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10 tax-smart tips for salary earners

August 19, 2008

As in Alice's Wonderland, so too in the labyrinth-land of income tax, things are often not what they appear to be. 'Yes' may not always mean yes, and 'no' may not necessarily mean what we generally take it to mean.

So, it pays to be tax-smart; you can get to keep more of your hard-earned money for yourself rather than having to cough it up to the taxman . . .

1. Exemption on soft furnishing expenses Sec. 10(14) [of the Income Tax Act] offers exemption for expenses (and not allowances) incurred wholly, necessarily and exclusively in the performance of the duties. There are two distinct arguments to render soft-furnishing non-taxable.

The first one is to claim that the employee needs to entertain guests at his residence for official purpose. The second one is that the expense is incurred to protect the furniture belonging to the office at the residence of the employee from deterioration.

2. Notice period salary equivalent paid to employer is not tax deductible

Most employment conditions require an employee who desires to change his job, to give his employer a notice of his intentions and serve him for certain pre-fixed months.

In case an employee desires to leave the services immediately, or before the notice period, he should pay the employer an amount equivalent to the salary he would have earned during the notice period or shortfall thereof. Is this amount deductible from the salary income of the employee?

What the employee is paying to the employer cannot come under the head 'Salaries' since he is not the employer's employer. This amount represents application of his income and therefore, it is not deductible. He has merely applied this income to discharge a liability and therefore, it is not tax deductible.

This is the view generally accepted by all accountants and the income tax department.

3. Employment after retirement can be less taxing

These days many employees are re-employed by their ex-employers on retainership or contractual basis after their retirement. The fact that the person happens also to be the ex-employee is immaterial and inconsequential.

Such a person enjoys better concessions than a normal employee. He can claim deductions for expenses incurred for earning his consultancy fee. Moreover, the TDS applied by the principal would be only 10% of the fee paid.

4. How gardener and helper can be tax-free perks

Here, two points are of great interest: � Circular 122, dated 19.10.73, clarified that if the employer employs a gardener for a building belonging to the employer, it would not be treated as a perk. This principle continues to be applicable even now with the possibility of it being extrapolated to other servants. � This is more interesting. A helper engaged for the performance of the duties of an office or employment of profit; is not considered as a perk under Rule 2BB, read with Sec. 10(14). Many employees, particularly at the top level, and especially in view of communication handshakes available through e-mail, do not necessarily work only in the office. Some part of the work is done at residence. We will go to the extent of stating that the employee can directly engage the services of a helper and claim reimbursement from the employer without it being considered as a perk.

5. Tax nuances when a house / flat is given on lease to employer

Top management category employees usually get rent-free residential house as a perk. Sometimes, the flat belongs to the employee, taken on lease by the company from the employee and the employee is allowed to reside in it.

In other words, the landlord of the residential flat used by the employee is the employee himself and simultaneously he is also a tenant.

Under such a situation, the employee will have to pay tax on the lease rent received as income from house property and also as perk. Is this double taxation? Definitely not. The employee is enjoying double benefit and will have to pay tax on each benefit separately.

Is this flat self-occupied or let-out? Of course it is let-out. No one can pay rent to himself.

The Sec. 80C deduction is possible both on self-occupied and let out flats. The interest is deductible in full since the flat is let out. If the employee pays some rent to his employer, this rent cannot be deducted from the lease rent for tax purpose. This rent will be taken cognisance of while computing the perk value.

Before the revision in perk values, many of the employees used to give their flats or the flats of their wives on lease to the employers and benefit immensely. Now, after the large-scale amendments to perk values, the advantage has been watered down.

Nevertheless, normally the lessor takes an interest-free deposit from the lessee. This is a deposit and not a loan. Consequently, it does not have any perk value. We do not think the Department will question the size of the deposit in such cases.

6. Interest on deposit for a leased flat

The ITO cannot treat the difference between the market rate of interest and the actual interest paid by the landlord to his tenant on deposits placed by the tenant in custody of the landlord, as further rent received. [CIT v Satya Co. Ltd., (1994) 75Taxman193 (Cal.)].

7. LTA and Relatives

As per the Rules, you can claim the LTA benefit only twice during the block of 4 years. For this purpose

You should be on leave.

You should travel.

During such travel you may have your family with you. Family includes spouse, children as well as dependent parents, brothers and sisters. In respect of children born on or after 1.10.98, the exemption will be restricted only to two surviving children unless the birth after one child has resulted in multiple births.

The expense incurred by you is exempt up to the LTA received.

Obviously, if your wife and other family members travel, without you accompanying them, no LTA can be claimed.

LTA and working couple

Take the case of a working couple. Both the husband and wife can claim the exemption on LTA from their employers and claim benefit for 4 journeys in one block. There is no need for them to take the precaution of not travelling twice during the same year.

Moreover, they can take the same family members or different ones as long as they stick to the definition of the members for this purpose.

8. Tax-free perks of ex-employees

Aditya Cement Staff Club v Union of India & Others is an interesting case which states that where an employee has resigned and is allowed to occupy company quarters free of rent or at concessional rent, it is not to be taken as perk value, unless it is a contractual obligation to that effect according to the terms of employment.

In order that any benefit, amenity or payment may be termed as perquisite, it must be in pursuance of a right conferred on or option given to the employee to receive such benefit or advantage from his employer.

Unless such advantage or benefit flows from the status of the person working as an employee it cannot be termed as perquisite. The employee must have a vested right to claim advantage or benefit whether in cash or in kind, in order to fall within the purview of perquisite as part of salaries taxable under the ITA.

9. Provident Fund not encashed

Interest on Registered Provident Fund (RPF) of an employee is tax-free. Does it still remain tax-free after the employee retires and does not claim his Provident Fund for say 2 to 3 years?

If one goes strictly according to the drafted provisions, it appears that this interest is tax-free since the amount becomes payable only when the ex-employee asks for it. However, we are told that many ITOs take the stand that the balance in Co-PF gets the colour and character of company fixed deposits when the employee retires. This stand is challengeable.

10. When PF becomes taxable

If an employee leaves the service before completion of 5 years, Rule 10 of Part A of Schedule IV, requires the trustees of a Recognised PF to deduct tax when the accumulated balance due to an employee is paid. This payment is to be treated as income chargeable under the head 'Salaries.'

Rule 9 puts a different responsibility on the Assessing Officer. He shall calculate the total of the various sums of tax which would have been payable by the employee in the respect of the total income for each of the related years to arrive at the amount by which such total exceeds the total of taxes paid by the employee for such years.

This excess amount is payable by the employee in addition to tax on the income during the year in which the accumulated balance of PF becomes payable.

According to Rule 8 of Part A of the Fourth Schedule, this requirement of 5 years shall not be applicable where the service has been terminated by reason of the employee's ill-health, or by the contraction or discontinuance of the employer's business or other causes beyond the control of the employee.

All the same, it is not clear if the employer's contribution becomes taxable if the employee has to retire on attaining superannuation age after a continuous service of less than 5 years. It is our considered opinion that since the retirement is beyond the control of the employee, the amount does not become taxable.

It is erroneous to feel that the employee's contribution to PF is not taxed during the year of contribution. It is fully taxed in any case. All he gets is the deduction which stands withdrawn if the employee withdraws the PF before 5 years. To tax the contribution once again in the year of withdrawal is tantamount to double taxation.

In the case of unrecognised provident fund, there is a triple taxation if the employee withdraws within 5 years. Not only he is not allowed any deduction on his own contribution but also the employer's contribution is taxed during the year of contribution and also during the year of withdrawal.


[Excerpt from the book, Taxpayer to Taxsaver by A. N. Shanbhag and Sandeep Shanbhag, published by Vision Books.]

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