The Hindu Business Line : Fiscal harmony in final handshake

AS CORPORATE houses plunged into business re-organisation mode to improve efficiency and productivity, they came up with innovative proposals to prune the muster rolls. Companies embarked on restructuring programmes and voluntary retirement schemes for employees. The amounts payable under the schemes were sizable and did represent business expenditure, to be allowed in full in the year in which the schemes came into force. The Government took steps to regulate such payments, by insisting on that the schemes be approved ones.

As against the practice of allowing the entire VRS expenditure in one year, a new formula for amortisation of such expenditure was introduced from assessment year (AY) 2001-02 with the insertion of Section 35DDA in the Income-Tax Act, 1961 by the Finance Act, 2001.

The section allowed amortisation in equal instalments over a five-year period the expenditure incurred on an employee at the time of his voluntary retirement as per an approved scheme. Such payments, normally in the nature of ex gratia payments, were over and above the regular terminal benefits such as pension, gratuity, leave and encashment for which the normal provisions of the Act applied.

The section has now been amended, apparently to benefit the companies. In fact, Section 35DDA curtailed the benefit by providing for amortisation instead of full deduction in the year of acceptance of VRS. The liability is fully ascertained and crystallised at the time of acceptance of VRS.

The newly-introduced amendment is apparently innocuous. The memorandum explains that where there is an instalment scheme for the payment of VRS only the payment made in the first year is allowed to be amortised over five years and the balance instalments in subsequent years will not be allowed as a deduction.

The memorandum clarifies that the proposed amendment will provide for amortisation of the payment made in any year and each such payment will be independently admissible for amortisation over a five-year period. This explanation can give ideas to revenue officers and lead to a restrictive interpretation of Section 35DDA in 2001-02, 2002-03 and 2003-04. The amended section takes effect from April 1, 2004, and will apply from the AY 2004-05 onwards.

The impact of the amendment would be that whenever VRS is paid in instalments, each of such instalments will be amortised over the next five years and the company and the tax officer will be struggling with amortisation for a nine-year period. Will it not be a better and easier option to allow the entire VRS payment liability in the year of acceptance irrespective of the instalments agreed upon?

After all, there are Supreme Court rulings interpreting the term "paid" as taking in accrued liabilities under the mercantile system of accounting. It should not matter to the Revenue whether the compensation is paid in instalments or lump sum. Once capital expenditure is taken for separate treatment, it should be easier to allow the same either in a single assessment or in two/three years rather than carry on the task over a longer number of years, making record keeping more difficult.

VRS is governed by guidelines prescribed under Section 10(10C) of the Act. Section 35DDA (1), as at present, refers to payment of any sum to an employee "at the time of" his voluntary retirement.

The amendment by Clause 11 of the Finance Bill, 2005 provides for amortisation of the amount of payment "in connection with" the voluntary retirement of the employees. Does this mean that payments made to employees even after retirement will be eligible for amortisation? The answer seems to be in the affirmative.

Finance Act, 2003 amended Section 10(10C) with effect from AY 2004-05. By virtue of the amendment, exemption was conferred on "the amount received as soon as receivable in connection with the voluntary retirement".

The benefit conferred on the employee by the amendment to Section 10(10C) is now extended to the employer, too, through amendment to Section 35DDA (i). Section 10(10C) conferred a tax exemption of Rs 5 lakh on the employee. No relief is available unless the scheme is approved before the date of retirement.

Subsequent approval will not confer the benefit of exemption to a retired employee. It is necessary that both Sections 10(10C) and 35DDA (i) should go hand in hand so that the same amount of payment does not result in different consequences for the employer and the employee.

The present amendment secures such harmonious balancing of the two provisions, though one may wish that it had been introduced last year itself. The benefit, however, is secured by making the amendment operative from April 1, 2004, akin to the amended Section 10(10C).

(The author is a former Chief Commissioner of Income-Tax.)

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