Evolution of Tax Regulations for Perquisites in India: FBT to Current Framework

Introduction

This blog discusses the evolution of tax regulations surrounding perquisites (perks) in India, focusing on the introduction and eventual abolition of the fringe benefits tax (FBT), and the implications for both employers and employees.

Historical Context of Perquisites Taxation

On September 25, 2000, Rule 3 concerning perquisites was revised through Notification SO 940(E). This amendment established a taxation framework based on the "cost to employer" principle, effectively categorizing perks as salary. As a result, many employers prefer to increase employee salaries instead of providing perks to circumvent the need for extensive record-keeping.

Over time, it became evident that direct taxation of perks on employers was more beneficial for revenue collection. Mixed personal and business expenditures—common with motor vehicles, credit cards, and club entertainment—necessitated complex record-keeping to distinguish among personal and professional use, creating subjective challenges for verification.

Introduction of Fringe Benefits Tax

In response, the Finance Act (FA) 2005 introduced the fringe benefits tax (FBT), applicable entirely to employers. This tax covered various mixed perquisites, enhancing administrative ease. Following this, Notification 68/2005 dated February 28, 2005, removed perks previously taxed in employees’ hands along with the corresponding rules.

According to Section 115W, FBT applied exclusively to certain entities, including companies, firms, associations of persons (AoP), bodies of individuals (BoI), local authorities, and artificial judicial entities, thereby excluding individuals, Hindu Undivided Families (HUFs), and trusts from FBT liability. To incorporate employees of these exempted employers into the tax system, the government reinstated the previously deleted Rule 3 subsections via Notification SO 1896(E) effective FY08, mandating that only employees of non-FBT liable employers would be subject to perk taxation.

Transition and Abolition of FBT

The revenue authorities recognized that FBT presented significant compliance burdens for both employers and employees. Consequently, the Finance Act 2009 abolished FBT by deleting Chapter XII-H, while Rule 3 remained intact. From FY10, all employees, regardless of their employer type, were subject to taxation on perks.

Additionally, the Finance Act 2009 amended Section 17 to include two new categories of perks:

Contributions to the employee's superannuation fund exceeding Rs 1 lakh within the financial year.
Employee stock options.

Given that the FBT had been repealed, the Central Board of Direct Taxes (CBDT) needed to issue new notifications to redefine tax provisions promptly. This necessity emerged from employers failing to deduct tax at source for perks during the financial year. Finally, CBDT announced Notification 94/2009/F. No. 142/25/2009-50(TPL) on December 18, 2009, implementing minor adjustments to Rule 3, effective April 1, 2009.

Impact on Taxation and Compliance

Under the former FBT regime, the tax rate ranged between 5% and 50% of employer-incurred expenses. Post-abrogation of FBT, employees would again face taxation under the "cost to employer" model, effectively reverting to the situation preceding the FBT introduction.

The delay in issuing the revised notification imposed additional challenges for employers, requiring the application of Tax Deducted at Source (TDS) on perks over the fiscal year within a limited timeframe, leading to potential financial strain for employees.

Section 17, which now classifies contributions exceeding Rs 1 lakh as perks, has prompted some employers to increase employee salaries to match this limit, thus restricting contributions at the set threshold.

Conclusion

This analysis emphasizes the need for stability in tax provisions related to perks, particularly considering the difficulties employers face in applying TDS for employees who have resigned. It is crucial for future tax frameworks to be clear and consistent to alleviate compliance burdens and enhance clarity for all stakeholders involved.