The Hindu Business Line : Taxing fringe benefits: Don't harm the goose that lays golden eggs

Indian business has reached a certain level of maturity so that what seemed an excessive fringe benefit by yesterday's standards may not be so in today's globalised environment. We have to evolve a system of taxation that will be fair and equitable, and not necessarily from a revenue angle.

IN his address to businessmen at a post-Budget CII meet, the Finance Minister, Mr P. Chidambaram, ruled out the rollback of the fringe benefit tax (FBT). FBT is used in different forms in several countries but the reason why this has not received attention in India so far is because its impact on incomes (indirectly) and revenue was insignificant.

Today, the situation is rapidly changing. Several corporate employers use fringe benefits as a means of attracting and retaining talent. For example, the employees stock option plan (ESOP), relatively unknown a few years ago, is used by many successful corporates to retain employees, particularly in the IT sector, where competition is intense and the rate of attrition high.

Tax treatment of ESOP has been taken care of by taxing the benefit at the time employees exercise the option to encash it. There are, however, other fringe benefits that are disguised but which nevertheless add significantly to employee's well-being, both materially and emotionally. It must also be recognised that not all fringe benefits are irrelevant or freebies.

No company would incur an expenditure that does not promote its business interests. In today's competitive environment, keeping employee morale high is a must if businesses have to succeed and grow. Attracting foreign investment and striking profitable deals also involve certain levels and styles of functioning that do require fringe benefits which may seem extravagant but are not really so.

But the moot question is whether at least part of the substantial costs incurred by companies on providing fringe benefits to employees should be taxed. The answer to this question is both `yes' and `no' — yes, if these expenses are excessive and frequent or have no direct bearing to the growth of business, and no if they do contribute to business development.

In his Budget speech, the Finance Minister said: "I have looked into the present system of taxing perquisites and I have found that many perquisites are disguised as fringe benefits and escape tax. Neither the employer nor the employee pays any tax on these benefits, which are certainly of considerable material value...

"I now propose that where the benefits are usually enjoyed collectively by the employees and cannot be attributed to individual employees, they shall be taxed in the hands of the employer." Thus the FM proposes to levy 30 per cent tax on an `appropriately defined base'.

Two ideas flow from his statement. One, that there are perquisites disguised as fringe benefits which confer substantial benefits to employees, particularly at top management levels. These are not taxed under the present tax system, either with the employer or employee.

Fringe benefits are essentially a feature of large corporate institutions or enjoyed by high-income professionals. Apart from providing tax shelter, liberal fringe benefits create both horizontal and vertical inequities and income inequalities not measurable by normal criteria of income distribution.

The number and size of MNC operations in India have been growing and their compensation patterns as well as those of some of the large Indian corporates follow the western model, where significant cash and non-cash benefits accrue to the employees. It is not surprising that fringe benefits are becoming a key component of remuneration packages and their popularity is not solely attributable to favourable tax treatment. Fringe benefits also represent a certain social and economic status of the employee.

The Finance Ministry has issued a new rule to re-categorise perquisites and redefine their tax status in the hands of the employees at enhanced valuation while shifting the tax liability of some others to the employer. Free residential accommodation will be taxed at 20 per cent henceforth instead of 10 per cent till now.

Certain other perks, such as credit card, recreation, club membership and holidays, at present taxed in the hands of the employee at actual cost, will henceforth be taxed in the hands of the employer at 30 per cent on 50 per cent of total expenditure which works out to 15 per cent net tax.

Similarly, in the case of a car given to an employee, the tax burden will from now on be shifted to the employer on a differentiated basis depending on engine capacity.

What apparently lies behind the exercise is to curb tax avoidance through payments for fringe benefits, which are becoming more diversified and enhance real incomes of beneficiaries or recipients.

While taxing the above, the government should ensure that legitimate and reasonable business expenses on travel and accommodation, entertainment, recreation etc are not taxed. This is where valuation plays an important role and business organisations such as chambers of commerce should be consulted before the exercise is completed to identify the types of fringe benefits and fix their valuation for tax purposes.

Indian business has reached a certain level of maturity and is moving towards international standards where what appeared to be an excessive fringe benefit by yesterday's standards may not be so in today's globalised environment.

The fine line is difficult to draw and that is the reason why the views of business organisations must be taken into account. An IFA (International Fiscal Association), research concluded that, in general, in all the jurisdictions reviewed, the frequency and significance of fringe benefits were "skewed towards higher-income employees".

In civil code jurisdictions and the US, the concept of income is broadly defined to include fringe benefits but in common law countries other than the US, the concept of income is much narrower and excludes several gains accruing to the employees. Further, jurisdictions with broad tax bases provide exemptions or preferential valuations for selected fringe benefits while jurisdictions with narrower tax bases subject fringe benefits to tax under specific statutory inclusion measures.

Despite the convergence in taxation of fringe benefits, the level of tax liability on them is usually less than that imposed on direct employment incomes, which is what makes use of fringe benefits popular. The IFA survey concluded that the importance of tax benefits is much greater in common law countries than in civil code countries. Moreover, when fringe benefits happen to be common to a large section of employees, the employer gains from certain economies on the supply side because of size or bulk purchase agreements and the ability to get lower tax incidence of indirect taxes.

Apart from income-tax, in the developed countries, payroll taxes and social security levies also tend to have an influence. Unemployment insurance, medicare and higher education levies do not impact the value of fringe benefits in most jurisdictions reviewed in the survey.

Further, to the extent that certain fringe benefits such as club membership and official travel are seen to confer `status value', such fringe benefits may be reserved for employees who reach the top managerial level. Thus fringe benefits also have a motivational aspect.

A more ubiquitous form of fringe benefit is the use of productivity and profit bonuses. In general, it can be said that common law courts following British income concepts normally do not recognise non-convertible benefits that come as fringe benefits as income, even for purposes of income-tax. Also, to date, courts have given little consideration to the significance of fringe benefits in non-tax situations.

Apart from the question of equality, questions of inter-sector and inter-employer neutrality in payment systems may also arise if fringe benefits occupy an important place in the compensation package. In India, we have to evolve a system of taxation that will be fair and equitable, and not necessarily from a revenue angle.

For the present, the Finance Minster's proposal seems reasonable, provided business, which will be the ultimate bearer of the tax, is taken into account so that the goose that lays the golden egg is not harmed.

(The author is a New Delhi-based management and financial consultant.)

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