Post-independence, India saw its legislators make several social security and welfare legislations aimed at providing statutory benefits and protections to the Indian working class. Over the decades, the legislators, the Government of India and the labour authorities have been reasonably steadfast in upholding and safeguarding the interests of the Indian workforce.
The Legislative Framework – brief summary
In 1952, India formulated the legal regime governing provident funds in India vide the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952 (“EPF Act”), the Employees Provident Fund Scheme, 1952 (“EPF Scheme”), and related rules and schemes. Through the EPF Act and the EPF Scheme, the Government of India (“Government”) implemented a mandatory Government-backed savings scheme for salaried employees whereunder both the employers and employees were required to make contributions to a statutory fund with the objective of accumulating a retiral corpus from such monthly contributions, compounded by the interest declared by the Government on such contributions every year.
Presently an employer covered under the EPF Act is required to make monthly contributions towards the statutory fund at the rate of 12% of the basic wages, dearness allowance and retaining allowance payable to employees (collectively, “PF Wages”). Employees are also required to make an equal and matching contribution which is deducted from their salaries by the employer and deposited with the Employee Provident Fund Organization (“EPFO”) along with the employer’s own contribution. The contribution is mandatory for covered employees earning PF Wages up to INR 15,000/- (i.e., a mandatory contribution of INR 1800/- each by the employer and employee) beyond which the said contribution is voluntary.
The EPF Act also simultaneously allows establishments to apply to the Government for seeking an exemption from any or all provisions of the EPF Act and the EPF Scheme and allowing it to operate a private trust (“Trust”) for in-house management of the provident fund contributions made by the employees and employers. Such approvals are typically granted subject to certain conditions of exemption stipulated by the Government including those prescribed under Para 27-AA of the EPF Scheme read with Appendix-A thereto (“Exemption Conditions”). Once such an approval is granted, the exempted establishment is required to ensure that the benefits afforded to its employees are no less favourable than those specified in the EPF Act or the EPF Scheme.
The Exemption Conditions inter alia require an exempted establishment to (a) make good any losses caused to the Trust due to any fraud, wrong investment decisions, defalcation, etc.; and (b) fund any deficit between the interest declared by the Trust, and the statutory interest rate declared by the Government.
Establishments have historically applied for such exemptions for various reasons. It provides them the desired flexibility and autonomy to invest their corpus as per their own preferences and their independent market research. Prudent research-backed investments also usually have the potential for generating returns that are higher than the statutory rate of interest declared by the Government on the statutory fund, which potentially results in accumulation of a higher retirement corpus for employees as well. Lastly, an exemption status also provides an establishment localized control over its compliance and administrative needs and significantly reduces dependence on external agencies.
Why are industries moving away from exempted status?
Despite the aforesaid benefits of an exemption, a trend seems to be emerging whereby a number of major industrial players are opting to surrender their exemption and are transferring their accumulated corpus to the EPFO maintained statutory fund. In our view, this is attributable to several factors including those discussed below.
- Limitation on utilization of reserves and surplus
The Exemption Conditions require an employer to make good losses arising to the Trust due to theft, misappropriation, wrong investment decisions, and also to make good any deficiency between the interest rate declared by the Trust and the statutorily declared rate of interest.
The EPFO does not allow exempted establishments to utilize historically accumulated ‘Reserves and Surplus‘ to set-off such losses or to use such funds to bridge the gap in statutory interest payments. While the EPFO has taken seemingly obscure positions on this issue vide its circulars  issued over the years, the view currently held by the EPFO is that such reserves are to be used only for the purposes of providing enhanced interest payments to the members of the Trust on a year-on-year basis, and not for funding any prior or future losses.
The above has led to a situation where an exempted establishment, on the one hand, is penalized for poor investment decisions of the Trust, but on the other hand, is also precluded from taking any benefits from the prudent investments made by it earlier. This has been a contentious issue for the industry lately in the background of the recent downgrade in credit rating of certain securities which led to significant losses to the Trusts that made sizeable investments in such securities. However, despite this being an unprecedented event, and one which has occurred in the background of the COVID 19 pandemic, in our experience, the EPFO has been opposed to allowing exempted establishments to dip into their accumulated reserves and surplus to offset such losses. In the aftermath of the COVID 19 pandemic, the industry has taken such a ‘double-whammy’ seriously.
In our view, as long as the members of the Trust are being paid at least the statutory declared interest on a year-on-year basis and their interests are not impacted, exempted establishments managing provident fund contributions through a Trust are acting beneficially for the members, which satisfies the requirement under the law, in letter and in spirit. We do not see the EPFO administered provident fund being subject to the aforesaid limitation and therefore, it creates a sense of imbalance or disadvantage for exempted establishments.
- Impact of ground-level enforcement
It has also been seen that at times, enforcement action by the EPFO against Trusts have been unjustified and seem to lack legal backing.
In certain cases, EPFO appointed auditors have required Trusts to calculate returns on the investments made by the Trust on a per-security basis and not on a consolidated portfolio level. In other words, their position is that an establishment should fund the losses for each loss-making security even if the Trust is profitable at the consolidated portfolio level or has met the statutory interest obligation. This appears to be a misplaced interpretation of the law, which in reality requires an exempted establishment to fund/make good losses “to the Trust” thereby indicating that losses are contemplated to be funded when the Trust (at an overall level) has suffered a loss, and not on a per-security basis.
Demand notices / orders under Section 7A of the EPF Act are often issued without even conducting an inquiry or affording establishments an opportunity to make their case.
Besides, there appears to be little uniformity in the interpretation of law and the procedure followed by EPFO officials of different jurisdictions which further adds to confusion for corporates.
It appears to be an industry view that the current enforcement of the provident fund law has come at the cost of discouraging the very tenets which promoted the industrial growth fostered by large private industrial players. Among other factors, this growth was hinged on ease of doing business and the preference of the private sector to retain administrative flexibility in fulfillment of social security initiatives for its employees.
The impact of various recent Government enforcement actions (which do not appear to be in sync with the economic reality) and the patterns being seen by the industry are a cause of concern for the industry. This is either disincentivizing establishments from applying for an exempted status or are making the existing exempted establishments contemplate giving up such status.
If such a trend continues and exempted establishments continue to surrender such exemptions, while the EPFO may benefit from managing a much larger corpus, this is also likely to pose substantial extra burden on the existing EPFO infrastructure and resources.
 The Circular dated May 4, 2010 stated “Condition No. 6, 7, 28 of the revised conditions specify that in the event of any loss to the trust as a result of any fraud defalcation, wrong investment decision etc. or any deficiency in the interest rate as compared to statutory rate, the employer shall be liable to make good the loss/interest. You are therefore directed to ensure that wherever losses to the trust have been reported, the same is made good by the employer/establishment and is not adjusted against previous years surplus/reserves of the trust.”
Circular dated October 20/21, 2010 stated “A reference has been received in Head Office regarding the utilization of reserves and surplus lying with the Exempted Provident Fund Trusts. In this context it is clarified that the Reserves and Surplus are created over a period of time out of the yield on the investments of the contribution of the members. Hence, the same has to be utilised for extending benefits to the members in the form of enhanced interest payments.”
However, the EPFO Circular dated March 17, 2011 stated “Head office has been receiving references regarding the utilization of the amount available in the reserves & surplus account of the exempted PF trusts for payment of statutory rate of interest. In this context it is clarified that, the amount lying in the reserves can be used for the purposes of declaring interest at statutory rates or even higher than statutory rates only.”