Fringe issue takes centrestage

The government's proposal to impose a 30 per cent tax (33.66 per cent after a 10 per cent surcharge and 2 per cent education cess) on the fringe benefits offered by companies to their employees is all set to burn a deep hole in India Inc's pocket.

A day after Finance Minister P Chidambaram introduced the tax, corporates were still trying to gauge its impact. Although the government gave no estimates of how much it planned to collect, early estimates suggested the impact could be severe.

Wockhardt chairman Habil Khorakiwala said the impact on his company's bottom line would be 5-7 per cent as 1,200 Wockhardt medical representatives travelled 20 days a month. Twenty per cent of all such expenses incurred by the company will now be taxed at 30 per cent.

Cipla joint managing director Amar Lulla added the tax was tantamount to an additional corporate tax of 9-10 per cent, given the high sales budgets of pharmaceutical companies.

Escorts chief financial officer Shailendra Tandon said the company would have to pay a tax of Rs 1.2 crore (Rs 12 million) because of its annual contribution of Rs 4 crore (Rs 40 million) to the superannuation fund.

According to a study conducted by a software company, the impact of the tax can be about 1-1.5 per cent of the total salary cost. This impact can be reduced to about 0.75 per cent by appropriate salary restructuring.

There were indications that companies could reduce these expenses in the days to come. LG Electronics India pays around Rs 4-5 crore (Rs 40-50 million) annually on the travel of executives and nearly Rs 800,000 per month in phone bills.

"If it has to pay a 30 per cent tax on 50 per cent of these expenditures, then the company will have to undertake drastic cost-cutting measures," YV Verma, director (HR), LG Electronics India, said.

TK Bhowmick, deputy director-general of the Confederation of Indian Industries, said up to 20 per cent of the turnover of a company went into meeting expenses listed as fringe benefits. "The companies that have been spending large sums on skill development will now cut down," he added.

Financial institution nominees may not attend board meetings or curtail the number of meetings as staying in hotels or guest houses will also be liable for tax. "The burden on tax will actually increase on account of tax on fringe benefits," said R N Bhardwaj, chairman, Life Insurance Corporation of India.

The proposal will also bring all companies that are currently not paying any taxes because they are either making losses or operating out of tax-free zones, under the tax net. According to CMIE, there are 2,200 such companies.

A number of companies spoke out against the tax. Said Santrupt Misra, director (human resources and IT) of the Aditya Birla group: "Most things listed there are basic necessities of conducting business today. This needs to be revisited and possibly abolished."

Added Tarun Jain, director (finance) of Sterlite Industries: "It is a tax on expenditure rather than income. This is not progressive reform and it will offset the positive effect of lowering the corporate tax."

According to an analysis by global consultants Ernst & Young, there are only a handful of countries in the world like Australia, New Zealand, Hungary and Malawi that levy such a tax. "Even there, the scope of the tax is very narrow in comparison," said Rajiv Memani, CEO and country managing partner of Ernst & Young.

It is also being felt that the burden will be felt more by companies in the FMCG, information technology and pharmaceutical sectors, where the spends on promotions and publicity, travel and conferences tend to be high.

CMIE data show that 1,355 companies had an advertisement and publicity expenditure of Rs 8,595 crore (Rs 85.95 billion) in 2003-04. Under the new rules, 50 per cent of this expenditure will be taxed at the rate of 30 per cent. This can result in an additional burden of Rs 1,290 crore (Rs 12.9 billion).

Information technology companies that send their personnel abroad will now have to pay a tax on such expenses.

"The fringe benefits tax covers many heads of expenses that, in a service industry, are nowhere in the nature of benefits for employees. Given the intent of this tax, one can only assume that this is an unintended anomaly and will be corrected," Suresh Senapathy, chief financial officer and corporate executive VP (finance) of Wipro, said.

"The definition is too wide and needs to be clarified," said Mohandas Pai, director, CFO and head, finance and administration of Infosys Technologies.

Added Lakshmi Narayanan, president and CEO of Cognizant: "We are concerned about the wide sweep on fringe benefits taxation, as there are some genuine business expenses that are indicated as benefits. The definition and ambit of this tax have to be looked into deeper to understand its implications."

Another question that was debated was how much of the additional tax burden can companies pass on to its employees. Several CFOs Business Standard spoke to said the fringe benefit tax on items like leave travel allowance and telephone bills could be passed on to employees.