Shanker Iyer is a smart, ambitious young executive with a mid-sized consulting company in Mumbai. So ambitious, in fact, that he almost reminds you of that wheeler-dealer played by Sharman Joshi in the Bollywood film “Life in a Metro,” the one who rents out his flat to earn that extra buck and curry favour with the boss. Our Mr Iyer is a fictional character inspired from the Aparna Sen film “Mr and Mrs Iyer” to explain a potential income-tax (I-T) problem.
The young executive knows life in the country’s financial capital can be quite expensive. And now that he has married his college sweetheart, the rent for a bigger house is really going to burn a hole in his pocket.
Iyer is innovative and has an affinity for risk, so he puts his ideas into action by starting a small business on the side. The move pays off and it isn’t very long before he has a business that is doing well enough for him to put in his papers at the consultancy he is employed with.
But the soaring profits of his enterprise also bring along with them the challenges of tax planning. Among the many things he does to minimize his contribution to the exchequer is the inclusion of his wife in his business as a personal assistant.
At the end of the year, when her husband files his annual tax return, he claims the salary he has paid her as a legitimate expense and reduces the amount from his taxable income. It takes a while for the I-T department to respond, but when it does, Iyer is in for a surprise.
The tax department says the salary paid to Iyer’s wife isn’t legitimate. It has added the entire salary to the income Iyer declared on his return and has reworked the tax payable by him on the new income calculated by the I-T department. Worse, it has also demanded interest on the additional tax.
Iyer probably thought nothing of the taxman’s ability to understand human nature. Section 64 of the I-T Act plugs several loopholes the average family is prone to exploit in order to save taxes. One such way is the salary paid to a person (Mrs Iyer) by a business owned by the recipient’s spouse (Shanker Iyer).
The taxman wouldn’t treat the salary as an expense even if the entity making the payout were a company in which Shanker held a stake of 20% or more. In I-T parlance, such a holding is called “substantial interest” . Iyer would have been able to claim the payout if his wife had applied her technical or professional expertise for the good of the business. Not otherwise.