resources and calculation related complexities.

So how is Basic Salary determined?

Well it is not as easy as setting a percentage out of the total compensation to break it into the basic salaries and allowances. Normally we observe the employers allocating 60% of the total compensation as basic salary and arbitrarily distributing the other 40% of the total compensation into several headings of allowances. But is it really the correct approach to do it? What kind of allowances should constitute the employee compensation?
We can theoretically and logically construe that the allowances provided in top of the basic salary should at least be indicative of the followings:

  • The allowance should be a common basic expenditure made by the employee from their employment income (i.e. traveling expense, communication expense, rent expense, medical expense, and insurance expense etc.)
  • The allowance should be an expense of the employee of personal nature
  • The amount of the allowance should be the minimum common expenditure of the working population in that category
  • The headings of the allowance should be in the nature of controlled and regulated expenditure of public interest (e.g. public school education, basic medical amenities, traveling expense, communication expense, basic rent and insurance expenses etc.) those that have public drive for price check and regulation (i.e. it should not include headings of entertainment expenditure, refreshments, fooding, capital expenditures etc. where the cost are driven by personal preferences)
  • Generally, the expenses under the headings of the allowances should be of fixed nature and not variable on the number of hours of employment.

Components of Employee Compensation

Total compensation is usually expressed in annual, gross terms. Total compensation is the total value of any or all benefits paid to employees. Remuneration is only one component of total compensation. Total compensation includes:

  1. Remuneration
    • Basic Remuneration
      • Base Salary
      • Annual Increment
    • Allowance
    • Overtime Pay
  2. Bonus
  3. Social Security Contribution

Everything depends on Basic Salary

It is very essential that the ratio of basic salary is correctly determined and employers should not simply get away by setting 60% as the basic salary rate without proper explanation. The Labor Department should also be really cautious on how the rates of basic salaries and allowances are being set or decided. This is mainly because every other labor form of employment benefits and labor protection depends on what the rate of basic salary has been determined. Some of them are listed below:

  1. The provident fund, gratuity and social security contributions made by the employer is based on the basic salary (Section 21 of Labor Act 2074)
  2. The rate of the overtime payment for the employees is based on the basic salary (Section 31 of the Labor Act 2074)
  3. Annual salary increment / grades is based on the basic salary (Section 36 of the Labor Act 2074)
  4. Festival allowance provided by the employer to employee is based on the basic salary (Section 37 of the Labor Act 2074)
  5. Leave encashment of the employee is based on the basic salary (Section 49 of the Labor Act 2074)
  6. The retrenchment compensation provided to employee is based on the basic salary (Section 145 of the Labor Act 2074)
  7. The benefits under many schemes under Contribution based Social Security Fund Act 2074 is based on the basic salary (Section 35 of the Contribution based Social Security Fund Act 2074)

Does it really have to be 60%?

An important question we all have is whether or not there is a predetermined rate to set the basic salary. We keep hearing discussions whether the basic salary has to be at least 60% of the total compensation. Well that is not true exactly. We have learnt and discussed above that the determination of the base salary is a much more nuanced topic than just determining the percentage rate of basic salary.

The Ministry of Labor, Employment and Social Security under Section 106 of the Labor Act 2074 fixes the minimum remuneration of the employees every two years on the recommendation of the Minimum Remuneration Fixation Committee and publishes it in the national gazette. Such a fixed minimum remuneration comes into force on the first day of the new financial year provided that if it is otherwise agreed between the trade union and the employer concerning the date of coming into force of the minimum remuneration, it comes into force accordingly.

Section 170 of the Labor Act 2074 provides that the basic remuneration of the labor on task-based employment shall be determined as prescribed. Provided that if not so determined, the minimum remuneration fixed for the laborers shall be regarded as the basic remuneration. Similarly, in the case of laborers on piece rate work, the rate of wage per piece shall be determined as prescribed on the basis of the minimum remuneration fixed pursuant to this Act.

As of date, no such remuneration has been prescribed specifically for task based employment, piece rate work also being a type of task based employment. Despite that it is wise to set a minimum compensation on work or piece based on the harmonic mean of the productivity among the employees in the industry. It is better to make this study at least internally so that the employees are not deprived of the minimum compensation – even when this has not been set specifically by the department or ministry. In the meanwhile the minimum remuneration set by the ministry for the regular / time based employment can be taken as guidance for this internal assessment by the employers.

In case of the work based employment, there is an additional direction given in Rule 77 of Labor Rules 2075 which provides that the minimum basic salary of the employees under work based employment shall be equal to the 60% of the average of the last three months salary. This provision normalizes the productivity of the employees working in work based employment to have the basic salary determined. This is a rather quick fix for a rather complicated problem – but still very commendable at the rate specified i.e. 60% is a very appreciable ratio in terms of the total compensation. It also ensures that the basic salary rate so specified for the work based employment should not be lower than the minimum basic salary rate determined by the ministry.

Minimum Remuneration Link 
Salary Structure for Minimum Remuneration

So what about the basic salary rate of employment other than work based employment? Viz. Regular Employment, Time Based Employment and Casual Employment and Part Time Employment? The rate of the basic salary for these employees has not been determined but it is obvious that they should at least meet the minimum salary determined by the ministry. When the salaries are well above the government determined minimum salary, they may be set in a manner fit considering the principles of setting basic salary and allowances and discussed above in earlier topics. However, employers should have a reason and basis for the determination of the rates of the basic salaries – it is better to have them prepared through a logical and technical assessment rather than setting them arbitrarily to minimize the cost to the employer. Employers also need to be cautious that where the rate of the basic salary has not been determined normally 60% of the total compensation could be construed as a basic salary (for compensation purposes) as indicated in Rule 77(3) of the Labor Rules. This again although only an indicative provision could be construed as compulsory and create employment liabilities to the employer if this should come to a dispute – so it is always wise to have a salary structure set and announced in an entity.