As the dust begins to settle on the Budget 2009-10, both employers and employees have started to assess the impact of the proposed changes on their incomes. Undoubtedly the Budget will impact the average employee, and employers will respond varyingly to the abolition of the fringe benefit tax (FBT), especially on the employer?s contribution to a superannuation plan in excess of Rs 1 lakh a year.
The Finance Act, 2005 introduced the FBT on the value of certain fringe benefits provided by employers to their employees. This tax has been perceived as imposing a considerable compliance burden on the employer as well as a significant administrative overhead. Empathising with these sentiments, the finance minister proposed to abolish the FBT in the recent Budget. More critically, this step on FBT, coupled with removal of surcharge for personal tax, seems to have put more cash in the hands of a salaried employee.
Prior to 2005, employees paid tax on certain benefits and perquisites. However, with the introduction of FBT, the onus of paying tax on the same shifted to the employer. But this is set to change yet again and the actual impact on an employee?s personal finances might not be the most optimal. The removal of the FBT means that certain benefits and perquisites will be taxed in the hands of employees. We will have to await the valuation rules applicable to perquisites. Employees will have to pay tax on employee stock option plans (Esops) and employers? contribution to an approved superannuation fund, if the amount exceeds Rs 1 lakh a year.
While Esops will no longer be subject to FBT, they will now be subject to perquisite tax in the hands of employees. The perquisite tax will be applicable on the difference between the fair market value (FMV) of the shares on the date of exercise of the options less the exercise price. However, the story does not end here. Upon sale, capital gains tax may also be payable.
For contributions to superannuation funds, the employee may have to pay tax on any amount contributed by his employer over and above Rs 1 lakh. Thus, if the employer?s contribution is Rs 1.5 lakh, the employee may have to pay tax on the incremental Rs 50,000 and the rate will depend on his/her tax slab. Most employers offer supplementary superannuation plans wherein the employer contributes 15% of basic salary on behalf of each employee. Typically, these plans are offered to employees belonging to the management cadre. Hence, if an employee has an annual basic salary of Rs 6.67 lakh or more, s/he may have to bear tax on the contribution amount exceeding Rs 1 lakh.
In order to understand the situation better, we consider three different examples and the tax payable on the
employer?s contribution to the superannuation fund in the accompanying table. The table indicates that in cases where net taxable income is above Rs 10 lakh, the saving on tax liability, from removal of surchange, increases substantially and even nullifies the impact of the increase in tax on superannuation contribution exceeding Rs 1 lakh. However, this may not be the case when other benefits or perquisites are considered in totality.
Importantly, companies normally have a vesting schedule for their superannuation plans wherein an employee gets a certain percentage of the total accumulations to his/her credit after the completion of a certain number of years of service. Employees may be able to enjoy the entire benefit only after they have put in a total service of at least five years. However, the employee needs to pay tax at the contribution stage itself. If the s/he leaves the company before completing five years, s/he would have paid the applicable tax but will not enjoy the superannuation benefit. This may not be fair to the employee.
Earlier, companies could pay perquisites to employees and pay FBT of around 6 to 10%, which may have been recovered from the employees. Employees had little to complain about because the rate of FBT was far lower than regular tax rates applicable to them. The amount charged as tax under perquisites will be then added to the employee?s total taxable amount, leading to a steep fall in the in-hand salary. So, larger the salary, larger the benefits and steeper the fall in the in-hand salary.
We have only analysed the impact of the abolition of FBT on contributions to superannuation funds. However, many other perquisites will henceforth be taxed. The additional income tax payable after the abolition of FBT will be substantial. The abolition of FBT may have reduced the employer?s cost of providing benefits and the administrative hassles associated with the FBT. However, the adverse effect on employees? taxes payable will have to be looked into. Employers may need to react suitably to ensure that the benefits to their employees are maintained. One way employers could do so is to increase the value of the perquisite to nullify the effect of taxes so that cash in hand remains the same for the employee. Also, savings on the FBT and the associated administration costs could be redeployed to give extra benefits to the employees. Employers have given the finance minister a pat on his back for abolishing the FBT and reducing the associated administrative hassles. However, once employees begin to realise the adverse effects on them, they are bound to pressure employers to maintain their benefits. So even though employers may save on the FBT in the short term, costs are bound to increase in the long term.
The author is India business leader, retirement, risk and finance, Mercer