BW Communities

Case Study: The Stock Option

BW Online Bureau Nov 08, 2014

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[Samar Das slid the folded newspaper across the table towards the MD, Naren Kant. Samar had circled an item about a chief minister titled, "What did I do that my predecessors did not?" Kant said stiffly, "This is old hat. What has this to do with anything?" Samar: That is my question too — what unusual act have I done for you to impale me? Kant: Come to the point, Samar. Your actions leave no scope for humour. Samar: No humour this, Naren. I mean what I ask — what have I done? Cut to what Samar Das had done. In the tax audit, the auditors Bright & Thakur had slammed Delana India with the allegation of defrauding the government, allowing the use of SEZ (special economic zone) status (accorded to its subsidiary Newtree) by another with an intent to gain illegitimate advantage.... Samar the CEO of Newtree, had abused the benevolence of the government, said Bright & Thakur, who had qualified the accounts of Delana India, saying: "We view these acts as gross misdemeanours... The qualification in the Audit Report is not negotiable as Mr Das has sought to enable." And in a telephonic chat with Kant, Cyrus Daftary, the senior partner had said, "Naren, appalling, I say! And please don't ask me to tone it down!" A distraught Kant had summoned Samar, one of the stars at Delana who  was slated for active growth . Naturally, Kant was stunned. Samar who had been appointed head of the Newtree business four years ago, had awarded the construction of the eight-storey office to Lathika Construction Company as a turnkey contract which included the setting up of mini plants and installing various equipment.. On cross verification, it was found that the purchase of steel, cement, etc., by Lathika was routed through Newtree's books as if a direct purchase by Newtree, so that Lathika illegally derived the SEZ benefits. Kant's ears burned with shame when he heard Daftary tell him all this. "Do you realise how many careers, images, names, equities are at stake? You are no trainee, Samar! And now you have the gall to sit there and say this to me?" Samar: Naren, it is easy to agonise, wrapping yourself in a blanket of sorrow. Dammit, all along each of you have made me do this! Kant: I don't believe this! I have a raving lunatic before me... Good Lord! This is what had happened. When Samar handed over the contract to Lathika, the chief at Lathika said, why don't you let me order the material using your name as if you are buying it directly? Samar agreed, negotiated with vendors of carpets, granite and glass, furniture and equipment — directly, and reaped all the indirect tax benefits that the law gave generously as exemptions for being in an SEZ. In effect, the purchases had been made by Lathika but using Newtree's letterheads. The only problem here was Samar had no business to straddle two stools, said Daftary. If he had a turnkey contractor, then it was for the contractor to buy the material. But now, as Daftary told him, neither Newtree nor Lathika had paid the taxes on material, so that the government had unfairly lost money. The flip side of this was that when the contract was analysed and capitalised as assets in Newtree's books as furniture and fixtures, office equipment, carpets, light fittings, etc., they had as a consequence of all above acts, been undercapitalised. Kant: Do you realise that you have cast a huge slur on your integrity as a result of all this? Samar: How does integrity suddenly enter? Kant winced; this was exactly what he had asked Daftary when he had questioned his integrity. And Daftary had said, "I will tell you where integrity comes in. There are two parties entering a transaction together. One is a very reputed MNC, large company, highly respected, trusted by the government, always presented as an organisation with good people, good employers, therefore ‘we also employ good people'. Delana is also considered a respectable unit of society, especially since your tag line reads,  ‘We do business in an ethical manner''." Kant to Daftary: That agreement to tweak the billing happened in the individual capacity of Samar Das! That fellow did not call me and ask, ‘I am going to do this, is this okay with you?' Daftary: Either you are naive or I am a monkey's uncle, Naren. When Samar Das as a senior manager acts on behalf of his business, that act is an act Delana has done. What is in it for Samar when he agrees to this with Lathika, yes? Every manager has a responsibility to get his job done at a lower cost. So he gets his brownies if he negotiates to save costs. He is then an example for others  — "Dekho, what a good boy hai! "The corporate world is keenly aware that tax is present at all stages in every transaction that entails creation of product or service, yet most companies and individuals consider it a wasteful spend. The corollary then is, a good manager is one who cuts taxes. Don't protest, Naren. All my clients hire me for exactly this reason. There are n number of discussions on what can we do to change the incidence of tax, and many of these discussions border on the unethical or use interpretational ploys to save taxes. break-page-break Companies take pride in reporting their effective tax rates (ETR): "From a high of 23 per cent taxes, we have managed to bring our ETR to 15-16 per cent thanks to aggressive tax planning measures...". Back to Kant and SamarKant This is definitely not what we expect reasonably intelligent business graduates to understand of ethical behaviour. I have to rethink a lot of how I staff my organisation! Samar: I am surprised you should paint me with horns and fangs. Why don't I tell you how it all began, so that you can see how it begins? Kant was appalled by the nonchalance as Samar, adjusting his sitting posture , began... "Nine years ago, when I was an accountant for Milk, Foods & Health business, Anant Inamdar was heading it. On 31 December one year, the sales team raised invoices well after 5.30 pm which was our audit cut off. It was 7.30 pm and they had just convinced a huge wholesaler to accept goods. The value of the invoice was, if I remember right..."Kant: Cut out the details please! Samar: Very well. So I had signed off the sales ledger, the last Goods Outward Note (GON) had been double struck and signed by the factory accountant and the last number had been fed into the system. Anant said to me "Samar, ask your boy to scratch off that GON and make a new one. More sales have been ‘made' and we need to ‘back time' them." I told him that 5.30 is 5.30 and I was not comfortable asking junior staff to do hanky-panky stuff. (Kant shuddered at this point) He looked at me for a long time then shutting my room door he said, "In your last appraisal you said you wanted profit center head responsibility. My dear friend, responsibility is meeting top line, meeting bottom line, meeting targets and that includes all this..., hmm? Where do you think your 12 per cent increment is going to come from? If this is ‘difficult' my dear chap, fat chance you stand of qualifying for the Newtree vacancy!" That was how when the Business Head position for Newtree fell vacant, Anant pushed my name for it because the whole setting up, negotiating, etc. needed a huge commerce sense. Kant: What's your point, Samar? That Anant is corrupt? That he put you up for corrupt practices? That you were pure as driven snow and were forced at gun point? Samar: Oh! Why do I sense you are angry? Kant: Yes, I am angry. Yes, yes, yes! You work 17 years in this organisation, partake of all the largesse, the teaching and the learning and blame your integrity on Anant? You have done a lowly act Samar, be a man and accept that first! Samar: Hmm. Let me see... what was it that I was replying to? You have chosen to replace the original question with your anxiety. Ah yes, this is what you had said Naren, something like "this is not what we expect reasonably intelligent business graduates to understand of ethical behaviour". I was replying to that, Naren! Maybe you want to examine what was ethical about Anant's ploys? Kant: You say ‘ploy'?! Samar: I say ‘ploy'! Yes I do! He was holding out a veiled threat to me or say, carrot to me to toe the line if I wanted to move up the ladder. And today when I do the same on a larger scale, you call me "a slur on integrity"! Kant: Samar, can we cut out the theatrics, please? I am here to take away an understanding of where you went wrong! This is a company very high on ethics and integrity, Samar, and it pains me to see you make a meal of your career! Samar: You clearly harbour some illusions about business graduates and senior managers. Let me take you back in time. In 1993, I joined Delana India as an industrial trainee. My father worked with the electricity board as a petty engineer doing thankless jobs and it was his desire to make a great man out of me. Yes, I belong to that transiting India where fathers did boring government jobs and mothers coughed over the cooking pot. So I did my cost accountancy and then a second tier MBA. At 24, I still held the values of my parents very close to my heart. When I joined Delana, everyone told me what a wonderful company this is… great people, law abiding, no one takes or pays bribes, honest…. At the orientation, nine different senior managers addressed us 25 trainees with stories of great men and great stories of small men.  Then I was posted in the Kopla factory. It was a very distressed area given to a lot of Naxal activity, and I wondered why we even had a factory there. They told me that the government of India was incentivising development of backward areas, and Delana offered to set up a factory there in Kopla. In return, Delana got a seven- year tax holiday (TH). When I was sent there, the TH was over.  Activity was low, the overall mood was bleak, workers were argumentative, the factory head was irritable because he was losing money... After seven years, we were having to pay excise and everyone's mood was spoilt. Seeing the factory working at 60 per cent, I asked the factory manager, how come...? He said the freight cost from Kopla to the markets , was prohibitive, and we are deliberately downsizing, capacities have been shifted to other units and I ask him what is the plan, and he says we will shut it down. In the three months I was there, there were two strikes, 42 per cent of workers were paid off, one gherao... and I sit there wondering. We had been given that TH to enrich the place, to develop it, to create employment, to bring hope to a people, to incentivise which, the TH! But we took the TH, and left after seven years. Was that partnering the GOI in development? What happened to the hope of the people? break-page-break We knew that the delivery to those areas was going to be expensive anyway, then why did we accept the GOI offer? Kopla was a pretence! So where is Delana that was touted as ‘does the right things'? At the age of 24-25, I was watching Delana bend the rules and reshape it to adhere to their definitions. Could it be that they misunderstood the spirit of the tax holiday? Could it be that they think  they were expected to be here for seven years only? Can the GOI be stupid? Is that the right thing? Or am I stupid? And thus my mind raged and raged... Kant: Cut out the verbal blogging, Samar, and get to the point! Samar: We are at the point, that's how funny it is! What other point can one get to from here? My ‘cutting the milk tooth' moment happened under the tutelage of Bharat Maini, who was then the head of Commercial when I was posted in Accounts department. Our rent costs were going up every month as we were hiring more managers. Now there is a service tax paid on rentals. Every commercial contract has a rent element and a maintenance element. So a lot of effort went into converting rentals into maintenance to ‘save' 10 per cent tax. And that was my job too. Maini had a boss who took him out for a beer if he ‘saved' the 12 per cent tax on a new rent contract! I didn't know all this. I would go to Maini and say "Sir, if there is so much maintenance we are paying, surely this property is not worth renting!" and he would shoo me away saying, go do your work! But I worried about how much was being spent on maintaining rented property. So I made a spreadsheet and showed him how the maintenance was stupidly high. That was when he did this calculation and showed me how much we saved as taxes! My jaw dropped, but Maini said, "If you want to be a dull munshi, you won't go far in this organisation. Do some creative accounting, the sky is the limit!" My great moment came when I geared some rentals for Maini. One of the penthouses we rented at Ha-Ha Home was offered at Rs 50,000 per month and belonged to one Mr X. I said to him naively, "Let us account for this creatively, please?" He was very pleased… and like a true mafia trainee, I committed my first felony. The law said if the annual rental value (ARV) paid is in excess of Rs 1.2 lakh, you have to deduct tax at source, called TDS, and deposit with GOI. So under guidance from X, I broke the rentals into five parts, X would show there were five co-owners, and Delana had to give him five different cheques in different names. In return, he reduced the rent from Rs 55,000 by Rs 7,000 — Delana was going to save a lot as rental costs. Kant: I don't believe this... dammit you are lying. Any idiot will ask to see the sale deed before renting the property! Then you will know there are no five co-owners. Samar: That's the beauty. And incidentally, this was how Maini too objected! It was simple. X had to just declare that the property is owned by five different people. From simmering vein-busting anger, Kant had now grown intrigued. "Understand this, and this does not require an IIT degree. You have a fiduciary duty to ensure that the person with whom you are contracting is in fact the owner of the property. Samar: I agree. Delana has the obligation to check the sale deed but it does not do this. Can't you see, since each cheque was below Rs 10k, there was no TDS, hence X won't come under the scanner? He could bank the cheques in an undeclared account and have fun? "So if Delana is goody two shoes, and says no no I will pay one cheque only, then X will charge us Rs 55,000 and after tax paid to GOI, X will earn only Rs 40,000. Instead he showed me the way forward. He said pay me Rs 48,000, in five cheques; also 30 per cent of that I will show as maintenance, not  rentals;  I will save service tax (15 per cent on the maintenance portion) —  I don't declare all of this as income, so my Rs 15,000 gets saved, and I will give you Rs 7,000 out of my Rs 15,000 as a saving in the rental cost, so that instead of 55 you will pay me 48." Kant's mind reeled. The calculations were fast, the intrigue too much... in a devious way he had to admit these guys were very smart, even if it was a kind of smart he did not subscribe to. Samar: Maini was delighted. We copied this on all flat rentals, divisional profits looked better. And since Delana doesn't make a TDS, there is no link to the landlord and hence X can choose to not declare the income! You understand? Was I doing this to cheat the GOI? Nope! I'm doing this to save my bottom line. If I can save Rs 7,000 in the rent line, I can spend more in the advertising line, see? That is so much more better for my top line, my visibility, my blah! Kant: Not ‘realising' is worse than thieving! I cannot buy this line of argument, sorry. It only means the strategy ideation was not all inclusive, it has been done only from your personal standpoint, to gain, to win, to look good! Considering how many hundreds of crores are lost to the GOI in taxes, can you think that we could have bought bullet proof vests for ATS Karkare? Samar: Or Raja would have several crores in Seychelles. That is another rationalisation! Kant: Karkare did not have a bullet proof vest because his department did not have the budgets, but uniquely Samar, they had a resource like Karkare to save Mumbai! Samar: It depends on who is rationalising and how. I can say other Indians are not paying taxes, so why me? Recently, I met the CFO of Kosta India. His company used pirated copies of all software, and his rationalisation was, "The original costs Rs 16,000. Who pays so much? Nobody does." This CFO also told me, "We pay our taxes." So I asked him, either you don't know that you have an obligation to pay for intellectual property, like the operating system, or you don't pay everything you owe to people! He said, "I agree. This is a concept of not guilty by association because everybody is doing it!" "Naren... you will sack me I know. But this minister (said Samar pointing to the newspaper article) did not get sacked. His argument was the same, ‘The guy before me also allotted land to his family, what wrong have I done?'" Classroom Discussion Are acts that are legal, also ethical? Are companies preoccupied with only being on the right side of the law? casestudymeera(at)gmail(dot)com (This story was published in Businessworld Issue Dated 28-03-2011)