Nothing 'Fringe' About The Fringe Benefit Tax!

Nothing 'Fringe' About The Fringe Benefit Tax!

Ganga Prasad G. Rao
http://myprofile.cos.com/gangar


Two years back FM Chidambaram proposed in his budget what was considered a 'bold' step to the left by proposing a 'Fringe Benefit Tax' (FBT) on firms. It was a surprise, though one that we should have expected of a communist-backed coalition. The FBT taxes a firm's expenses on certain categories of benefits provided to executives (one's own and clients/suppliers) in the course of business. The Fringe Benefit Tax was bitterly opposed by the industry and not only because it hurt their bottom line. It created a new rationale for taxation that could be copied in other countries. It forced firms to monitor expenses that they considered 'on the house', so to say. More than anything else, it smacked of government intervention in matters considered privy by the company. After all, offering fringe benefits to one's executives and clients is an entirely private decision of the company. Or, is it?

What are the incentives of firms with regard to this expense category? I am no company economist (at least not yet, and after this column, never!), but it seems to me that those incentives depend on ownership structure, manager incentives and the type of industry. A private company in which all economic profits flow to the owners will likely seek to minimize expenses, including benefits to its managers and employees. Thus, fringe benefits if any, are likely necessary and competitive with those required to retain managers and employees. But what are the incentives elsewhere, in particular, in publicly-held companies traded on stock exchanges? Executives in publicly-traded companies are answerable to majority stockholders who tend to be mutual funds, HNIs, and FIIs besides the original promoters. Their compensation package is not a rigid Rs X lakhs per years; rather, it is a combination of a base pay, incentive pay and various fringe benefits. While the incentives are most commonly bonuses and stock options for executives, benefits take various forms - from company-provided residence and vehicle, membership in posh clubs, cruises and lavish vacation in foreign countries billed as 'business trip', to exotics that I dare not even think off lest I have a heart attack from jealousy! Jealousy aside, do these firms, their executives and managers have any incentive to self-aggrandize each other with 'fringe benefits'? In a booming stock market, or conversely, in a market down on account of extraneous reasons, do promoters (who serve as executives in firms with low public ownership) and managers have an incentive to pad up cost to under-report profits so they may add some comfort to their stressful lives? Why should they work their butts off so Prasad Rao may short the company stock and make his 4-figure getaway (and why should my executives suffer if the market crashed on account of sub-prime losses half-way across the world)?!!! I suspect there is, though the extent to which executives and managers in the higher echelons of the company engage in such nefarious, hard to detect practices depends on the firm's management tenets, 'auditorial scrutiny' and the degree of competition in the industry. The problem of illegal fringe benefits is likely more prevalent in industries with economic rents (whether on account of oligopoly, patents or regulatory price protection) than in intensely-competitive industries. Then, again, fringe benefits might camouflage so many other illegal payments – illegal considerations to competitors, suppliers and customers, even good times that are bestowed upon government and regulatory officials when they visit factories, or even implicit sharing of vacations with policy-makers at conferences ... the list is endless.

Anyway, it is this suspicion regarding the incentives behind these 'on the house' expenses that can be readily explained off as business expenses necessary to retain clients/talent that underlies my support of the FBT. As I write, the FBT is under the proverbial guillotine; its fate hanging in balance ('No FBT' or your scalp!). Knowing human greed and urges though, and the disdain with which the retail shareholders are treated with, I'd argue that the FBT is not a bad idea that helps the government and the public keep a tab on the degree of self- and -mutual aggrandizement/appeasement that promoters and managers engage in. In a country with endemic poverty, where many a poor live off the dividends and stock price appreciation, a tax on 'luxury' expenditures by firms is, in my opinion, eminently justifiable. It even serves a social purpose by forcing firms to monitor and account for FBT expenses. The FBT provides the shareholders an additional handle with which to question the performance of their firm. An FBT tax necessitates record-keeping that could help monitor corruption and evaluate executive performance; it would facilitate comparison of firms within or across industries. And it opens a little 'wiggle room' for the FM in his otherwise cash-strapped budget.

I'd vote for the FBT!