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Wednesday, August 17, 2011

Understanding CTC (Cost To Company) of your Salary and its Components

               Whether you are joining your first job or changing jobs, it is important to understand the difference between Cost to Company (CTC) and take home salary. It will help you in better negotiation with the HR and structuring of the salary.
              The CTC, as quoted by employers and the take home pay are two different amounts. Also salary hikes in the form of an increased CTC doesn’t necessarily increase the monthly salary. So what exactly is this CTC and as an employee what all are you entitled for? This article aims to clarify the confusions that often arise in people’s minds when it comes to salary structures.
              The Cost to Company refers to the total expenditure a company would have to incur to employ you. It includes monetary and non-monetary benefits, such as monthly pay, training costs, accommodation, telephone, medical reimbursements or other expenses, borne by the company to keep you employed. The total CTC as need not be the actual salary in hand at the end of the month. It is simply a sum of various components put together.
              Simply speaking, CTC is the amount that you cost your company. That is, it is the amount that the company spends – directly or indirectly – because of employing you.
Thus, it is the money given to you (your in-hand component), plus the money spent because of you.

First we will see what the components of salary are. Here they are:
  • Basic
  • Dearness Allowance (DA)
  • Incentives or bonuses
  • Conveyance allowance
  • House Rent Allowance (HRA)
  • Medical allowance (Reimbursement)
  • Leave Travel Allowance or Concession (LTA / LTC)
  • Vehicle Allowance
  • Telephone / Mobile Phone Allowance
  • Special Allowance
All the above are a part of your in-hand salary, and therefore, are a part of your CTC pay as well. Now let’s look at some of the other components of your CTC pay – the parts that inflate your CTC package but may not be actually given to you!

Components of CTC
Companies, offer various attractive components in the CTC to retain and boost the morale of the employees. Where some salary components are fully taxable some are fully tax-exempt. The composition of your CTC and a few of its components could be grouped as below-

1) Fixed Salary – This is the major part of your CTC and forms part of your monthly take home. It commonly consists of:
-Basic Salary: The actual pay you receive for rendering services to the company. This is a taxable amount.
-Dearness Allowance: A taxable amount, this is paid to compensate for the rising cost of living.
-House Rent Allowance (or HRA): Paid to meet expenses of renting a house. The least of the following is exempt from tax.
    a) Actual HRA received
    b) 50% of salary (basic + DA) if residing in a metropolitan city, or else 40% for residing in
         non-metro city 
    c) Rent paid – 10 % of your salary (Basic + DA)
-Conveyance Allowance: Paid for daily commute expenses. Up to an amount of Rs 800 per month is exempt from tax.
2) Reimbursements - This is the portion of your CTC, paid as reimbursements through billed claims.
-Meal coupons: Many companies provide their employees with subsidized meal coupons in their cafeterias. Such costs incurred by companies in the form of subsidies are included in the CTC. Meal coupons are tax exempt provided it is not in the form of cash.
-Mobile/Telephone Bills: Telephone or mobile expenditure up to a certain limit is reimbursed by many companies through a billed claim, and is a taxable amount.
-Medical Reimbursements: Paid either monthly or yearly, for medicines and medical treatment. The entire amount is taxable. However, up to Rs 15,000 could be tax exempt, if bills are produced.
3) Retirement Benefits - This is available to you only on retirement or resignation.

-Provident Fund: Employers contribute an equal 12% to the provident fund account. This employer’s contribution though received only on retirement or resignation is an expense incurred by the company every month and thus is included in the CTC.
-Gratuity: Companies manage gratuity through a fund maintained by an insurance company. The payment towards the gratuity annually is sometimes shown in CTC.
4) Other Benefits and Perks
-Leave Travel Allowance: It is the cost of travel anywhere in India for employees on leave. Tax    exemption if allowed twice in a block of four calendar years.
-Medical allowance: Some companies offer medical care through health facilities for employees and their families. The cost of providing this benefit to the employee could also form part of CTC.
-Contribution to Insurance and Pension: Premiums paid by companies on behalf of employees for health, life insurance and Employees’ Pension Scheme, could form a part of the CTC.
-Miscellaneous Benefits: Other perks which companies include under CTC could be electricity, servant, furnishings, credit cards and housing.
5) Bonus: This is the benefit paid on satisfactory work performance for employee motivation. Though this amount is not assured to the employee, most companies include the maximum amount that can be paid as bonus, to the CTC. The two types of bonuses that are normally paid out are:
-Fixed Annual Bonus: Paid on the basis of employee performance, either monthly or in most cases annually, it is a fully taxable amount.
-Productivity Linked Variable Bonus: Complete bonus amount is paid only on 100% achievement of target, nevertheless it still is included as part of your CTC.
A note on salaries of Government Employees:-
We often hear people say that the salary of government employees is quite low. Although there is truth in this, government salaries wouldn’t seem too less if we look at it from a “CTC” point of view.
When we talk about government salaries, we only talk about the “in-hand” component. But we forget that on a cost-to-company basis, it can be quite substantial.

What extras do government servants get? Here’s a sample list:

  • The 12% of basic that the government deposits in their PF accounts, just like private companies
  • Membership of government clubs or gymkhanas
  • Free stay at various circuit houses and government guest houses
  • Free telephone connection at home
  • Free car with driver
  • Reimbursement of newspaper bills
  • Free use of many libraries
  • In case of defense personnel (Army / Navy / Air Force), a huge subsidy on items bought from their “canteens” (like groceries, appliances, etc.)
When these things are taken into account and salaries of government employees is considered on a cost to company (CTC) basis, it won’t seem too less compared to the private sector!

Having understood what CTC is:
             Each company too has its own way of calculating the cost to company. One must take time to find out what the actual benefits are by asking for the break-up of the CTC so as to know the entitlement.
             If you are just joining the company, try to negotiate with the HR as to opting out of some facilities in exchange for increasing the take home.
            Understand the expenditure limits and tax angle of perks and benefits, and use them smartly. In further articles we will see tax implications of each of these components separately.

Saturday, August 13, 2011

Tax Basics

Taxes form a major source of revenue for the Government. These are of two types:
a) Direct Tax - Direct taxes like income-tax, wealth-tax, expenditure-tax etc.  are those whose burden falls directly on the taxpayer.
b) Indirect Tax - Indirect taxes like excise duty, customs duty, service tax, sales tax, etc  form the cluster of indirect taxes.

In personal finance we will deal with income tax which falls on total income of a person. A person includes-

1. An Individual
2. Hindu Undivided Family
3. Firm
4. Association of Persons or Body of Individuals
5. Local Authority - BMC, NMMC
6. Artificial Juridical Person - Trusts (Religious / Educational Trust)

Assessee – An income tax is to be paid by the assesse under this act. Assessee  means a person by whom tax is payable, or a person by whom any other sum of money (interest / penalty) is payable.
Assessment Year (AY) – Income tax is charged in an assessment year (1st April – 31st March). Income earned in previous year (PY) is charged in AY.
Previous Year (PY) – PY means a financial year immediately preceding AY. It is the year in which an income is earned.

Types of income
Income tax is a tax on all incomes received, or accruing, or arising to a tax payer during a previous year. Incomes from various sources are computed under five different heads as:
1.  Salary: Includes allowances, value of perquisites, profits in lieu of salary and pension.
2.  House Property: whether residential or commercial, self-occupied or rented.
3.  Profits and gains: from business or profession
4.  Capital gains
5.  Income from other sources: - Includes bank interest, interest on securities, lotteries, crossword puzzles, races, games, gifts from unrelated persons exceeding the specified limit etc.
Gross total income is total income computed before making any deductions under chapter VI-A. Total income is calculated after making deductions and rebate known as taxable income.

Exemption vs Deduction vs Rebate
Exemption – It is not considered under any source of income while calculating total income of a person.
Deduction – First mention the head of income then claim the deduction.
Rebate – It is allowed on the amount of income tax so computed.

Determination of Residential Status of an individual–
According to Income Tax Act 1961, every person, who is an assessee and whose total income exceeds the maximum exemption limit, shall be chargeable to the income tax at the rate or rates prescribed in the finance act. Such income tax shall be paid on the total income of the previous year in the relevant assessment year. However scope of the total income depends on the residential status of a person. The residential status of a person is determined for each previous year separately.

It is determined on the basis of the physical presence of the individual as against nationality or domicile in India. It is determined for every previous year separately. A person may be a resident in one previous year and non-resident in next year.
An individual may be resident, Resident and ordinary resident, Non-resident or resident but  not ordinarily resident.

a) Resident:
 An individual is treated as resident in a year if he is present in India, any one of the following conditions to be satisfied:-
           i)  For 182 days or more during the previous year
          ii)  For 60 days or more during the previous year and 365 days or more during the preceding four previous years
However this second condition is not applicable for Indian citizen or a person of Indian origin or a person coming on a visit to India or in case of an Indian citizen going abroad as a member of the crew of an Indian ship or for employment
              Hindu Undivided Family or Firm or other Association of Persons is Resident of India in any previous year except where the control and management of its affairs is wholly situated outside India in that previous year.
Company is resident of India if
 i)  It is an Indian company
 ii) During the previous year its control and management is Situated wholly in India.

b) Resident and ordinarily resident (ROR)-
For person to be ROR, both the following conditions are to be satisfied-
1) He has been resident in India in 2 out of the 10 P.Ys preceding the relevant P.Y.
2) He has been in India of 730 days or more during the 7 P.Ys preceding the relevant P.Y.
If none or only one of the above condition is satisfied, the individual will be treated as a resident but not ordinarily resident (RBNOR). 

c) Resident but not ordinarily resident (RBNOR):
A resident who was not present in India for 730 days during the preceding seven years or who was non-resident in nine out of ten preceding years or resident in India in 2 out of the 10 P.Ys preceding the relevant P.Y. is treated as not ordinarily resident. In effect, a newcomer to India remains not ordinarily resident.

d) Non-resident:
Non-residents are taxed only on income that is received in India or arises or is deemed to arise in India. A person not ordinarily resident is taxed like a non-resident but is also liable to tax on income accruing abroad if it is from a business controlled in or a profession set up in India.

Income Received in India-
Income received in India is included in the total income of all the persons, irrespective of their residential status. Any amount received outside India but later on brought to India is not treated as income received in India. Also past untaxed foreign income (i.e. Income earned outside India) brought to India during PY is not treated as income received in India. Hence not taxable.

So this is all what I wanted to cover in basics of tax. In upcoming articles we will see each and every head of income and their tax implications. Also we will see how you can save tax (legally :)) with little restructuring of the income that you earn. Any additions / comments are welcome.
Till then Ciao!

Thursday, August 11, 2011

A Bit About Time Value of Money

Ever wondered how the value of money grows when invested and falls when not invested? Here comes the concept of time value of money. A rupee today is more valuable than a rupee a year after. This is so because, in such an inflationary period a rupee today represents a greater real purchasing power than a rupee a year after. Also rupee earned today can be employed productively to generate positive returns. 
Let us see this by a simple illustration - 

Assuming a 5% interest rate, Rs. 100 invested today will be worth Rs. 105 in one year (Rs100 multiplied by 1.05).  Conversely, Rs100 received one year from now is only worth Rs. 95.24 today (Rs100 divided by 1.05), assuming a 5% interest rate.
This is how your money grows when invested and degrades when not invested. Now when it is invested, see the difference of earning between interest earned on simple interest method and that earned on compound interest method.

To make it simpler see the diagram

The money earned in future has less value (which is interest factor ) as compared to the money earned today (which can be invested to earn interest on it.

Mr. Sharukh Khan invested Rs.1000 for Three years in a savings account that pays 10% interest p.a. Mr. Khan Reinvests the 22 interest earned. What would be the total amount after three years?

Compound Interest

Simple Interest










Here you clearly see the difference of earnings. Compounding maximizes your return by making interest portion also participate in growth of money.
Now what about the constant cash flow you receive will change. Here comes the concept of annuity.
An Annuity is a stream of Constant Cash Flow (payment or receipt) occurring at regular intervals of time.

E.g. EMI payment, Payment of life insurance premium
Two types of annuity
1. Deferred annuity / Ordinary Annuity / Regular Annuity - When Cash Flows occur at the end of each Period.
2. Annuity due - When the Cash Flow occur at the beginning of each period.
1. Deferred Annuity
Mr. Gates deposited Rs. 1000 annually at the end of the year in a bank for 5 years & earns a compound Interest rate of 10% p.a. What will be the value of the deposit after 5 Years ?



Amount invested







2. Annuity due-
Mr. Gates deposited Rs. 1000 annually at the beginning of the year in a bank for 5 years & earns a compound Interest rate of 10% p.a. What will be the value of the deposit after 5 Years?



Amount invested







This concludes that it is always better if you receive your annuity at the beginning of the year so as to maximize your returns.
Here arise some concepts-

Present value - It is the value on a given date of a future payment or series of future payments, discounted to reflect the time value of money.

Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.

E.g. You have to lend Rs 1,00,000 to one of your friends and He is offering you following choices .
Choice 1 : He will pay you Rs 18,000 per year for next 10 yrs .
Choice 2 : He will pay you 13,000 per year for next 15 yrs .
Choice 3 : He will pay you Rs 8,000 per year for whole life .

Which One should you choose?
You have to see that which choice has the highest worth if you calculate its Value today . So how do you calculate the Net Present Value in this case , where you have Rs X receivable every year for n years . Here you also have to consider present rate of returns which you can assume at 8% .

So We have 3 variables
X : Amount received per year
n : Number of years
r : Present rate of return
NPV = X * [(1+r)^n - 1]/[r * (1+r)^n]
Calculating through this formula , we get the NPV of the choices as
1. 120781
2. 111273
3. 100000

Net Present Value of the last choice is simple , how much money do you put in bank today that will fetch you 8,000 per year forever ? If X is the amount than at 8% interest you get 8,000 , so

8% of X = 8,000
.08 * X = 8,000
X = 8,000 * (1/.08)
X = 1,00,000

If you see the total amount received in all the cases you will realise that the choices with lesser NPV will give you have higher Total amount .

For Case 1 : NPV = 120781 , Total amount received = 1,80,000
For Case 2 : NPV = 111273 , Total amount received = 1,95,000
For Case 3 : NPV = 100000 , Total amount received = Infinite (The amount is paid forever)

The present value of the 3rd option is less so it is better option. So we see the lowest present value for our future cash flows gives us maximum return of money.

Future value -
You can afford to put Rs. 10,000 in a savings account today that pays 6% interest compounded annually.   How much will you have 5 years from now if you make no withdrawals?
PV = 10,000
i = .06
n = 5

FV = 10,000 (1 + .06)5 =  10,000 (1.338) = 13,382  

End of Year

Thus we conclude that Rs. 13382 received after 5 years is equivalent to Rs. 10000 invested today.

Thus to conclude time value of money has greater significance to determine how much your money is worth. So before investing do the necessary calculation and achieve the maximum from your portfolio.

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