S Murlidharan

Bypassing pass-through principle

Updated on: Jun 17, 2011

The Fringe Benefit Tax ought to have been continued in respect of select items of expenditure that really defy pigeonholing the beneficiaries with substantial accuracy.

The pass-through principle is in keeping with the fundamental canon of taxation that tax should ideally be imposed in the hands of the ultimate beneficiary of the income, and that conduits should as far as possible be spared from tax liability especially when there is no difficulty in identifying the beneficiaries to whom a specific share or sliver of the income can be attributed.

In India this principle is followed at best in fits and starts in a muddled fashion characterised by a bit of ad hocism and lack of holistic, wholesome thinking.

Fringe benefits which account for a sizeable part of the benefits enjoyed by employees especially at the higher echelons and their hangers-on went largely untaxed. Fringe Benefit Tax (FBT) of 30 per cent was imposed on employers in respect of an arbitrary chunk of various expenses deemed to be enuring for personal use of the employees n. It was given up following persistent protests.

Come to think of it, this was the best case for bypassing the pass-through principle because a lot of expenditure incurred by companies was defying taxation at beneficiaries' end. Thus the tax department has to watch helplessly as a mute spectator when employees of a company or their benefactors in power board the company-owned aircraft with singular nonchalance to fly say to South Africa to watch World Cup cricket matches.

Lopsided approach

FBT ought to have been continued in respect of select items of expenditure that really defy pigeonholing the beneficiaries with substantial accuracy. Its indiscriminate and greedy application to a whole lot of expenditure many of which admittedly did not present insurmountable difficulties in such pigeonholing efforts resulted in its demonisation and ultimate ouster. Collecting tax at the payers' end is a time-tested principle of taxation in accelerating collection and foiling evasion. The result is the increasing popularity of Tax Deduction at Source (TDS). But Dividend Distribution Tax (DDT) is not a TDS scheme. It absolves the payees' of tax liability on dividend, with DDT paid by a company on dividend considered to be the liability of the company and shareholders spared of the tax burden.

Dividend ought to be taxed in the hands of the ultimate beneficiaries, with the company paying it being allowed deduction from its income towards what it has paid to the shareholders by way of dividend.

DTC's take

One expected the Direct Taxes Code to adopt a fair approach to the issue of pass through. But it is also characterised by muddled thinking in this regard. Dividend paid by companies would continue to be taxed in the hands of companies paying them by way of DDT. In an inexplicable climb-down in favour of equity-oriented funds, it proposes to reduce the DDT rate to a token 5 per cent thus giving a huge impetus for big ticket investors in the highest income tax bracket to court mutual funds. The DTC, while sparing the venture capital companies and venture capital funds from taxation, has rightly made it categorical that the ultimate investors i.e. the promoters of such companies and funds would be taxed according to the pass-thru principle.

(The author is a Delhi-based chartered accountant.)

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Published on June 24, 2011

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