VIP Road Chartered Accountants Association

Basic Concepts – An Overview

Introduction

Taxation of salaries is a subject that always interests both the tax-payers and tax practitioners. This is because salary earners constitute a majority of tax-payers in number, and consequently a majority of the clientele of a tax practitioner. The importance of this class of tax-payers will be apparent from the various announcements that have been made by the Finance Minister on the eve of the forthcoming general elections.

The process of globalisation has affected this class as well. While the number of those seeking employment abroad has undergone an increase, we also have a class of employees who work overseas for Indian employers. Further, in the coming years, we will have foreign citizens taking up employment with Indian entrepreneurs in India.

The components of salary have also undergone a change in recent years. The perquisite rules underwent a change in Financial Year 2001-02, while the taxation of ESOPs (Employees Stock Options) and Sweat equity have seen some developments. In view of the foregoing, the Chamber felt it is necessary cover all the tax issues in a special story. It is possible that the concepts, controversies and issues discussed in the seven articles, that make up the special story have found place in earlier issues of the Chamber. Though this may result in some repetition, it is unavoidable in the interest of completeness of the special story.

Charge under the head salary

For income to fall under this head, there must exist an employer-employee relationship. These principles are now settled by a plethora of judicial pronouncements. To determine whether the person rendering a service is an employee or a professional, one has to determine as to whether the contract is a "contract for service "or a "contract of service". [Dhrangadhra Chemical Works vs. State of Saurashtra AIR 1957 SC 264]. The greater the independence of the person as to the manner in which service is rendered, the greater the possibility of the contract being treated as one "for service" thereby resulting in the person rendering service being treated as a professional.

Whether the receipt is chargeable under the head business income or under the head salary is essentially one of fact. One will have to look at the facts carefully in the case of principal agent relationship. In the case of Directors, whether payments made to them partake the character of salary has engaged the attention of the Courts. The settled position now seems to be that remuneration payable to Managing Director and whole time directors falls under the head salary. Useful reference may be made to two decisions of the Bombay High Court in CIT vs. L. Armstrong 14 ITR 606, CIT vs. V.R. Chaphekar 107 ITR 49 and a decision of the Apex Court in Ram Parshad vs. CIT 86 ITR 122 (SC).

Year of chargeability, components of salary, exemptions and reliefs

In a salary package apart from salary and allowances, perquisites constitute a significant portion. Like most income tax definitions, both term "perquisites" and "profits in lieu of salary" have been defined in an inclusive manner in the Income Tax Act.

In his article, Kirit Kamdar analyses the year of chargeability of salary and the issues regarding various payments which are made to a prospective employee and an ex-employee in terms of section 17(3)(iii).

Perquisites of an employee are often the cause a person to make a choice between two employments. Perquisites are today, barring a few exemptions, taxed in the hands of the employee on the cost to employer principle. However, in its zeal to plug all potential loopholes the rules are drafted in a manner that if results in a genuine hardship to employees. A few years ago, the Bombay High Court stepped into direct the CBDT to issue a circular under section 119, where in the case of an accident, an employee was sought to be taxed on expenditure incurred on medical treatment. Refer All India Bank Officers Federation vs. Union of India 100 Taxman 558 (Bom.). The article by C.N. Vaze analyses the controversies in perquisite valuation and issues arising therefrom.

The provisions of section 10 grant exemptions to certain payments and allowances received by employees, while section 89(1) grants relief in case of receipt of arrears. The article by Ameet Patel deals with these aspects.

Special topics

As discussed in the foregoing paragraphs, salary in the case of non-residents and also salary received by expatriates would attain importance in future years. The article by Hiten Shah discusses various issues in this area. Stock option, or rewarding an employee with participation in equity are the norm in the pay package of many an executive. With the number of professionally managed companies, increasing as compared to family run businesses, ESOPS, and their taxation are likely to engage the attention of professionals in the near future. The article by Rajesh Kothari discusses these concepts and emerging issues.

Tax Deduction at Source

The large class of salary earners is of importance to the Taxman because the tax deduction from employees constitutes a regular cash flow to the Government treasury. It is also an important responsibility of an employer and any default would result in penal consequences. Makarand Herwadkar’s article analyses various issues on tax deduction at source.

Conclusion

An attempt has been made to cover all aspects relating to taxation of salaries. We hope the readers will find the various articles useful.

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