Tax Implications and Exemptions

Salaried employees form the major portion of the overall taxpayers in the country. The contribution they make to the tax collection is also quite significant. Income tax deductions offer a great scope of opportunities for saving tax for the salaried class. With the help of these deductions and exemptions, one could easily reduce his/her tax substantially. Here we try to list some of the major exemptions which are available to salaried persons, using which one can reduce their income tax liability.

1. House Rent Allowance

A salaried individual having a rented accommodation can get the benefit of HRA (House Rent Allowance). This could be totally or partially exempted from income tax. In case an individual isn’t living in any rented accommodation, however, continues to receive HRA, it would be taxable. Also, it’s important to note that if one couldn’t submit his/her rent receipts to their employer for claiming HRA, one could still claim the exemption while filing the income tax return. However, one must keep such rent receipts as a piece of evidence and also maintain the details of such payments which is made towards rent.

The least of the following is allowed as the HRA exemption to a salaried employee:

1- Total HRA received.
2- Rent paid less than 10 percent of salary.
3- 40 percent of salary (Basic+ DA) for non-metros and 50 percent of salary (Basic+ DA) for metros.

2. Standard Deduction

The Indian Finance Minister during his speech while presenting the Union Budget 2018, announced a standard deduction amounting to INR 40,000 for salaried employees. This has replaced the existing transport allowance of INR 19,200 and medical reimbursement of INR 15,000. In effect, the income tax exemption available to the salaried is INR 5800 with effect financial year beginning 1 April 2018.

3. Leave Travel Allowance (LTA)

The income tax law also provides for an LTA exemption to salaried employees who are restricted to the cost of travel incurred by such employees. It is important to note here that the exemption doesn’t include costs which are, incurred for entire trip which could include shopping, food expenses, entertainment and leisure, and other expense. LTA is allowable for two travels in a block of four years. In case an individual doesn’t use this exemption within a block, he/she could carry the same to the next block.

Below are the restrictions which are applicable to LTA:

1- LTA only covers domestic travel and it doesn’t cover the cost of international travel
2- The mode of such travel must be either railway, air travel, or public transport

4. Section 80C, 80CCC and 80CCD (1)

Section 80C is the most extensively used option for saving income. According to this section, an individual or a HUF (Hindu Undivided Families) who invests or spends on stipulated avenues then they can claim a deduction up to INR 1.5 lakh. Expenditures/investment u/s 80C isn’t allowed as a deduction from income arising due to capital gains. It means that if the income of an individual comprises capital gains alone, then Section 80C cannot be used for saving tax.

Deductions under Section 80C of the Income Tax Act, 1961 are offered for the investments made in a range of instruments. Some of these instruments are more well-known than others due to various reasons. The Indian government too supports a few as the tax-saving instruments for encouraging individuals towards these investments.

The Government of India encourages investment in certain avenues which provides for a good amount of retirement corpus for the salaried while in parallel providing them with an income tax benefit too. Some of such investments are given below which are eligible for an exemption under Section 80C, 80CCC, and 80CCD (1) up to a maximum of INR 1.5 lakhs.

1- Life insurance premium
2- Equity Linked Savings Scheme (ELSS)
3- Employee Provident Fund (EPF)
4- Annuity/ Pension Schemes
5- Principal payment on home loans
6- Tuition fees for children
7- Contribution to PPF Account
8- Sukanya Samriddhi Account
9- NSC (National Saving Certificate)
10- Fixed Deposit (Tax Savings)
11- Post office time deposits
12- National Pension Scheme

5. Medical Insurance Deduction (Section 80D)

This is a deduction that is provided for medical expenses. Deduction under this Section is available over and above the deduction under 80C. One could save tax on medical insurance premiums paid for the health of self, family, and dependent parents. These expenses could be deducted from overall taxable income. The limit for this deduction is INR 25,000 for premiums paid for self/family. For premiums paid for parents who are senior citizens, one can claim a deduction of up to INR 30,000. This limit has been raised in Budget 2018 from INR 30,000 to INR 50,000. i.e. Effective 1 April 2018, one can claim up to INR 50,000 as a deduction for premium paid for senior citizen parents. Additionally, health checkups to the extent of INR 5,000 are also allowed.

6. Interest on Home Loan (Section 80C and Section 24)

Another key tax-saving tool is the interest that is paid on home loans. Homeowners have the option to claim up to INR 2 lakhs as a deduction for interest on a home loan for a self-occupied property. In case the house property is let out, the deduction is allowed for the entire interest pertaining to such a home loan. However, here it becomes essential to note that from FY 2017-18, the loss from house property that can be set off against other sources of income has been restricted to INR 2 lakhs. In addition to the above, one can also claim the principal component of the housing loan repayment as a deduction under 80C up to a maximum limit of INR 1.5 lakhs.

7. Deduction for Loan for Higher Studies (Section 80E)

Income Tax Act provides exemptions for interest on education loans. The significant conditions attached to claiming such deduction are that the loan should have been taken from a bank or a financial institution for pursuing higher studies (in India or abroad) by the individual himself or the spouse of his children. Further, one may begin claiming this deduction beginning from the year in which the loan starts getting repaid and up to the next seven years or before repayment of the loan whichever is earlier. Even a legal guardian could avail of this income tax exemption.

8. Deduction for Donations (Section 80G)

The donations made which are provided u/s 80G of the Income Tax Act, 1961 offer income tax exemption to an assessed. This deduction varies based on the receiving organization, which implies that one might get exemptions from 50% to 100% of the amount donated.

9. Deduction on Saving Account Interest (Section 80TTA)

Section 80TTA of the Income Tax Act, 1961 offers a deduction of INR 10,000 on income earned in the form of bank interest. This exemption is allowed for Individuals and HUFs. The maximum limit of deduction under this section is INR 10,000. In case the income from bank interest is less than INR 10,000, the whole amount will be allowed as a deduction. However, in case the income from bank interest exceeds INR 10,000, the deduction would be restricted to INR 10,000.

10. Employee Stock Option Plans (Sec 17(2)(vi))

When an employee gets ESOPs from the company where he/she works, he/she gets the right to purchase a certain number of shares in the company at a predetermined price after a predetermined period or period. It is generally given as a reward for performance or tenure with the company. The option granted under the plan confers a right, but not an obligation on the employee. The life cycle of an ESOP has three key stages – grant, vesting, and exercise.

1- Grant: This is the first stage, where an option is granted to the employee which will vest over a predefined period of time and or is subject to meeting certain conditions.
2- Vesting: Here the employee gets the unconditional right to acquire shares. The employee does not receive actual shares at this stage.
3- Exercise: Here, the employee can use his right to acquire shares from the company on payment of a pre-determined price. Post allotment, the employee can hold these shares or sell them based on the exit mechanism provided in the ESOP scheme.

Taxability of ESOPs in the hands of employees. There are two stages of taxability in the hands of the employee which is as below:

1- The first stage is when the options are exercised by the employee. The benefit, which is the difference between the fair market value (“FMV”) of the shares on the date of which the option is exercised and the amount at which the options were granted to the employee, is treated as a prerequisite as per Income Tax Act, 1961.
2- The second stage is when the shares are sold or transferred by the employee in which case the difference between the sale consideration and the FMV of the shares would be treated as capital gains and will be subject to capital gains tax.
3- In case the shares are sold within a year after acquiring them, the gains resulting from such a sale are known as Short Term Capital Gains, and shares sold after a year of acquiring them are known as Long Term Capital Gains.

Tax Implications for ESOPs of Listed companies

1- When the options are given by the company, there is no tax.
2- When the options get vested, there is no tax.
3- When the employee exercises his option of buying the shares, the difference between the market value and exercise value is treated as perquisite and is taxable as per the tax bracket that the employee falls in.
4- When the employee sells the shares, the profit is treated as capital gains. If the shares are sold within one year, 15% capital gains tax has to be paid just like in the usual purchase and sale of shares. If the stock is sold after 1 year, there is no tax as it is considered long-term.

Tax Implications for ESOPs of Unlisted companies

1- For non-listed companies, the FMV is determined by a Category I merchant banker registered with the Securities and Exchange Board of India, the stock market regulator.
2- The perquisite value is derived as the difference between the FMV of the share on the date of exercise and the exercise price.
3- The perquisite tax needs to be paid on the date of exercise even though the shares are not sold.
4- Short term capital gains tax is as per income tax slab rates.
5- Long-term capital gains tax of 10% without indexation or 20% with indexation if you sell them after three years of holding period.
6- Indexation is a technique to adjust income payments by means of a price index, in order to maintain the purchasing power of the public after inflation.

Tax Implications for employees if the company is listed abroad

1- An employee’s income is taxable in India, according to his/her residential status.
2- If the employee is a Non-Resident, it will not be taxable, as the gains occur outside India.
3- If the employee is a resident in India, then Taxation will be as under:
4- Long-term capital gain: Either pay 10% income tax on gains without indexation benefit or pay 20% income tax on gains with indexation benefit.
5- Short-term capital gain is added to the employee’s overall income and taxed according to the prevalent slab rate.

Impact on the company issuing ESOPs

1- Expenses related to ESOP be claimed as a deduction by the company.
2- In respect of the options granted during any accounting period, the accounting value of the options shall be treated as a form of employee compensation in the financial statements of the company.
3- When we account for employee stock options, the following new accounts come into existence:
4- Employee compensation expense account – It forms part of the compensation expense account and is taken into the profit and loss account.
5- Deferred employee compensation expense – This account is created at the time of grant of options for the total amount of compensation expense to be accounted for. This account is a part of the Balance sheet and forms a negative balance in the Shareholder equity or Net worth.
6- Employee Stock Options Outstanding account – It is a part of the Shareholder equity and is transferred to Share Capital, Share Premium, or General Reserves. Amortized employee stock compensation expenses are taken into the Profit and loss account.
7- Impact of ESOPs on the Cash Flow of the company:
8- At the point of the grant of the option: No Impact
9- At the time of exercise: Cash Inflow increases by the exercise price.

Restricted Stock: This involves the company directly awarding shares to an employee, subject to a vesting period. If the employee leaves the company during this restricted period, the shares are forfeited.

Tax Implications of Restricted Stock:

1- At the time of grant: No tax
2- At the exercise date: Taxed as perquisites. The perquisite value will be the difference between the FMV and the original purchase or exercise price of the share (which may be zero)
3- At the time of sale: Taxable as Capital Gains. The Capital Gain is computed as the difference between the sale price and the share price on the date of exercise

Stock Appreciation Rights(SAR): SAR conveys a right given to an employee entitling him to receive the appreciation of the market price of a share of the Company on the date of vest or exercise of that right, as the case may be, over the SAR price/base price. The appreciation is made either by way of cash payment or shares of the Company. An employee does not have to pay anything on the date of exercise and hence he/she need not plan for any exercise expense.

Tax Implications in the hands of employees:

a) In case of Equity settled-SAR:

Perquisite Tax: As per Section 17(2)(vi) of the Income Tax Act, 1961 the taxable value of perquisite refers to the ‘value of equity shares issued or transferred to the employee as on date of exercise’ as reduced by ‘amount recovered from employee’. As per Rule 3(8) of the Income Tax Rules, 1962 value of listed equity shares refer to the average opening and closing market price of equity shares on the relevant Stock Exchange. In the case of unlisted equity shares, the value refers to the fair market value of equity share on the date of exercise as determined by a Category – I Merchant Banker registered with SEBI. This tax is determined on the date of exercise of SAR at the rate of tax that applies to the Salary of that individual employee.

Capital gains tax: Further, at the time of sale of equity shares, the employee is liable to pay income tax on the capital gain arising out of such sale. The capital gain refers to the excess of ‘sales consideration of shares’ over the ‘cost of acquisition of shares. As per section 49(2AA) of the Income Tax Act, the cost of acquisition refers to the value of such shares as on the date of exercise of SAR which was considered for perquisite tax determination. Long-term gains are taxed at preferential rates than short-term capital gains. Even at times, the long-term capital gains are exempt in the case of listed shares.

b) In case of Cash settled-SAR:

The amount of appreciation received by way of cash payment from the Company is subject to tax in the hands of the employee as a prerequisite. It is treated as part of salary and is accordingly taxed. Tax Implications for the company:

1- As a consequence of perquisites being taxable at the time of exercise of equity/cash-settled SAR as salary, the Company is liable for tax deduction at source under Section 192 of the Income Tax Act.
2- In case of Equity settled-SAR, the Company may claim deduction up to perquisite earned by the employees on the basis of the decision of Special Bench of Income Tax Appellate Tribunal, Bangalore which was rendered in ESOP context.
3- The principle upheld was that perquisite earned by an employee is at the cost of the Company which is a claimable expense.
4- However, in the absence of any supporting provisions in the Income Tax Act or precedent of the Supreme Court, the acceptability of such a claim by the Tax Authorities in other Jurisdictions is not certain.
5- In the case of Cash settled-SAR, the cash compensation made by the Company is deductible as allowable expenditure under Section 37 of the Income Tax Act.

Comparative effectiveness of SAR

Employer’s contribution towards superannuation fund (Sec 17(2)(vii)) An approved superannuation fund is a fund that is approved by the Commissioner of Income Tax. Taxable in the hands of employees to the extent such contribution exceeds INR.1,50,000. An employer’s contribution to an approved superannuation fund is allowed as an expenditure deduction for business under Section 36 (1) (iv), subject to certain limits.

11. Interest free loan or Loan at concessional rate of interest (Sec 17(2)(viii))

Interest-free loan or loan at a concessional rate of interest given by an employer to the employee (or any member of his household) is a perquisite chargeable to tax in the hands of all employees on the following basis:

1. Find out the ‘maximum outstanding monthly balance’ (i.e. the aggregate outstanding balance for each loan as on the last day of each month);
2. Find out the rate of interest charged by the SBI as on the first day of the relevant previous year in respect of loan for the same purpose advanced by it;
3. Calculate interest for each month of the previous year on the outstanding amount (mentioned in point 1) at the rate of interest (given in point 2)
4. Interest actually recovered, if any, from employee
5. The balance amount (point 3-point 4) is the taxable value of the perquisite

However, nothing is taxable if:
a) Loan in an aggregate does not exceed INR 20,000
b) Loan is provided for treatment of specified diseases (Rule 3A)
The advancement of such types of loans has a short-term impact on the cash flow of the company.

12. Free food and beverages are provided to the employee (Sec 17(2)(viii))

Fully Taxable: Free meals in excess of INR. 50 per meal less the amount paid by the employee shall be a taxable perquisite

Exempt from tax: Following free meals shall be exempt from tax

1- Food and non-alcoholic beverages provided during working hours in a remote area or in an offshore installation;
2- Tea, Coffee, or Non-Alcoholic beverages and Snacks during working hours are tax-free perquisites;
3- Food on office premises or through non-transferable, paid vouchers usable only at eating joints provided by an employer is not taxable if cost to the employer is INR. 50 (or less) per meal.

13. Gift or Voucher or Coupon on ceremonial occasions or otherwise provided to the employee (Sec 17(2)(viii))

1- Gifts in cash or convertible into money (like gift cheques) are fully taxable.
2- Gift in kind up to INR. 5,000 in aggregate per annum would be exempt, beyond which it would be taxable.
3- For example, if the employee has received a gift worth INR. 7500, then INR. 2500 (7500-2500) will be treated as perquisite and will be taxable in the hands of the employee.
4- The gifts form part of the salary of the employee and will be represented in the profit and loss statement of the company under the head “Salaries”.

14. Credit Card (Sec 17(2)(viii))

1- Expenditure incurred by the employer in respect of credit card used by the employee or any member of his household less the amount recovered from the employee is a taxable perquisite.
2- Expenses incurred for official purposes shall not be a taxable perquisite provided complete details in respect of such expenditure are maintained by the employer.

15. Free Recreation/Club Facilities (Sec 17(2)(viii))

1- Expenditure incurred by the employer towards annual or periodical fee etc. (Excluding the initial fee to acquire corporate membership) less the amount recovered from the employee is a taxable perquisite.
2- Expenses incurred on club facilities for official purposes are exempt from tax.
3- Use of health club, sports and similar facilities provided uniformly to all employees shall be exempt from tax.
4- They impact the cash flow of the company in a short term.
5- Use of movable assets of the employer by the employee is a taxable perquisite (Sec 17(2)(viii))
6- Use of Laptops and Computers: Nil
7- Movable assets other than Laptops, computers, and Motor cars: 10% of original cost of the asset (if asset is owned by the employer) or actual, higher charges incurred by the employer (if asset is taken on rent) less the amount recovered from employee.

16. Transfer of movable assets by an employer to its employee (Sec 17(2)(viii))

1- Computer, Laptop, and Electronics items: Actual cost of asset less depreciation at 50% (using reducing balance method) for each completed year of usage by employer less amount recovered from the employee.
2- Actual cost of asset less depreciation at 20% (using reducing balance method) for each completed year of usage by employer less amount recovered from the employee.
3- Other movable assets: Actual cost of asset less depreciation at 10% (on SLM basis) for each completed year of usage by employer less amount recovered from the employee.

17. Leave Travel Concession or Assistance (Sec 10(5))

This is with regards to Leave Travel Concession or Assistance (LTC/LTA) extended by an employer to an employee for going anywhere in India along with his family. The family includes a spouse, children, and dependent brother/sister/parents. However, a family doesn’t include more than 2 children of an Individual born on or after 01-10-1998.

18. Medical facilities in India (Sec 17(2))

1- Expense incurred or reimbursed by the employer for the medical treatment of the employee or his family (spouse and children, dependent – parents, brother, and sister) in any of the following hospitals is not chargeable to tax in the hands of the employee:
2- Hospital maintained by the employer.
3- Hospital maintained by the Government or Local Authority or any other hospital approved by Central Government.
4- Hospital approved by the Chief Commissioner having regard to the prescribed guidelines for the treatment of the prescribed diseases.
5- Medical insurance premium paid or reimbursed by the employer is not chargeable to tax.
6- Any other expenditure incurred or reimbursed by the employer for providing medical facilities in India is not chargeable to tax up to INR. 15,000 in aggregate per assessment year.

Medical facilities outside India (Sec 17(2))

1- Any expenditure incurred or reimbursed by the employer for medical treatment of the employee or his family member outside India is exempt to the extent of the following (subject to certain conditions):
2- Expenses on medical treatment – exempt to the extent permitted by RBI.
3- Expenses on stay abroad for the patient and one attendant – exempt to the extent permitted by RBI.
4- Cost on the travel of the employee or any family or one attendant – exempt, if Gross Total Income (before including the travel expenditure) of the employee, does not exceed INR. 2,00,000.

Article Source: incometaxindia.gov.in

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