GAAR, GST can impact your compensation

Your employer might need to relook at the salary structure to comply with the new changes in laws

The salaried class accounts for the bulk of the total collection of the individual income tax. More than 50 per cent of the income declared in individual tax returns are by this class. The government has introduced new provisions under the General Anti-Avoidance Rule (GAAR) and goods and services tax (GST) that can impact salaries.

GAAR addresses arrangements and structures made only to save tax. These apply to every resident taxpayer, including individuals, Indian companies or foreign investors. The income tax department can, therefore, disallow arrangements if it feels these were made to avoid tax, and it can even levy interest and penalty on it. 

GST, on the other hand, is a tax on services and goods. But, the government has brought in some provisions that can impact some of the benefits that employers offer to employees.

While the new rules fortify the established principle of “substance over form”, it is important that the employees look at their contracts to ensure that they are not caught on the wrong foot. 

Popular salary structures

The way employers structure salaries of employees can be broadly categorised into two — cost to company (CTC) and perquisites that depend on a company’s policy. In CTC,  aggregate compensation is available to the employee. 

Of this, an employee can choose components which allow flexibility in tax planning within the four corners of the law. The tax-friendly compensation elements include house rent allowance (HRA), leave travel allowance (LTA), conveyance allowance, reimbursement for medical expenses, and so on.

Employees, at times, say that within CTC, a car should be provided to them by the employer for their official and personal use. Such preferential treatments are of course available to the employee only when they comply with the relevant rules or requirements as laid down in the law.

The CTC concept is evolving and getting recognised by various judicial authorities, as well as by the tax department. The other concept of compensation — salary and perquisites — is also in vogue. It is true especially in the case of government and public sector enterprises, where perks are provided based on the hierarchical level of the employee.

Based on these structures, let’s look at how the compensation structuring will shape under the two tax changes.

Structure matters

The provisions of GAAR are applicable from April 1, 2017. It has been introduced to address aggressive tax planning and to codify the doctrine of “substance over form”. It is implemented to address cases where a party creates a structure or arrangement solely to avoid tax.

The introduction of GAAR does not mean that legitimate tax planning structures no longer exist. But, it calls for a fundamental change in approach and mindset of the taxpayer. Planning CTC with the legitimate options provided under the tax laws like HRA, LTA, etc, will not come under the ambit of GAAR, unless the arrangement is done with the ulterior motive of tax evasion.

Individuals still have a breather. GAAR sets in only when the amount of tax benefit availed in a relevant tax year arising in aggregate to all the parties to the arrangement is more than Rs 3 crore. From an employee’s perspective, therefore, GAAR might not be applicable, as the tax benefit under the scheme most likely will not cross the threshold frequently.

The revenue department, however, might still try to hold the employer responsible for not deducting taxes, which, in aggregate, might exceed the threshold. Also, if the employer gains any unfair tax advantage on such transactions — like being eligible to claim higher depreciation on movable assets or transfer of assets to the employee with the ulterior motive of the employee making windfall gains — such transactions might face further probe.

A few benefits to attract tax

The Ministry of Finance has issued a press release on July 10, to determine the applicability on employees’ compensation. The release specified that services by an employee to an employer in the course of or relation to his employment are outside the scope of GST.

Accordingly, by the employer to the employee within a contractual agreement will not be subjected to GST. Benefits such as membership of club and health/fitness centres will not be liable to GST when provided free of charge to all employees if the appropriate GST has been paid by the employer when procuring the service. Provision of housing by an employer will not attract GST and this is a huge relief. Gifts of more than Rs 50,000 will, however, be subject to GST.

The press note does not specifically address a scenario where there is any recovery from the employee against the benefit provided as part of compensation. Such recovery may be required to be specifically analysed to determine the applicability. 

Also, the law states that the benefits provided to the employee have to be clearly enunciated in the employment contract. But, it’s unclear what happens if the benefits are not laid down in the contract. Such situations will have to be examined in detail.

The writer is tax partner, people advisory services, EY. Rahul Agarwalla, manager, people advisory services, contributed to the article