The Hindu Business Line : Taxing expat income in India

If expatriates’ salaries are taxable in India, the tax should be deposited in accordance with TDS provisions, regardless of where the salaries are paid.

The onus is on the Indian company to ensure that TDS obligations on the expat’s entire salary subject to tax are fulfilled.

Amitabh Singh

Towards the mid-1990s, as India opened itself up to foreign investment, there was an influx of foreign nationals into India. These foreign nationals (“expatriates”), who typically came to India on temporary assignments of three to five years, continued to be paid either a retaining allowance or portions of their salary outside India by the head office/ parent company/ affiliate. Some salary, living allowances and benefits were paid in India as well by the India n entity. Salaries paid outside India to the expatriates were normally not cross-charged to the Indian entities.

In those days, there was prevailing uncertainty on whether salaries paid to expatriates outside India (in their home country) could be subject to tax in India. Many companies took the view that salaries paid outside India by the overseas entities was not subject to tax in India. Consequently, only the Indian salary and benefits were considered for deduction of tax at source.

When the tax authorities became aware of this issue, they came out with a time-bound “amnesty scheme” and later, a “Voluntary Disclosure of Income Scheme (VDIS)” wherein they encouraged companies to pay taxes on income not reported earlier with the incentive that no penalty or prosecution would be imposed on such companies. Many companies took advantage of these schemes, declared the foreign salaries and allowances of their expatriates and paid the taxes.

On the expiry of these schemes, the tax authorities surveyed some multinationals and discovered that overseas salaries of expatriates were not being reported in some cases. Many multinationals came forward and voluntarily paid taxes and interest on the overseas salary paid to the expatriates for past years. The tax authorities, in the latter two instances, also imposed penalty on these companies for non-compliance with provisions relating to deduction of tax at source.

Issues raised by SC

Since more than 30 companies were involved, Supreme Court framed some common questions to be addressed. One question was whether the provisions relating to tax deduction at source (TDS), being machinery (i.e. operative or mechanical) provisions, are independent of the charging provisions (i.e. provisions that determine whether an income is taxable or not).

The contention was that the TDS provisions, being machinery provisions and independent of the charging provisions, did not have extra-territorial applicability — that is, their applicability could not extend beyond the boundaries of India. It was argued by the counsels of the defendants that though the salary paid outside India was taxable in India if the salary related to services rendered in the country, as the TDS provisions did not have extra-territorial applicability, there was no obligation on the foreign companies to deduct tax at source on such salaries.

The Supreme Court held that the machinery provisions and the charging provisions present an integrated code and, hence, if any income is taxable then TDS provisions are automatically attracted, without any exceptions on account of extra-territoriality. The Supreme Court also held that the Indian company would be liable to comply with the TDS provisions on the entire salary and not just the salary paid in India.

The second question was whether the companies had reasonable cause for the alleged non-compliance. The Supreme Court conceded that this issue was new and not earlier deliberated upon and hence companies could be said to have reasonable cause for the default. On this basis, the penalties imposed on these companies were dropped.

The implications arising out of the court’s order can be summarised as follows: If salaries paid to the expatriates are taxable in India, the tax thereon should be deposited in accordance with the TDS provisions, regardless of where the salaries are paid. Other modes of tax deposit, such as self-assessment tax or advance tax, should not be used for the purpose.

Either both companies should comply with the TDS provisions on their respective salary payments or one of the two companies, as chosen by the employee by submission of Form 12B, should discharge the TDS obligations on behalf of both.

There is onus on the Indian company to ensure that TDS obligations with respect to the entire salary subject to tax in India are being fulfilled. (I personally do not agree with this conclusion of the Court and feel that, in the absence of any submission of Form 12B, the Indian company’s TDS obligations should be limited to the salary paid or borne by it and not beyond. However, in light of this judgement, future litigation on this front is not ruled out).

(The author is Tax Partner, Ernst & Young.)