January

A reader of this blog sent us the below question some days ago.

As per 192 TDS on salary is to be deducted on actual payment and not on accrual basis, here if a person resigns in Feb, his salary for the month of Jan and Feb is paid in April along with F&F settlement, then in which year it is accountable. As the payment is made in April [sic].

This is an important question which touches on one of the most fundamental issues in salary taxation – at what point in time should salary be taxed? When salary for the months of January and February is held back and paid only in April (a new tax year), how does Section 192 come into play?

A study of when salary should be taxed starts with Section 15 of the Income Tax Act. Let us take a look at Section 15 before we get to Section 192.

Section 15: Salary is to be taxed whenever it accrues or is paid, whichever is earlier

According to Section 15:

Salaries.
15. The following income shall be chargeable to income-tax under the head “Salaries”—

(a) any salary due from an employer or a former employer to an assessee in the previous year, whether paid or not;

(b) any salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer though not due or before it became due to him;

(c) any arrears of salary paid or allowed to him in the previous year by or on behalf of an employer or a former employer, if not charged to income-tax for any earlier previous year.

According to Section 15, salary should be taxed as soon as it accrues, even if it is not paid then. When can one say that salary has accrued? For example, can it be said that salary for the month of January accrues on the last day of January?

Salary is said to have accrued when it can be claimed by an employee from a legal standpoint. Statutes such as the Payment of Wages Act specify the deadline by which salary will have to be paid to an employee after a wage period (say, a calendar month) ends. One could argue that salary can be said to accrue at the end of a wage period. Surely, right to receive salary payment arises only when accrual is deemed to have taken place.

From the perspective of the employer, if salary for January is charged as an expense for the purpose of accounting in the month of January, one could state that salary expense accrues in January for the employer. In other words, the employer explicitly recognizes that the salary income to employee accrues in January.

So, what does Section 15 say with regard to salaries that are deemed (even if not paid) to accrue in January and February?

According to Section 15, income tax on January and February salaries should be calculated as per the income tax rates prevailing in the relevant financial year. For example, salary for January 2017 and February 2017 should be added to the total salary income of FY 2016-17 and income tax should be calculated as per the tax slabs mandated for FY 2016-17. This holds even if the January 2017 and February 2017 salaries are paid in April 2017 (in FY 2017-18).

What about Section 192?

According to the Income Tax Department, “Section 192 casts the responsibility on the employer, of tax deduction at source, at the time of actual payment of salary to the employee. Unlike the provisions of TDS, pertaining to payments other than salary where the obligation to deduct tax arises at the time of credit or payment, whichever is earlier, the responsibility to deduct tax from salaries arises only at the time of payment.”

It follows from the above that since tax deduction needs to happen at the time of salary payment, the remittance of tax too needs to take place only after salary payment.

While Section 192 talks about the timing of tax deduction, the quantum of deduction itself should be only as per Section 15. For example, tax on salary which accrues in January 2017 and February 2017 (see the question posed at the beginning of this post) should be calculated on the basis of the tax rates in FY 2016-17 even if the salary is paid late in April 2017. Section 192 states that the tax – which is calculated as per the rates in FY 2016-17 – needs to be deducted only in April 2017, the time of salary payment. This is important because the tax rates for FY 2016-17 (the period of salary accrual) could be different from the tax rates for FY 2017-18 (the period of salary payment).

One can summarize that Section 192 specifies the timing of tax deduction while Section 15 specifies the quantum of tax deduction.

Actually, Section 192 is in a bit of conflict with Section 15 particularly in cases where salary payment is made late, in the next financial year. We think the text of Section 192 should be rewritten to clear the confusion. Please see our blog post in this regard. Section 15 is what determines how much tax should be deducted.

Practical issues in complying with Section 192

Even if salary for January and February is paid in the next financial year, the details of salary and TDS should feature in the fourth quarter Form 24Q of the financial year pertaining to the January and February salary. In case the fourth quarter Form 24Q has already been filed, one has to refile Form 24Q for the late salary payments.

Also, if accounting entries pertaining to January and February salary have to be finalised on time before the end of the year, the TDS amounts too have to be recognized in the books of accounts. However, this is not in line with Section 192 according to which the TDS payable arises only at the time of salary payment (in the next financial year).

Please note that, as a general rule, salary payment can be held back but payroll processing should never be stopped or deferred. For the months of January and February, PF, ESI and other statutory remittances can be made on time only if payroll processing is carried out without delay.

So, what do organizations do in case of delayed salary payment?

We find most organizations processing payroll and deducting/remitting TDS as soon as payroll is processed. This even if the net pay is paid along with settlement amounts at a later point in time. For example, in the example we are discussing in this post, the payroll of January and February salary shall be processed in January and February, and TDS for January and February shall be deducted and remitted to the Income Tax Department immediately. However, the net pay for January and February shall be held back and paid as part of settlement processing carried out in April.

While this is not fully in line with Section 192, this ensures compliance with Section 15 and that Form 24Q filing and Form 16 issuance are completed on time.

Some organizations misstate the period of accrual as the next financial year when salary payment is deferred to the next financial year. For example, let us assume that an employee’s last working day is 3rd of March and his final settlement consisting of March salary is processed in April. Some organizations calculate 3 days’ salary pertaining to March, state the same as April salary and include it in the income for the financial year in which settlement is processed. Of course, this is incorrect from the point of view of Section 15 of the Income Tax Act.

Ideally, organizations should aim to complete payroll/settlement processing without any delay. This would ensure compliance with income tax and other laws to a large extent.

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Organizations pay what is called per diem (per day) allowance to employees who travel for business purposes. The allowance is meant to help employees cover daily expenses pertaining to food, local travel, etc. When employees travel abroad they receive the allowance in foreign currency. Many organizations do not seek information on the actual daily expenses incurred by the employees. In other words, employees are not required to submit receipts (proof of expenditure) for the per diem allowance they receive.

Are per diem allowances non-taxable? If yes, are there are any conditions to be met for the allowance to be non-taxable?

Income tax and judicial authorities have gone through the matter of taxability of per diem allowance in a variety of cases. Let us take a look at the key issues in this regard.

Per diem allowance while on business travel is non-taxable

If the nature of a per diem allowance is as per Section 10(14) of the Income Tax Act along with Rule 2BB of the Income Tax Rules, then the per diem allowance shall not be included in the Total Income of the employee for the purpose of calculating tax on salary.

Section 10(14) states that an allowance should be “specifically granted to meet expenses wholly, necessarily and exclusively incurred in the performance of the duties of an office or employment of profit” in order to be exempt from tax.

Rule 2BB(1)(b) states that “any allowance, whether, granted on tour or for the period of journey in connection with transfer, to meet the ordinary daily charges incurred by an employee on account of absence from his normal place of duty” shall not be taxable.

In Saptarshi Ghosh, Kolkata vs Department Of Income Tax (ITA No. 915/Kol/2010), a Kolkata bench of the Income Tax Apellate Tribunal (ITAT) went into the issue of applicability of Section 10(14) and Rule 2BB to the taxability of per diem allowance in great detail. The bench examined the terms of the agreement (between the employee and the employer in the said case) under which employees were sent abroad for business purposes and concluded that “keeping in view the entirety of the facts and circumstances of the case, assessees were to be treated on tour and, therefore, eligible for claiming deduction under section 10(14)(i) read with Rule 2BB(1)b).”

Since the per diem allowance is not taxable, there is no requirement on the part of the employer to deduct TDS on such payments. The Andhra Pradesh High Court in Commissioner Of Income-Tax vs Coromandel Fertilisers Ltd. (Equivalent citations: 1991 187 ITR 673 AP) stated that if an employee is not liable to pay tax under the head “Salary” for a payment received by the employee, the obligation to deduct tax (by the employer) under section 192 does not arise.

Should the expenses be verified by the employer?

Judicial and tax authorities have ruled that an employer need not verify the exact nature of the expenses incurred by an employee, for the per diem allowance to be tax exempt. The Income Tax Department, by way of a circular (No. 33 (LXXVI-5) dt. 01 August 1955) has said:

Special allowance or benefit being reasonable and not disproportionately high–No details of expenses actually incurred need be asked for the purpose of granting exemption under Section 4(3)(vi) of 1922 Act.

In other words, as long as the allowance is within “reasonable” limits, the employer need not seek details of the expenses. Experts believe that the above circular is currently relevant even though it is based on the Income Tax Act of 1922. In Madanlal Mohanlal Narang vs Assistant Commissioner Of Income Tax (Equivalent citations: 2007 104 ITD 190 Mum, (2006) 101 TTJ Mum 1005), a Mumbai bench of the ITAT stated that the circular of 1955 is valid even in the context of the Income Tax Act, 1961.

8. The above circular was undoubtedly issued under the IT Act, 1922 but then all the circulars issued under Section 1922 Act do not cease to hold good in law. Section 297(2)(k) specifically provides that notwithstanding the repeal of IT Act, 1922, amongst other things, any instructions issued under any provisions of the repealed Act shall, so far as not inconsistent with the corresponding provisions of IT Act, 1961, deemed to have been issued under the corresponding provisions of the new Act, and shall continue to remain in force accordingly. In other words, to the extent the legal provisions of 1922 Act and 1961 Act are in pan materia, circulars and instructions issued under the 1922 Act will also hold good.

What is a “reasonable” per diem allowance?

Authorities say that per diem allowance is not taxable as long as the payment is a reasonable amount. Now, how does one conclude what is reasonable? Is a per diem allowance of USD 100 reasonable? What about, say, USD 300? There is nothing etched in law as to what a reasonable allowance is.

In Income Tax Officer (TDS), Vs. M/s. Symphony Marketing Solutions India Pvt. Ltd. (ITA Nos.874, 1252 & 1586/Bang/2014), a Bangalore bench of the ITAT, while hearing a matter pertaining to per diem allowance, accepted the prior ruling of CIT (Appeals) who said:

There is no monetary limit prescribed and hence unless such allowance is said to be fictitious or abnormally high or otherwise taxable in the hands of the employee, no liability could be fastened under Section 192 on the employer to deduct tax on such allowance. Moreover, it is also not possible to collate bills for every minuscule expenses and mere non-collation of bills in support of amount expenses cannot prevail over the fact of incurring such expenses.

The CIT (Appeals), in the above case, went through a couple of circulars (No.Q/FD/695/1/90 dated 11/11/1996 and No. Q/FD/695/2/2000 dated 21/09/2010) issued by the Ministry of External Affairs, Govt. of India and concluded that the per diem allowance of USD 50 to USD 75 paid by the assessee to its employees on official trips to USA and Europe was reasonable and that the same would be tax exempt under Section 10(14) of the Income Tax Act. The circulars referred to here, issued by the Ministry of External Affairs, specify the per diem allowance payable to government officials when they travel to different countries. The authorities, in this case, determined the reasonableness of the per diem allowance by referring to the allowance paid by the Indian government.

When the above case was escalated to The High Court of Karnataka (ITA 653/2015), the honourable judges accepted the above arguments and ruled that the per diem allowance, as long as it is reasonable, is not taxable.

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The Income Tax Department has issued the “TDS on Salary” circular for FY 2016-17. You can take a look at it here.

Please ensure that all tasks (income tax deduction, investment proof scrutiny, etc.) related to salary TDS compliance in your organization for FY 2016-17 are carried out as per the circular.

Para 4.6.5 in the circular

This para states that the employer should receive and scrutinize documentary proof supporting investment declarations made by employees. Para 4.6.5 states:

To bring certainity and uniformity in this matter, section 192(2D) provides that person responsible for paying (DDOs) shall obtain from the assessee evidence or proof or particular of claims such as House rent Allowance (where aggregate annual rent exceeds one lakh rupees); Leave Travel Concession or Assistance; Deduction of interest under the head “Income from house property” and deduction under Chapter VI-A as per the prescribed form 12BB laid down by Rule 26C of the Rules.

In the above excerpt, the phrase “where aggregate annual rent exceeds one lakh rupees” in the context of collecting proof for providing House Rent Allowance (HRA) exemption is striking. To our knowledge the Rs 1 lakh cut-off is relevant only with regard to obtaining landlord PAN (or a no-PAN declaration by the landlord). However, this phrase gives one the impression that employer needs to collect proof (house rent receipt etc.) for providing HRA exemption only if the aggregate rent exceeds Rs 1 lakh. In other words, this seems to imply that employers need not collect any proof for HRA exemption in case the aggregate annual rent does not exceed Rs 1 lakh.

We are of the view that “where aggregate annual rent exceeds one lakh rupees” refers only to submission of landlord PAN and employers will have to collect house rent receipt even if the rent paid is less than Rs 1 lakh. As you may be aware, currently, employers need not collect rent receipts only if an employee receives a monthly amount of Rs 3,000 or less as house rent allowance.

Para 4.9 in the circular

The due dates for Form No. 24Q filing, presented in the circular, seem to be incorrect. The circular presents the due dates for non-government deductors as follows.

However, the Income Tax Department, by way of a notification dated 29-Apr-2016, revised the due dates (with effect from 01-June-2016) for Form No. 24Q filing each quarter as follows.

The circular seems to contain the due dates which were in effect prior to the above notification.

Para 9.2 in the circular

According to para 9.2 in the circular, “rebate as per Section 87A upto Rs 2000/- to eligible persons (see para 6) may be given.”

This seems to be a mistake since the maximum rebate under Section 87A for FY 2016-17 is Rs 5,000 and not Rs 2,000. In fact para 6 (referred to in para 9.2) in the circular states the correct amount (Rs 5,000).

Suggestions

1. It would help if the Income Tax Department releases the salary TDS circular well ahead of the last quarter of the year. Many organizations initiate the process of investment proof scrutiny in January and hence need adequate time to study and implement the guidelines in the circular.

2. While it is fine to copy text from the previous year’s circular for the sake of convenience, it would help if the Income Tax Department does a thorough check on whether changes to income tax procedures for the current year are presented accurately in the circular.

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What’s in a name? that which we call a rose
By any other name would smell as sweet;

– William Shakespeare in Romeo and Juliet

While it is perfectly legitimate for organizations to hire consultants (along with hiring full-time employees) during the course of business, it is important that the underlying statutory requirements are fully adhered to. We find many organizations not calculating salary-related statutory deductions such as income tax, PF and ESI for personnel they classify as consultant. Just because the title of consultant is used does not automatically make a person non-employee. Authorities, in a variety of cases, have gone beyond mere titles given to work personnel to examine whether the underlying relationship between an individual and the organization is that of employee and employer.

TDS – Under section 194J or 192 of the Income Tax Act?

In a case (ITA No. 747/2009) involving a health care organization and the Income Tax Department, The High Court of Karnataka has provided guidelines for ascertaining the nature of relationship between an individual and his employer. In the said case, the assessee (health care organization) deducted TDS for payments made to consultant doctors under Section 194J (TDS on fee for technical services). The Income Tax Department argued that the TDS should have been deducted under Section 192 (TDS on salary) since the nature of relationship between the consultant doctors and the assessee organization was that of employee and employer.

The Honourable Judges, in their verdict, said:

13. To decide the relationship of employer and employee we have to examine whether the contract entered into between the parties is a ‘contract for service’ or a ‘contract of service’. There are multi-factor tests to decide this question. Independence test, control test, intention test are some of the tests normally adopted to distinguish between ‘contract for service’ and ‘contract of service’. Finally, it depends on the provisions of the contract. Intention also plays a role in deciding the factor of contract. The intention of the parties can also determine or alter a contract from its original shape and status if both parties have mutual agreement. In the instant case, the terms of contract ipso facto proves that the contract between the assessee-Company and the doctors is of ‘contract for service’ not a ‘contract of service’.

The courts of India, including the Supreme Court, have gone into the issue of whether the relationship between an individual and his employer can be said to be that of employee and employer in several cases. The key factors considered by courts in this regard are as follows.

a. Control
Does the employer exercise significant or absolute control over the day to day functioning of the individual? For example, does the individual have any flexibility in work timings? Does the individual work on the basis of specific tasks (such as those in a short-term project) or does the individual have to commit a certain period of time to the employer irrespective of the actual work done? Does the individual work under the complete supervision of managers in the employer organization or can the individual work independently to achieve work objectives?

The more the control exercised by an employer on an individual’s daily work routine, the more the individual’s role can be characterized as that of an employee’s.

b. Payment of remuneration
Does the individual receive a fixed remuneration on the basis of hours spent or a variable remuneration on the basis of certain work outcomes? An individual can be characterized as an employee if the remuneration has a significant fixed component.

c. Applicability of services rules
If the contract with consultants contain terms which resemble the service rules which govern employees, the statutory authorities could well argue that the consultants are in fact employees.

d. Independence to work for other employers
Organizations typically require employees to sign an exclusivity agreement that bars them from working for other employers while in service. Consultants, in most cases, are independent to pursue multiple work opportunities across employers at the same time.

e. Service duration
An individual who is employed for short periods of time on a sporadic basis is more likely to be a consultant than an employee (who is more likely to be hired on a permanent basis).

In a recent ruling (Appeal No. Income Tax 572/Bang-2014), a Bangalore bench of the Income Tax Apellate Tribunal, said that the assessee incorrectly deducted TDS under Section 194J instead of Section 192 on account of the assessee misclassifying employees as consultants. The Tribunal Bench, after going through the terms of the contract between the assessee and the individuals hired as consultants said, “All these conditions go to prove that it is a case of contract of service.” The term Contract of Service, as you would appreciate, refers to employer-employee relationship.

The Bench in the above case also stated that mere title (such as Consultant) does not change the nature of the relationship. To quote from the ruling,

All these circumstances go to prove that the assessee is only making an attempt to camouflage real nature of the transaction by using clever phraseology. It is not the form but the substance of the transaction that matters. The nomenclature used may not be decisive or conclusive to determine the nature of transaction. The intention of the parties is to be ascertained with reference to terms of conditions contained in the agreement.

Hire consultants, but..

If your business requires hiring consultants, do so by all means. However, do not create a category of work personnel called consultants with the sole objective of avoiding statutory deductions such as PF and ESI. The PF and ESI authorities can and do examine whether exclusion of any of the work personnel is on valid legal grounds.

The Supreme Court of India (in Royal Western India Turf Club Ltd. Vs. E.S.I. Corporation), while commenting on exclusion of certain types of personnel from ESI, said:

The definition of “employee” is very wide. A person who is employed for wages in the factory or establishment on any work of, or incidental or preliminary to or connected with the work is covered. The definition brings various types of employees within its ken. The Act is a welfare legislation and is required to be interpreted so as to ensure extension of benefits to the employees and not to deprive them of the same which are available under the Act.

In other words, please be clear about the legal basis when you keep a person out of statutory deductions such as PF and ESI.

Finally, please make sure that your organization’s agreements with consultants contain terms which, beyond any doubt, denote that the relationship is one of “contract for service” and not “contract of service”.

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