When it comes to employment, it is normally the employee who bears the tax, with the employer withholding the appropriate amount from the salary to deposit with revenue authorities. However, employers sometimes require employees to move across borders and work in different tax jurisdictions. In such situations, it is a global practice for employers to enter into an agreement with employees to take over the tax obligation of the employees in the new jurisdiction. Such an assurance guarantees employees a definite pay package irrespective of the tax rates or tax situations applicable in the new location.
The taxes so borne by the employer would in the normal course be considered an additional benefit (perquisite), taxable in the hands of the employee. Such taxes paid would be subject to a gross up (taxing the tax), leading to multiple calculations. For example, if the taxable income of an employee is Rs 1,000, the taxes borne by the employer at 30 per cent will be Rs 300. Without any exemption, taxes borne by the employer shall be subject to tax again in the hands of the employee. As a result, the taxable income of the employee will be Rs 1,000 + Rs 300 (tax on Rs 1,000) + Rs 90 (tax on Rs 300), and so on.
The Income-tax Act, 1961 was amended to insert Section 10(10CC), which exempts the employee from paying tax on ‘non-monetary perquisites’ received from the employer, at the option of the employer. Thus, in the above example, if the benefit of Section 10(10CC) were to be claimed, the taxable income shall be only Rs 1,000 + Rs 300. The taxes payable will be Rs 300, as taxes payable by the employer shall not taxed again.
However, tax authorities have been denying the benefit of Section 10(10CC) on the grounds that taxes borne by the employer do not qualify as non-monetary perquisite. Herein lies the ambiguity, as the IT Act does not define a non-monetary perquisite. While taxes are a monetary payment, as no direct payment is made to the employee but an obligation of the employee is borne by the employer, there is a viewpoint that the taxes borne by the employer could be considered a non-monetary perquisite.
This ambiguity has been a bone of contention in the past decade, with several tax tribunals examining it. The special bench of the Delhi Tribunal in the case of RBF Rig Corporation, however, held that income tax payable by the employer on behalf of the employee is a non-monetary perquisite. This decision was recently upheld by the Uttarakhand High Court in the case of Sedco Forex International Drilling Inc. The High Court ruled that while the tax paid is certainly a monetary payment, the same is not paid to the employee, but on his account to the income tax department. Such payments are perquisites to be excluded from the income of the employee under Section 10(10CC) of the IT Act.
The decision of the Uttarakhand High Court will bring clarity and relief to employers who have negotiated a net of tax salary packages for employees. Though the exemption claimed under Section 10(10CC) is not permitted as a deductible expense while computing the taxable income of the employer, employees will not be liable to pay tax on tax paid by the employer, leading to overall savings in tax costs.
(This article does not include any analysis on Section 200 of the Companies Act.)
(Shuddhasattwa Ghosh is Director (International Assignment Services), PwC India)