Corporate chiefs such as Reliance Industries Mukesh Ambani, ITC Ltd YC Deveshwar and Tata Consultancy Services N Chandrasekaran would need to justify in unprecedented details why they take home heavy pay packets if the companies they run are to avoid reassessment of income and extra tax demands.
In the first audit cycle after executive pay was brought under transfer pricing provisions in the Finance Act of 2012, tax officers are now preparing to go deep into the returns of managerial remuneration companies have filed last November for 2012-13 to verify the reasonableness of corporate salary spending.
Tax officers unimpressed by the justifications given could disallow as business expenditure what they think is the excess remuneration and add the same to the taxable income of the companies. Such re-computation of income called transfer pricing adjustments would lead to higher tax claims.
Income tax department sources told FE that field officers would start assessing returns on managerial remuneration in July to take up possible cases of audit and transfer pricing adjustments.
Businesses have to justify directors remuneration in great detail to avoid transfer pricing adjustments. There are no hard and fast rules on how to justify the remuneration but when shown to an independent third party, it should appear convincing as reasonable compensation for the services rendered by the executive or promoter manager, said an official of the tax department, who asked not to be named.
Justifying the handsome salaries given to top executives is going to be a tough call for India Inc as assessing the contribution and potential of employees is highly subjective and would vary from company to company. Since directors remuneration is now classified as a related-party transaction between the company and the director, it has to be on an arms length basis that is, the amount has to be as if the parties were unrelated. It should be close to what would have been charged between independent parties in an open market.
Using comparable salaries of peers in similar companies for benchmarking and proving the arms length nature of executive pay is difficult. This is because such remunerations vary widely. For example, TCS CEO & MD Chandrasekaran received Rs 11.68 crore in 2012-13, compared with Rs 65 lakh Infosys CEO & MD SD Shibulal took home and Rs 4.93 crore accepted by Infosys whole-time director BG Srinivas.
In the case of Ambani, who