No dress code? Pay tax on uniform sop, employer company liable for TDS

MUMBAI: As India Inc slowly inches towards a relaxed dress code, a ‘tax free’ uniform allowance paid to employees will be relegated to history.
Employees who are prescribed a uniform, say nurses in hospitals, or front-desk staff in hotels, can claim the uniform allowance paid to them as part of their salary, as tax exempt.
Others cannot have their cake and eat it too.If employees are free to dress as they choose, such an allowance, if paid to them, is not exempt under section 10 (14). Consequently, their employer organisation is liable to deduct tax at source (TDS) while crediting their salaries.
The issue of taxability of uniform allowance and the employer’s obligation to deduct tax at source against salary income recently came up for hearing before the Income tax Appellate Tribunal (ITAT).
In its order dated June 25, the ITAT (Ahmedabad bench) has held that no exemption under section 10(14) shall be granted in respect of uniform allowance paid to employees, if there is no dress-code and employees are free to wear any dress.
“A few years ago, the issue of taxability of uniform allowance was commonly raised by tax authorities during TDS surveys. Today, most companies do not take an aggressive view of treating a uniform allowance as exempt where no uniform has been prescribed,” says Gautam Nayak, partner, CNK & Associates, a firm of chartered accountants.
“As a hotel chain, employees in some of our departments, such as those manning the front desk, do have to wear uniforms. We take care to ensure that only such category of employees are paid a uniform allowance , which is tax exempt for them,” says a tax manager in the hospitality industry.
A few tax officials spoken to, admit coming across some instances of a ‘tax free’ uniform allowances given by employers against which no tax has been deducted at source. "A general dress code, say one requiring wearing of formal shirts and ties by male employees, would also not meet the specific exemption criteria of section 10(14)," says a tax official.
In this recent case which was heard by the ITAT, a Surat based, private limited company – Facets Polishing Works paid what it termed a ‘wear-allowance’ to its employees. The company contended that such allowance was exempt in their hands under section 10(14), thus it had not deducted tax at source against salary income. As the Commissioner of I-T (Appeals) had ruled against the company, the company filed an appeal with the ITAT.
The ITAT observed that the company could not prove how the ‘wear allowance’ paid by it to its employees was tax exempt. In fact, during the hearing before the ITAT the company admitted that employees were free to wear any dress.
The ITAT in its order explains that two conditions must be met for the purpose of getting a tax exemption of an allowance (such as a uniform allowance) under section 10 (14). “First, the allowance should have been given to the employee to meet expenses ‘wholly, necessarily and exclusively’ incurred in the performance of his duties. Second, the expenditure must be actually incurred as the exemption is limited to the extent of expenses actually incurred.”
In the given case, for the three financial years 2006-07 up to 2008-09, for which the matter was under dispute, neither of the two conditions were met. Thus the appeals filed by the company were rejected by the ITAT.
“Companies that find themselves in a similar situation can recover TDS from the concerned employees against future salaries. The employee, in such a scenario can claim credit for the TDS from subsequent reassessment proceedings,” explains Nayak.
On the other hand, in case of ex-employees where the TDS cannot be recovered from employees, or where the employer does not wish to recover TDS from its employees, the interest and penalty would be borne by the employer company, he adds.