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D. Sampathkumar

ONE does not have to take up a job with a company headquartered in the Bahamas or in Saudi Arabia to savour the satisfaction of a tax-free salary. A similar arrangement could well become the norm if Mr Sinha's Budget proposals are carried through. The Finance Bill has a clause to this effect.

The clause 10CC to Section 10, to be inserted in the Income-Tax Act, says that if the tax on the value of perquisites enjoyed by an employee is paid for by the employer, the same will not be treated as income in his/her hands. The Bill also has a caveat. Such payments by the employer (tax on employee-perquisites) would not be allowed to be deducted in arriving at the taxable income of the employer.

An employer, while structuring a compensation package for an employee, always factors in the income-tax on the sum total of both cash payments and perquisites. Let us assume that an employer wants to leave a sum of Rs 100 as after-tax income in the hands of an employee. If the average rate of tax is 25 per cent then a salary of Rs 133.20 should result in a net sum of Rs 100 remaining in the hands of an employee as after-tax income (Rs 133.20- 133.20*0.25= Rs 100).

The incremental salary that should be incorporated in the compensation package is higher than the figure of Rs 25 that at first sight might appear to be the tax component. This is due to the fact that the reimbursement of tax as a form salary would in itself have attracted a fresh round of taxation and hence the employer would have to cover that in his compensation package, as well. In the process of iterative computation, the additional amount that is required to be added to the initial figure of salary approaches zero.

In other words, under the existing scheme of taxation an employer would have to factor in an additional compensation of Rs 33.20 in order to leave in the hands of the employee, a net after-tax salary of Rs 100. In contrast, under the new dispensation, the effective cost would stay only at Rs 25. Let us assume a case where the employee is paid a `nil' basic salary and a perquisite whose value is computed at Rs 100.

The proposed law requires that a perquisite tax be computed by adding to the basic salary the value of perquisite and arrive at a figure of tax applying the current rates of taxation. The rate that this tax bears to the gross salary (basic salary plus perquisite) is then reckoned as the tax rate to be applied on the perquisite value to arrive at the tax to be paid by the employer.

If under the existing rates of taxation the quantum of tax works out to Rs 25, the average rate for purposes of perquisite taxation works out to 25 per cent. This rate is then applied on the value of perquisite to determine the tax that the employer has to pay in order that the same is exempt in the hands of the employee. By applying a notional tax rate of 25 per cent, the perquisite tax works out to Rs 25. The effective cost to the employer from engaging the services of the employee in the instant case works out to Rs 125, a saving of Rs 8.20 from the earlier figure of cost (Rs 133.20-Rs125 = Rs 8.20).

It is easy to see why the tax implication under the new dispensation works out to a lower sum. The cascading effect of the tax on perquisite tax, applicable earlier, no longer prevails. In the above example, we have assumed a `nil' basic salary. But the principle of avoiding the cascading effect of tax on perquisite tax that the new law confers does not undergo any change, even if the employee were to receive any sum asbasic salary.

There is a flip side to this. The perquisite tax paid by an employer/company cannot be allowed to be deducted as business expenditure in arriving at the taxable income of the business of the employer. The disallowance may result in a larger sum of pre-tax (perquisite tax) profits being subjected to corporate taxation. In the process, the savings in employee compensation may be offset by the additional burden of corporate taxation. But there is a saving grace.

Companies that pay tax on the basis of a Minimum Alternate Tax should be indifferent to this stipulation. That is because the tax paid on employee perquisite not being allowed to be deducted in computing the taxable income is irrelevant where the corporate tax itself is computed on the basis of a notional figure (for tax purposes, that is) of profits, namely `book profits'. The figure of book profits must necessarily take in the charge of `perquisite tax', as that is consistent with the accepted principles of income recognition.

If the average tax based on book profits is lower than the rate at which employee salary is taxed — a perfectly reasonable proposition, considering that only a fraction of the book profits are brought within the ambit of taxation — the perquisite tax payment should be more advantageous to the employer-company.

That is not all. The proposed legislation talks about allowing the employer to pay the tax only on the value of perquisites. But the entire scheme of salary payment can be so arranged as to acquire the character of perquisites of different shades. The relevant provision merely talks of `perquisite not provided for by way of monetary payment' within the meaning of Clause 2 of Section 17 of the IT Act.

This clause does not in any way limit the normal meaning assigned to the term `perquisite'. The term in ordinary parlance would refer to any benefit or amenity in kind availed of by an employee. So, if an employer arranges to provide free groceries, free education, free life cover with an insurance company the privilege of the employer paying tax on the value of such perquisite should be available. But quite apart from the savings in actual cost, the old arrangement suffered from another drawback as well. Employee-satisfaction was not always assured, no matter how much of a taxation element is factored into the salary package. Considering that the taxation factor is always in the background, employees would quickly slip into the belief that the amount that is provided on a gross basis is, indeed, their true worth.

By providing a framework for separating the salary and tax elements, a dose of realism is likely to be injected into discussions on bipartite negotiations between executives and the management.

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