Gone are the days when companies offered only fixed components as part of salary to employees, who had little or no say in deciding the components offered to them. Executive compensation packages are now being designed to include a basket of flexible allowances to minimise the tax outgo, and more companies are embracing this approach. A bunch of elements such as meal coupons, customised allowance pool and “below-the-line” benefits have entered compensation structures, defining a major shift in designing pay packages. Most employers are giving employees the freedom to align their compensation packages to their expense patterns for tax planning. For most companies, a flexible salary package is a USP.
For instance, medical reimbursements and leave travel concession/ assistance are two components of salary which are exempt under limits prescribed by the Act. Expenses on medical treatment are exempt up to a maximum of Rs 15,000. Leave travel concession/ assistance received by an employee is also exempt subject to conditions. The employer is required to obtain proof/ declaration from the employees on the amount actually spent.
Notwithstanding the tax benefits these flexible allowances offer, there is ambiguity on the timing of payment. To get the tax benefits under the Act, a question arises whether these allowances could form a part of the fixed monthly salary or are payable as and when the expense is incurred by the employee.
An approach commonly adopted by most companies is that the allowance/ reimbursements should be paid by the employer once these expenses have actually been incurred by the employee and the relevant proofs submitted.
However, two recent rulings by the Bangalore Income Tax Appellate Tribunal in the case of Infosys BPO and SAP Labs India Pvt Ltd, have affirmed that such payment could form part of the fixed monthly salary and no taxes need to be deducted at the time of payment.
The necessary proofs could be obtained by the employer later during the tax year.
In cases where the employee does not submit adequate proof and/or the actual expenses are lower than the amount paid by the employer, the employer needs to deduct taxes right away.
In the case of Infosys BPO, salary was paid under a cost-to-company arrangement where employees were allowed to choose various components from a basket of allowances.
Medical expenditure and leave travel concession were paid as a fixed sum without the employee actually incurring them.
The assessing officer treated Infosys BPO as an assessee in default for not deducting the tax. The Bangalore tribunal, however, passed a ruling in favour of the company and made the following observations:
Though the allowances would not form a part of the salary (since they are exempt), if the employer was required to deduct tax treating it as a part of salary, it would be contrary to the provisions of section 192(3) allowing an employer to increase or reduce the tax deducted at source (TDS) for any excess or deficiency. What needs to be seen is whether the correct amount of tax has been deducted on the last day of the tax year.
The assessing officer’s reliance on the term ‘actually incurred’ is not relevant.
The exemption with regard to medical expenditure and leave travel concession was considered only after verifying the evidence furnished by the employees.
The employer is only required to make a bona fide estimate of the salary while deducting tax.
The Bangalore tribunal held the same for medical reimbursement in the case of SAP Labs India Pvt Ltd.
Thus, even if no tax is deducted initially on the basis of the monthly payments, the employer could subsequently take into account the amount for which proofs of expenses incurred are not submitted and deduct the appropriate tax.
The rulings also reiterate the position that the employer is only required to make a bona fide estimate of salary while deducting tax.
The above rulings would certainly encourage more companies to follow this approach and pay flexi allowances as a part of the fixed monthly payment to employees, and would be welcomed by both employers and employees.
Homi Mistry is Partner and Pallavi Dhamecha is Manager, Deloitte Haskins & Sells