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Mohan is a 26-year-old management graduate recruited by a startup company in Mumbai

recently. The company has offered him a CTC package of Rs 10 lakh. However, the company has
given him the flexibility to structure the salary part of his CTC as per his requirements. How
should Mohan structure his salary so as to derive maximum benefit?

Mohan needs to consider the following outflows while deciding his CTC structure:

• An annual rent payment of Rs 2 lakh


• An annual payment of Rs 1 lakh towards interest on his education loan.

Components of CTC

The cost to company (CTC) figure quoted by a company indicates the total amount of money it
will spend on an employee. Some of the important heads under CTC are:

• Basic Salary
• House Rent Allowance
• Supplementary Allowance
• Company’s Contribution to Provident Fund/Gratuity
• Company’s Cost on various perks:
o Child Education and Hostel Allowance
o Transport Reimbursement
o Lunch Coupons
o Medical Reimbursement
o LTA Reimbursement
o Car & Driver Reimbursement

What will Mohan achieve by structuring his salary?

To structure his salary, Mohan needs to divide the Rs 10-lakh CTC under various heads that are
mentioned earlier. But while doing so, he should also keep in mind his financial goals. By
structuring his salary Mohan can either reduce his overall tax liability or maximise his in-hand
salary.
How can Mohan minimise his taxes?

When interest rate is 9%

• Utilising various deductions allowed under the Income Tax Act, to the maximum.
• Allocating the CTC amount to various tax-deductible reimbursements like transport,
lunch coupons, etc.
• Splitting the CTC amount into Basic Salary, HRA and Supplementary Allowance such
that tax is minimised on account of HRA exemption and Section 80C.

I. Deductions

Mohan can avail the following deductions to reduce his taxable income:

Outflow

• Rs. 1 lakh, the interest payment on his education loan, is tax-deductible under Section
80E
• Contribution to PF, up to Rs 1 lakh, is tax-deductible under Section 80C

Mohan should, thus, optimise the breakup of CTC (basic salary and PF contribution) and also his
investments such that this limit is met.

II. Tax-deductible reimbursements


Mohan can claim various reimbursements that are also tax deductible. These include:

Tax-exempt Limit Exemption for Mohan


Reimbursement
(Rs) (Rs)
Child education & Hostel allowance* 9,600 0
Transport 9,600 9,600
Lunch coupons 15,600 15,600
Medical 15,000 15,000
LTA As per claim 0
Car & Driver * 26,400 0
Total 40,200

* We assume that Mohan does not have any children and that he does not use a car. Thus, he
cannot avail reimbursements under these two heads.

III. Allocation of CTC

Let us now look at some possible breakups of Mohan’s CTC and the tax he will be paying on
each of them:

Basic Salary as a % of CTC 60% 74.5% 80%


Basic salary (Rs) 6,00,000 7,45,000 800,000
House rent allowance (Rs) 2,87,800 1,25,400 63,800
Transport reimbursement (Rs) 9,600 9,600 9,600
Lunch coupons (Rs) 15,600 15,600 15,600
Medical reimbursement (Rs) 15,000 15,000 15,000
Company’s PF contribution (Rs) 72,000 89,400 96,000
Total Gross Salary (Rs) 10,00,000 10,00,000 1,000,000
Deductions
Employee contribution to PF (80C) (Rs) 72,000 89,400 96,000
Interest repayment on education loan (80E)
1,00,000 1,00,000 100,000
(Rs)
Annual Tax (Rs) 76,241 69,999 84,954

Unutilised deductions u/s 80C (Rs) 28,000 10,600 4,000


Tax exemption on HRA (Rs) 1,40,000 1,25,400 63,800
Taxable HRA (Rs) 1,47,800 0 0
We see that Mohan’s tax liability is minimal when the basic salary is 74.5 per cent of CTC. This
is the optimal percentage at which Mohan’s tax liability is minimum. As we decrease or increase
the basic salary from this optimal percentage, the tax liability increases. Optimal percentage is
the percentage at which Mohan is getting the maximum tax benefit from exemption under HRA
and deductions under Section 80C combined.

As the basic salary is decreased from the optimal percentage, employee’s contribution to PF also
reduces, which in turn reduces the tax-deductible income under Section 80C. This means there
will be a greater taxable income and hence a greater income tax. This will lead to an increase in
the tax exemption limit under HRA, which means an increase in the amount of CTC allocated to
HRA and the taxable HRA. This translates into a greater tax liability.

On the other hand, when the basic salary is increased from the optimal percentage, a smaller
amount of CTC is allocated to HRA and the tax benefit on HRA is not fully utilised. Also, the
employee pays tax on this amount which is now allocated under basic salary. This translates into
a greater tax liability.

Mohan’s tax liability vs basic salary

If we were to plot a graph of Mohan’s tax liability versus his basic salary as a percentage of his
CTC, we get the following:

This graph shows that there is an ideal level (70%-80% of CTC) at which Mohan can minimise
his tax liability. This level depends on the rent he pays, the deductions he claims and the CTC
that he gets (among other things). This level will be different for different people. You can use
our calculator to find the optimal CTC breakup for you.

Let us compare the optimal possibility with another possibility (A) in which Mohan decides to
rent a costlier house at Rs 3 lakh and invests another Rs 30,000 into NSS (deductible under
Section 80C). The new salary structure and annual tax would be as under:
Basic Salary as a % of CTC 74.5% Possibility A
Basic salary (Rs) 7,45,000 6,46,000
House rent allowance (Rs) 1,25,400 2,36,280
Transport reimbursement (Rs) 9,600 9,600
Lunch coupons (Rs) 15,600 15,600
Medical reimbursement (Rs) 15,000 15,000
Company’s PF contribution (Rs) 89,400 77,520
Total Gross Salary (Rs) 10,00,000 10,00,000
Deductions
Employee contribution to PF (80C) (Rs) 89,400 77,520
Interest payment on education loan (80E) (Rs)1,00,000 1,00,000
Annual Tax (Rs) 69,999 42,123

Unutilised deductions (80C) (Rs) 10,600 0


Tax exemption on HRA (Rs) 1,25,400 2,35,400
Taxable HRA (Rs) 0 880

In possibility A, Mohan is paying significantly lower taxes because:

• Increase in annual rent paid: By renting a costlier house, Mohan is able to avail the
maximum limit on tax exemption on HRA. Thus his total taxable income is reduced and
so is his tax liability. In short, Mohan can stay in a better house and still pay lesser taxes!
• Increase in deduction under Section 80C: Mohan has decided to invest another Rs 30,000
in NSS. This helps him get the maximum deduction limit under Section 80C, which
further reduces his tax liability.

The key to lower taxes is to utilise the total tax deduction limit available under both HRA and
Sec 80C. The HRA limit can be completely utilised by paying a higher rent (as far as possible)
whereas in case of the 80C limit it is done by investing into available options.

There are several options available to Mohan to invest under Section 80C. He could put his
money in provident fund, insurance schemes, NSC, NSS, post office, tax-saver (ELSS) mutual
funds, etc. Mohan must remember that for every rupee that he invests in PF, the company has to
put in an equivalent amount. Thus Mohan gets a double benefit. For every rupee that he invests
in his retirement fund, another rupee gets invested automatically. Hence if his company allows it,
Mohan might want to use PF as the major head to utilise the limit under Section 80C.

How can Mohan attain a significant monthly in-hand salary?

Instead of minimising his annual tax liability, Mohan might be interested in increasing his
monthly take home salary. Let us first understand the components of take home (in-hand) salary.
The monthly in-hand salary consists of:

• Basic salary
• House rent allowance
• Supplementary allowances
• Reimbursement under certain heads like transport, car and driver, etc.

From this total, contribution of the employee to provident fund, professional tax and income tax
are deducted.

Let us compare Mohan’s take home salary in two different salary structures: Possibility A
(described earlier) and possibility B (another salary structure).

Basic Salary as a % of CTC Possibility A Possibility B


Basic salary (Rs) 6,46,000 4,00,000
House rent allowance (Rs) 2,36,280 2,00,000
Supplementary allowance (Rs) 0 3,11,800
Transport reimbursement (Rs) 9,600 9,600
- Employee’s PF contribution (Rs) (77,520) (48,000)
- Professional tax (Rs) (2,400) (2,400)
- Annual income tax (Rs) (42,123) (56,465)
Net Annual In-hand Salary (Rs) 7,43,631 8,18,182
In-hand Monthly Salary (Rs) 64,153 67,878
*Notes:

• In possibility B, it has been assumed that the exemption limit for 80C has been met by
additional investments (similar to possibility A).
• Certain other reimbursements which are made either quarterly or annually have not been
included in the monthly in-hand salary. These include:
o Child education and hostel reimbursement
o Lunch coupons
o Medical reimbursement
o LTA reimbursement

To see an example click here

As discussed above, Mohan’s tax liability is minimised in possibility A. In possibility B, he pays


a marginally higher tax but at the same time takes home significantly greater salary. This is
because Mohan’s contribution to provident fund is reduced by almost Rs. 30,000 in option B. By
choosing option B over option A, Mohan might benefit by taking home greater salary but he
loses by paying greater income tax and saving less for his future. Further, the effect of reduction
in PF is twofold because not only Mohan’s contribution to savings is reduced but the company’s
contribution to PF is also reduced by an equivalent amount.
Summing it up

• To minimise taxes, Mohan needs to utilise tax exemption limits under HRA and Section
80C, to the maximum.
• Annual rent paid plays an important role in determining the overall tax liability. Higher
the rent paid, greater is the salary exemptible under HRA. Mohan might be better off
paying a higher rent as it would mean a lower tax liability for him. He can get the dual
benefit of living in a better house and paying lower taxes at the same time.
• To utilise the limit under Section 80C, investment into provident fund will be a better
option than insurance, NSC, MFs, etc. The reason: the employer has to invest an equal
amount into the provident fund as the employee – which doubles the investment for
Mohan. Also, the employer’s contribution is tax free.
• Various allowances and reimbursements, for example, lunch coupons, transport, LTA,
car & driver, etc., are a good means to reduce net taxable income and hence the overall
tax liability.
• Mohan can structure his CTC to reduce his tax liability or to maximise in-hand income.
In order to increase the take home salary, he has to pay a higher income tax and make
lesser investments towards retirement