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On a foreign assignment? Check out net-of-tax salary
May, 17th 2007

It is a common practice in case of international assignments, especially MNCs, to pay net-of-tax salary to employees sent on assignment to different countries including India. The idea behind the netof-tax salary payment is that the employee wants to be sure about the net take-home salary and does not want to be caught unaware on the tax liability in country he is being deputed to.

Gross-up of tax liability

The tax borne by the employer, by virtue of a contractual obligation between the employer and employee, is treated as income in the hands of the employee and is taxable.

To better understand this concept, lets take an example. A company agrees to pay Rs 100 as net-of-tax salary to an employee. The tax on the same is say Rs 33.99 (applying highest tax slab rate of 30% plus surcharge of 10 % plus education cess of 2% and additional education cess of 1 % on tax and surcharge). As tax is required to be paid by the employer, the same is considered as income in the hands of the employee.

The issue that arises is whether the amount of tax to be included in taxable income of the employee should be the amount calculated by single iteration (single grossing up) or the amount arrived at after multiple iterations (multiple grossing up).

In case of single iteration the tax payable by the employer would be 45.54% (i.e. 33.99% of Rs 133.99). In case of multiple iterations the tax payable by the employer would be Rs 51.49 (i.e. 33.99% of Rs 151.49). This is so because in order to compute the net cash salary of Rs 100, the tax on earlier tax of Rs 45.54 is again to be added in the taxable income of the employee. This process of tax on tax iterations continue till we arrive at net of tax salary amount of Rs 100.

It is pertinent to note that the net cash salary in the hands of employee remains Rs 100 (Rs 151.49 less Rs 51.49) in both the cases single and multiple grossing up. For the employer there is a big difference between 51.49% of multiple grossed up tax vis--vis 45.54% of one-time addition of tax. The difference between the two, when translated into actual tax liability, could result into huge additional tax cost for the employer. This being a direct cost to the employer has to be taken into account while finalising net of tax salary arrangements.

Issues to be settled

Tax perquisite or salary?: Whether tax paid by the employer is a perquisite or salary is not expressly stated under the Act. One view is that tax being an obligation of the employee and met by the employer is to be treated as a perquisite. The other view is that tax paid by the employer is no different from the salary paid to the employee and that it is merely an attribution of salary towards taxes.

If perquisite whether monetary or non-monetary: If the tax paid by the employer is considered to be a perquisite, then the next issue to be addressed is whether it is a monetary perquisite or a non monetary perquisite. This differentiation is important as it has direct impact on the taxability of the employee in terms of single or multiple grossing up.

As per Sec 10 (10CC) of the Income-tax Act, 1961 (the Act), if tax is paid by the employer on non monetary perquisites provided to the employee, then such tax (paid by the employer) is not taxable in the hands of the employee.

The phrase monetary perquisites and non-monetary perquisites have not been defined under the Act and different views are expressed as to their classification. Therefore, if tax paid by the employer is a perquisite then it is important to determine whether it is to be treated as a monetary perquisite or a non monetary perquisite.

Delhi tribunal decision

A recent decision of the Honble Delhi Income-tax Appellate Tribunal (Delhi Tribunal) in the case of B J Services Company Middle East has again brought to light the debate on this issue. The Tribunal has held that the tax liability of the employee paid by the employer is a monetary payment and part of the salary. Therefore, the same would be subject to multiple grossing up and not just a simple addition in the taxable salary.
It is pertinent to note that the other view that tax is to be treated as a perquisite by virtue of Sec 17(2)( iv) of the Act, which states that any sum paid by the employer in respect of any obligation which, but for such payment, would have been payable by the assessee, also merits attention. This view also draws support from certain other judicial precedents.

Learning

The issue whether tax paid by the employer is a salary or a perquisite and whether it is a monetary or a non-monetary perquisite, is likely to be debated and contested before the courts till it is finally clarified by the government or a decision of the higher courts laying clear principles on this is passed.

Till then, the ratio of the above ruling and the judgments supporting the other view that it is a perquisite should be taken note of while planning the international assignments, as single v/s multiple grossing up may have a significant impact on the total tax cost to be borne by the employer.

Vikas Vasal, KPMG

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