Computation of salary income of a Czech national employed with Skoda Auto AS, a company incorporated in Czechoslovakia and is currently under deputation to Skoda Auto India (P.) Ltd:
Income tax return filed on : 31-7-2006,
| Basic Salary: | Rs. 47,31,650 |
| Bonus: | Rs. 8,81,760 |
| Total Salary: | Rs. 56,13,410 |
Deductions:
- Hypothetical-tax : 20,21,281
- Social security charges: 9,23,498
| Net Salary: | Rs. 26,68,631 |
| Taxable allowances:
Taxable perquisite: |
Rs. 17,74,558
Rs. 25,79,856 |
| Taxable income under the head salary: | Rs. 70,23,050 |
Meaning of the term tax equalization policy and hypothetical tax:
This deduction on account of hypothetical-tax liability is made under tax equalization policy, which, in substance, restricts the tax liability of an employee in India to the tax liability which the employee would have incurred in their home country. For example:
| Particulars | Tax liability which the employee would have incurred in his home country,i.e Czech republic in the present case | Tax liability of an employee in India | Impact analysis |
| Tax rate | 20 percent of salary income | 30 percent of salary | Actual tax liability paid by the employer company. (it is the employee tax bill is paid by the employer and same will be taxable under the head salary income as a prerequisite of employee) |
| Whether tax equalization policy applicable | Yes | As tax rate in the country of employment is more. | |
| Tax liability to be borne by the employer | 10 percent of salary
(Being 30% tax in India Less 20% tax in home country) |
This is the tax liability of employer company under the term of employment and also paid employer company and hence, not a prerequisite income of the assessee employee. | |
| Tax liability to be paid to employee assessee | 20 percent of salary income | 20 percent of salary income | Hypothetical tax bill under the tax equalization policy of the employer company and reimbursed by an employee to the employer under the term of employment. Thus, income to this extent never accrue to an employee but received by him as an employer has already paid taxes at increased rates. Thus, this amount needs to be deducted while computing a taxable perquisite. |
| The net effect of the policy | tax equalization | tax equalization | Objective achieve |
Thus, what is deducted on account of hypothetical-tax is not a reduction of basic salary, but it is only restricting the tax liability of the employee as borne by the employer.
When a deduction to be made from the salary on account of hypothetical-tax, whether this deduction to be allowed while computing the basic salary or is it to be allowed at the stage of computing perquisite of tax on the salary being borne by the employer?
The hypothetical-tax liability thus only reduces the tax prerequisite of the employee and not his income. The deduction, therefore, should be made at the stage of computing the tax prerequisite and not the basic salary.
The view, that hypothetical-tax is not one of the three deductions permissible under section 16, and, accordingly, the deduction cannot be granted on account of hypothetical-tax from the basic salary is wrong as the hypothetical tax is not a tax liability and thus not an income of the assessee employee.
The explanation for deduction of hypothetical tax: This deduction was on account of hypothetical-tax under tax equalization policy and, in accordance with Tribunal’s decision in the case of Jaidev H. Raja v. Dy. CIT [IT Appeal No. 2021 (Mum.) of 1998], taxable base salary is to be reduced by the amount of hypothetical-tax.
In the case of Jaydev H. Raja (supra), as per the tax equalization policy framed by the employer company i.e., Coca Cola India Inc., employees were guaranteed a net of tax salary and the company was to bear all actual taxes imposed on the employee’s assignment income. The employees had to reimburse the company that part of the total tax liability which he would have paid had if he worked in Atlanta.
Thus, the deduction on account of hypothetical-tax is justified because the liability of the employer will be restricted only to the extent of additional liability over and above what would have arisen had the appellant been in the Czech Republic. Therefore, the amount of Rs. 20,21,281. which has been reduced as hypothetical-tax, is not accrued to the appellant at all and the same is not taxable.
