Nani Phalkivala, in the course of delivering his M. Ct. M. Chidambaram Chettiyar Memorial Lectures at Madras in 1965, observed "In the words of a great jurist, it is not permissible to enact a law which, in effect, spreads an all-inclusive net for the feet of everybody, upon the chance that, while the innocent will surely be entangled in its meshes, some wrong-doers also may be caught". The fringe benefit tax (FBT) introduced by the Finance Minister through the Finance Act, 2005 is an illustration for the above dictum of the great jurist. This is an instance of "The tax racket—Government extortion from A to Z" as commented upon by Martin L. Gross regarding the innumerable taxes levied in the USA. The learned author has commented on the cover of the book itself "Reform the tax system and close the IRS". Perhaps, a movement on those lines is called for in our country also with regard to this FBT. This article examines the constitutional validity and critically analyses some of the provisions of FBT, including Circular No. 8 of 2005 dated August 29, 2005, issued by the Central Board of Direct Taxes—[2005] 277 ITR (St.) 20.

The Finance Minister observed in paragraphs 159 and 160 of his Budget Speech as under (page 56 of 273 ITR (St.)) :

160. I have looked into the present system of taxing perquisites and I have found that many perquisites are disguised as fringe benefits, and escape tax. Neither the employer nor the employee pays any tax on these benefits which are certainly of considerable material value. At present, where the benefits are fully attributable to the employee they are taxed in the hands of the employee ; that position will continue. In addition, I now propose that where the benefits are usually enjoyed collectively by the employees and cannot be attributed to individual employees, they shall be taxed in the hands of the employer. However, transport services for workers and staff and canteen services in an office or factory will be outside the tax net. The tax is not a new tax, although I am obliged to call it by a new name, namely, Fringe Benefits Tax. The rate will be 30 per cent. on an appropriately defined base."

It is crystal clear from the above extract that the primary objective of the Finance Minister in introducing this tax is nothing but to raise resources. The justification given by the Finance Minister in para. 160 is an exercise in obfuscation. Let us look at the fallacies listed as justifications :

(a) The tax is not a new tax, though called by a new name.

(b) It is levied on benefits usually enjoyed collectively by the employees.

(c) Such benefits cannot be attributed to individual employees.

(d) But it shall be leviable on the employer.

What are the types of benefits enjoyed collectively, which are being subjected to this FBT ? There is a list of 18 items of expenses, out of which, 2 items are to be treated as fringe benefits in their entirety and in respect of the remaining 16 items, a specified percentage, namely 20% or 50% will be considered as fringe benefits.

(i) Free or concessional ticket provided by employer for private journeys of employees or his family members (100%) ;

(ii) Employer's contribution to approved superannuation fund (100%) ;

(iii) Entertainment (20%) ;

(iv) Hospitality (20%) ;

(v) Conference expenses (20%) ;

(vi) Sales promotion, including publicity (20%) ;

(vii) Employee's welfare expenses (20%) ;

(viii) Conveyance, tour and travel (20%) ;

(ix) Hotel facilities (20%) ;

(x) Motor car expenses (20%) ;

(xi) Air-craft expenses (20%) ;

(xii) Telephone expenses (20%) ;

(xiii) Guest house expenses (20%) ;

(xiv) Festival expenses (50%) ;

(xv) Health club expenses (50%) ;

(xvi) Club expenses (50%) ;

(xvii) Gifts (50%) ;

(xviii) Scholarships (50%).

Has the Finance Minister forgotten that it was he, who, "by his dream budget of 1997", deleted the provisions of the Income-tax Act dealing with the partial disallowances of legitimate business expenses, on the ground that they were artificial. Para. 106 of his Budget Speech for the financial year 1997-98 reads [1997] 224 ITR (St.) 23-24 :

Contrast the above measure of simplification and removal of artificial disallowances, on account of expenses incurred for legitimate business purposes with the present form of FBT. The taxpayer is visited with a new tax, which is not a new tax. He is required to pay tax on his legitimate business expenses, which are classified as disguised perquisites enjoyed collectively by employees, whose benefits could not be individually identified. In the process, the taxpayer is required—

(i) to pay one more quarterly advance tax ;

(ii) to get one more audit report ;

(iii) to file one more return of FBT ; and

(iv) to face penalty and prosecution for any non-compliance.

With all these attendant complexities it is claimed (according to Circular No. 8 of 2005 dated August 29, 2005 [2005] 277 ITR (St.) 20), that the presumptive method of levy of FBT has "the virtue of simplicity, minimum disputes, low compliance cost and less administrative burden"!!! Now, one realizes why most of the provisions in the tax laws are brought into force with effect from 1st April of any given year. Mark Twain said "1st April is the day on which we are reminded of what we are on the other 364 days".

All these changes are on the grounds of equity and economic efficiency. This circular has come out with some amusing statements to support the introduction of FBT such as :

(a) When fringe benefits are undertaxed, it violates both horizontal and vertical equity.

(b) Fringe benefits are generally provided to senior executives in the organization. Therefore, undertaxation of fringe benefits violates vertical equity.

(c) A taxpayer receiving his entire income in cash bears a higher tax burden in comparison to another taxpayer who receives his income partly in cash and partly in kind, thereby violating horizontal equity.

Without a basic threshold limit for levying FBT, it is an empty claim that FBT is levied to achieve horizontal and vertical equity. The pronounced logic advances a new theory and one should appreciate the imaginative skills of the authors of this theory. According to well established principles of tax jurisprudence, equity, in the sense of representing the spirit of the law, has often been invoked by judges all over the world in order to get over a hard situation though it is well said that hard cases often make bad law. When it comes to taxation, equity has been held repeatedly to yield ground to clear unambiguous language of the statute. Otherwise, equity has been restored to hold that a reasonable meaning would be preferred to the literal meaning with a view to mitigating rigours of the law—as held by the Supreme Court in Sir Hukumchand & Mannalal Co. v. CIT [1966] 60 ITR 99. Later, the apex court made its observations with regard to equity and taxation in a more transparent manner in the case of CIT v. Gotla [1985] 156 ITR 323 at page 339.

Strangely, these principles are invoked in order to justify a tax introduced as additional income-tax by Chapter XII-H in the Income-tax Act, 1961.

When it is not claimed as a new tax, is it the intention of the framers to treat it on par with the income-tax ? Is it an attempt to bring the tax constitutionally within entry 82, List I of Schedule VII to the Constitution ? The provisions in Chapter XII-H along with the explanations offered in the Budget Speech and the circular quoted above beg these questions. According to sub-section (2) of section 115WA—

Conceptually, if the so-called perquisites have been collectively enjoyed by the employees and the tax levied is of the nature of income-tax, the employer is obliged to pay income-tax on the income of the employees. This is one of the fundamental fallacies in the entire scheme of FBT because it is not known whether FBT is an expenditure tax or an income-tax.

The many conceptual fallacies in the introduction of FBT extend from the objective to the charging sections and to the methods adopted for deeming certain legitimate business expenses as collectively enjoyed perquisites. These fallacies can be categorized :

(a) FBT is in addition to income-tax payable by the employer ;

(b) FBT is payable even if income-tax is not payable by the employer on "his total income" computed in accordance with the provisions of the Income-tax Act ;

(c) The privilege, service, facility or amenity, contemplated as fringe benefits, do not include perquisites in respect of which tax is paid or payable by the employee.

From the above three fallacies, the following propositions are derived :

(i) The first two points are in direct conflict with each other. If FBT is an additional income-tax payable by the employer, read with (b) above, it is payable even when the employer is incurring only losses. That means, FBT is more than MAT (Minimum Alternate Tax) payable by the companies. At least, there was some justification for MAT because companies did earn book profit, though declaring total income less than 30% of such book profit or loss, which may be book loss and not cash loss. FBT does not discriminate. FBT is like Indian Railways' passenger trains because these trains carry passengers whether "they are with or without tickets". Similarly, FBT is payable whether an employer earns income or not. That is why it is called a new tax, but of the character of income-tax.

(ii) The fallacy, listed as (c) above, is funnier than the rest. The provisions of section 115WB(3) prescribe this concept, which is totally new in tax jurisprudence. Income-tax paid by an employee is not relatable to a particular part of his total income. In other words, tax is always paid on the total income. If an employee assessee has salary income of Rs. 1,05,000 and perquisites of the value of Rs. 25,000 and pays tax on a total income of Rs.1,10,000 (after claiming some rebate), then the tax payable at the current rate would be Rs. 1,000 only. Can it be construed that the tax payable by this particular employee is relatable to only Rs. 10,000 of his perquisite or Rs. 10,000 of his salary or towards the entire Rs. 25,000 of perquisite ? How does one determine in this simple illustration the tax paid or payable by the employee with reference to the perquisite drawn by him ? Consequently, will there be FBT payable by his employer, on the balance of his perquisites, if any, on the ground that the said employee did not pay tax on the full value of its perquisites ? From this fundamental issue, one can arrive at the basic fallacy that there is vagueness and arbitrariness in the basic provisions relating to FBT itself.

(iii) As per the charging section 115WA, FBT is proposed to be in addition to income-tax charged under this Act. The words "in addition to" obviously mean that there should be basically "tax chargeable". Whereas, sub-section (2) of section 115WA speaks of "notwithstanding that no income-tax is payable by an employer on his total income". The term "in addition to tax charged" will be meaningless, if FBT is payable by every employer even if such employer has no total income and consequently, no tax payable.

(iv) There is a significant distinguishing feature between the usages "tax chargeable" and "tax payable". One may have income chargeable to tax, but may not pay tax because of exemptions or the income being less than the threshold limit or setting off the income against brought forward losses and so on and so forth. But, the charging section of FBT does not contemplate these different situations. Strangely, the charging section contemplates only "tax payable". This is a fundamental fallacy in the introduction of this FBT. It cannot be justified as a valid tax under any of the entries in List I of Schedule VII to the Constitution of India. As held by the Supreme Court in Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706—from headnotes at page 709 "the test of liability for taxation is not to be determined on the basis of an exemption granted in respect of any particular source of income, but by taking into consideration, the totality of the provisions of the income-tax law . . . . Merely because, at a given time, there may be an exemption from income-tax in respect of any particular head of income, it is not correct to say that the taxable entity is not liable to taxation. Liability to taxation is not the same as payment of tax. Liability to tax is a fiscal situation ; payment of tax is a fiscal fact." Applying this principle, it can be said with all the emphasis at one's command that conceptually, the provisions of section 115WA are misconceived and consequently, constitutionally invalid.

Let us examine the charging sections of FBT in the background of the above propositions coupled with the law laid down by the apex court with regard to constitutional vires of tax legislation in the case of Gujarat Ambuja Cements Ltd. v. Union of India [2005] 274 ITR 194 at 210-211.

(b) Where the encroachment is ostensibly ancillary but in truth beyond the competence of the enacting authority, the statute will be a colourable piece of legislation and constitutionally invalid (A. S. Krishna v. State of Madras [1957] SCR 399 ; A. B. Abdul Kadir v. State of Kerala [1976] 3 SCC 219, 232 ; Federation of Hotel & Restaurant Association of India v. Union of India [1989] 3 SCC 634, 651 ; [1989] 178 ITR 97 (SC)). If the statute is legislatively competent the enquiry into the motive which persuaded Parliament or the State Legislature into passing the Act is irrelevant. (Dharam Dutt v. Union of India [2004] (1) Scale 425 ; [2004] 1 SCC 712).

(c) Apart from passing the test of legislative competency, the Act must be otherwise legally valid and would also have to pass the test of constitutionality in the sense that it cannot be in violation of the provisions of the Constitution nor can it operate extra-territorially. (See Poppatlal Shah v. State of Madras [1953] SCR 677 ; [1953] 4 STC 188)".

For instance, in the FAQ forming part of Circular No. 8 the answers to questions Nos. 27 and 28 read as under (page 32 of 277 ITR (St.)) :

In a case, where a foreign company has a permanent establishment (PE) in India, FBT is payable on the expenditure incurred or payment made for the purposes referred to in clauses (A) to (P) of sub-section (2) of section 115WB and attributable to the operations of the PE of the foreign company in India irrespective of whether the expenditure attributable to the operations of the PE is incurred in India or outside India."

"Answer to question No. 28

When these above answers are examined with reference to the DTAA between India and USA (taken as a sample), how this tax tries to advocate "treaty override" is intriguing. For instance, the DTAA between India and USA deals with "Taxes Covered" in article 2. Paragraph 1(b) reads :

(i) the income-tax including any surcharge thereon but excluding income-tax on undistributed income of companies, imposed under the Income-tax Act ; and

(ii) the surtax (hereinafter referred to as Indian tax).

Taxes referred to in (a) and (b) above shall not include any amount payable in respect of any default or omission in relation to the above taxes or which represents a penalty imposable relating to those taxes.

2. The convention shall apply also to any identical or substantially similar taxes, which are imposed after the date of signature of the convention in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States shall notify each other of any significant changes, which have been made in their respective taxation laws of any official published material concerning the application of the Convention."

The above para. (2) of article 2 of the DTAA between India and the USA does not allow any such presumption that FBT would be automatically payable by a foreign company having a PE. The interpretation given in the circular attempts a treaty override, which is not permissible according to many decisions of our apex court or according to decisions of courts in other countries on similar provisions in the DTAAs. Consequently, as held by the Supreme Court (quoted above), if the FBT provisions are meant to act extraterritorially, they become ultra vires.

When the provisions of FBT are examined in the backdrop of the above dicta of the apex court, the inescapable conclusion is that these provisions are a piece of colourable legislation and constitutionally invalid. Though income includes loss, so far, no nation has resorted to levy of tax even on a loss making assessee, in the name of a new tax on the ground (vide Circular No. 8 of 2005, paras. 2.2 and 3.3) that—

(b) many perquisites are disguised as reimbursements or other miscellaneous expenses so as to enable employees to escape/reduce tax on their real income . . . Under the presumptive method, the FBT . . . has the virtue of simplicity, minimum disputes, low compliance cost and less administrative burden." (emphasis supplied)

If the above averments in the circular are properly construed, the employers and the employees are indulging in "tax avoidance methods" with which the Government is not able to cope. Can the inefficiency of the Government lead to one more source of revenue for the Government ? Is it not unjust enrichment ? There are already penal provisions in the Income-tax Act for tackling concealment of income and furnishing of inaccurate particulars by any assessee, whether employer or employee. "If the real income" were to be taxed, how can there be an additional tax on deemed income, out of legitimate business expenditure ? If the expenditure is not a legitimate one incurred wholly and exclusively for the purposes of businesses, it is bound to be disallowed. Strangely, even in such circumstances, FBT is leviable in addition to tax on disallowed expenditure in the regular assessment. In other words, this is the real application of double jeopardy in tax legislation. Let the Income-tax Department go after those who indulge in tax avoidance methods, penalize them and prosecute them after bringing to tax "any income out of fudged accounts". Otherwise, let them gracefully accept the accounts. How does such failure justify a levy of an unwarranted tax, which has no constitutional leg to stand on ?

It is begging the question to say that the withdrawal of the provisions relating to taxation of fringe benefits by the employer-based disallowance method resulted in significant erosion of the tax base. This averment in the circular is totally contrary to the statistics published by the Income-tax Department. The collection of corporate tax and income-tax during the financial year 1999-2000 was hardly Rs. 55,000 crores and for the financial year 2004-05, the collection had crossed more than Rs. 1,24,000 crores. With that kind of collection and increase in the tax base, it is flummoxing to hear that there was "significant erosion of the tax base". If this claim of erosion of tax base is substantiated, the FM could have brought back the disallowance provisions in order to be consistent. At least, the law on those provisions is well settled and there would have been no need for one more advance tax, one more audit report, one more return and some more penal and prosecution provisions in the name of simplicity and less disputes and low compliance cost, etc. FBT is a bureaucratic cloning of a foreign statute (without adaptation for the Indian environment, which has no social security system) and founded on "vaulting fiscal ambition".

The power to impose a tax is not an incidental power under our Constitution, although legislative power includes all incidental and subsidiary power, according to the learned author H. M. Seervai. For instance, the power to legislate in respect of inter-State trade and commerce (entry 42, List I, Schedule VII) did not carry with it the power to tax the sale of goods in inter-State trade and commerce before the insertion of entry 92A in List I and such power belonged to the States under entry 54 List II. Entry 97 List I also militated against the contention that the power to tax is an incidental power under our Constitution. This was the principle laid down by the Supreme Court in M. P. V. Sundararamier and Company v. State of Andhra Pradesh [1958] SCR 1422. This principle was followed in State of Mysore v. D Cawasji and Co. [1971] 2 SCR 799 wherein it was held that the power to tax intoxicating liquor was not ancillary to the power under entry 8, List II but fell under entry 51, List II (duties of excise). Thus, it is clear that the power to impose a new tax cannot be automatically sourced from the residuary entry 97 of List I, "Any other matter not enumerated in List II or List III including any tax not mentioned in either of those Lists".

Viewed against this background, FBT cannot be justified either under entry 82 or under entry 97 of List I of VII Schedule to the Constitution of India. It is hoped that the constitutional advisors to the Government would appreciate the above analysis and take effective steps, in a courageous manner, to stay the operation of coming into force of FBT for a thorough parliamentary relook on the entire Chapter XII-H of the Income-tax Act, 1961. In this regard, the following observations of the Supreme Court in the case of Distributors (Baroda) P. Ltd. v. Union of India [1985] 155 ITR 120 at page 124 may be recalled, mutatis mutandis :

In this context, I recount an anecdote from the life of Abraham Lincoln from the book written by Dale Carnegie under the title "Lincoln The Unknown" : "One day a congressman persuaded the President to give him an order transferring certain regiments. Rushing to the war office with the order, he put it on Stanton’s desk ; and Stanton said very sharply that he would do no such thing. "But", the politician protested, "you forget I have an order here from the President." "If the President gave you such an order", Stanton retorted "he is a damned fool". The congressman rushed back to Lincoln expecting to see him rise up in wrath and dismiss the Secretary of War. But Lincoln listened to the story, and said with a twinkle in his eye : "If Stanton said I was a damned fool, then I must be, for he is nearly always right. I will just step over and see him myself". He did, and Stanton convinced him that his order was wrong and Lincoln withdrew it."

I urge the Finance Minister to lead the 389th verse of the Thirukkural of Saint Tiruvalluvar.

"Chevi Kaippa Chol Porukkum Panbudai Vendan

Kavigai Keezh Tangum Ulagu"

(That land is safe, which is under his parasol

Who hears with patience what may not please.)