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TAXATION OF EXPATRIATES-

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Title: TAXATION OF EXPATRIATES-


1
TAXATION OF EXPATRIATES- Structuring and
Planning Presentation at the IFA SEMINAR -
HYDERABAD On 12TH DECEMBER 2008 By Sampath
Raghunathan
2
CONTENTS
  • PROVISINS OF TAX TREATIES
  • Employers obligation
  • Tax Equalization
  • Hypo Tax
  • Manner of Tax Credit on Foreign Tax
  • Practice generally adopted
  • Shadow Pay Roll
  • Social Security obligation
  • Employees obligation
  • Permanent Establishment
  • Secondment / Dual Employment Status
  • Use of third country manpower company
  • Specific Country details
  • USA

3
TAXATION OF EXPATRIATES- a brief background
4
(No Transcript)
5
Policy Issues
  • Does the company have an appropriate expatriate
    policy for the assignment?
  • Type of assignment
  • Developmental
  • Technical
  • Managerial
  • Short term
  • Medium term
  • Secondment
  • Assignment
  • Approaches
  • Localization
  • Localization with benefits
  • Full balance sheet
  • Base
  • Tax equalized
  • Hypo tax
  • Foreign Tax - picked by the employer
  • Foreign Tax- the employees responsibility

6
Policy Issues - examples
Type of Assignment Possible Policy Approach
Nine month assignment to Switzerland to start a new project- Project Management Continued home base compensation package with full reimbursement of host living expenses.
Junior engineer on IT platform conversion project in Singapore Technical Services Localization - Reimbursement of some local living expenses.
55 year old engineer whose skills are needed on project in Germany. Balance sheet approach- Repartriation Long term building up a set of compensation and allowances keeping in view that the employee on leaving would not opt for any future employment.
Executive to New York to head up US subsidiary Localized package with relocation package.
7
Base Tax Issues
  • The following factors must be considered
  • Corporate permanent establishment issues
  • Residence of assignee
  • Compensation package
  • Deferred compensation
  • Stock options
  • Country specific tax planning strategies
  • Examples
  • Outbound short term assignments
  • Lease premium for UK assignments
  • Social Security Totalization agreements

8
TAXATION OF EXPATRIATES- treaty and tax law
provisions
9
Dependent Services clause -Extract from Indo US
DTAA
  • SITUATION 1
  • Remuneration derived by
  • a resident of a Contracting State (SAY INDIA)
  • in respect of an employment
  • shall be taxable only in that State (INDIA)
  • unless the employment is exercised in the other
    Contracting State (USA).
  • If the employment is so exercised, such
    remuneration as is derived there from may be
    taxed in that other State (USA).

10
Extract from Indo US DTAA
  • Situation 2. Notwithstanding the provisions of
    paragraph 1,
  • remuneration derived by a resident of a
    Contracting State (INDIA) in respect of an
    employment exercised in the other Contracting
    State (USA) shall be taxable only in the
    first-mentioned State (INDIA), if
  • (a) the recipient is present in the other State
    (USA) for a period or periods not exceeding in
    the aggregate 183 days in the relevant taxable
    year
  • (b) the remuneration is paid by, or on behalf
    of, an employer who is not a resident of the
    other State (USA) AND
  • (c) the remuneration is not borne by a permanent
    establishment or a fixed base or a trade or
    business which the employer has in the other
    State(USA). (some treaties use terms "deductible"
    or "claimed as deduction)

Employer economic or legal
11
BORNE BY. SC DECISION..ECONOMIC EMPLOYER?
  • The word borne by is not defined in the DTA.
    Para 2 of Article 3, containing General
    definitions of the DTA is the residuary clause
    stating any term not defined therein shall,
    unless the context otherwise requires, have the
    meaning which it has under the laws of that
    State.
  • This term is found in the pre-amended proviso to
    sub-section (1) of section 23. This was
    interpreted by the apex court as under
  • The expression borne may refer to either the
    liability which a person is liable to discharge
    or the actual sum paid by him in discharge of
    that liability. But in the present context it
    should be construed as referring to the former,
    namely, the amount of tax which the owner is
    liable to discharge as stated in the proviso to
    section 23(1) of the Act and not the latter one.
    The reason for taking this view flows from the
    scheme of the Act itself - CIT v. Dalhousie
    Properties Ltd. 1984 149 ITR 708 (SC).

12
Rendering of services or Provision of services
  • If it is Rendering of Services to be considered
    under Dependent Personal Services
  • if it is provision of services to be considered
    under Fees for technical services
  • Tests-
  • Which entity bears the responsibility or risk for
    the results produced by the individuals work
  • Which entity has the authority to instruct the
    individual
  • Which entity controls and has responsibility for
    the place at which the work is performed
  • .Which entity bears,. in an economic sense, the
    cost of the remuneration paid to the individual
  • Which entity provides the tools and materials
    required to perform the work at the individual's
    disposal and
  • Which entity determines the number and
    qualification of the individuals performing work
    on an application of the above conditions, one
    would have to determine who is the "real
    employer". The tests to determine the real
    employment in generally applied only to prevent
    Treaty abuse.

13
Who is the resident of the contracting State?
extract from Indo US DTAA
  • the term resident of a Contracting State (INDIA)
    means any person who, under the laws of that
    State, is liable to tax therein
  • by reason of his domicile, residence,
    citizenship,
  • provided, however, that this term does not
    include any person who is liable to tax in that
    State in respect only of income from sources in
    that State (SOURCE BASED TAX)

14
Tie Breaker clause
  • Where an individual is a resident of both
    Contracting States, then he shall be deemed to
    be a resident of the States
  • (1) in which he has a permanent home available to
    him
  • (2) with which his personal and economic
    relations are closer (centre of vital interests)
  • (3) in which he has an habitual abode
  • (4) of which he is a national

15
Income Tax Act provisions
  • An individual is said to be resident in India in
    any previous year, if he
  • (a) is in India in that year for a period of 182
    days or more or
  • (b) having within the 4 years preceding that
    year been in India for a period of 365 and sixty
    days or more in that year.
  • In the case of an individual,
  • (a) being a citizen of India, who leaves
    India in any previous year for the purposes of
    employment outside India, instead of 60 days 182
    days be considered
  • (b) being a citizen of India, or a person of
    Indian origin being outside India, comes on a
    visit to India in any previous year, instead of
    60 days 182 days be considered

Leaving India for the purposes of employment
outside India Different situations
16
Leaving India different situations
  • 1. an Indian employee leaving India in the
    course of his existing employment on a business
    visit. He continues to be on the payroll of the
    Indian company.
  • NOT ENTITLED to the benefit of the
    explanation.
  • 2. an Indian employee leaving India for taking
    up a new employment with his existing employer
    (e.g. on deputation). He continues to be on the
    payroll of the Indian company
  • ENTITLED to the benefit of the explanation.
  • 3. an Indian employee leaving India for taking
    up a new employment with his existing employer
    (e.g. on deputation). His payroll is transferred
    to the payroll of the overseas entity.
  • ENTITLED to the benefit of the explanation.
  • 4. an Indian employee leaving India for taking
    up a new employment, with a new employer
  • ENTITLED to the benefit of the explanation

17
Employer obligations
  • Test residential status -
  • 60 days test to determine whether the employee
    is on tour
  • 182 days test- to determine whether the employee
    is on transfer whether the employee leaves
    India for the purpose of employment outside India
    (as distinguished from for or in connection with
    an employment outside India under FEMA
    regulations)
  • Determine the tax liability in India and in the
    other country to which he has been transferred
  • Per diem allowance
  • Salary paid in India determining tax liability
  • Whether the taxes, as applicable in the other
    country can be taken credit
  • Whether any tax equalization policy or Hypo tax
    in place
  • whether lower WHT applied for
  • or pay and collect on refund from employees
  • ESOPs- Pre and Post Bonus, shadow pay roll etc
  • Keep a watch on calendar year financial year
    mismatch throwing Residential Status in both the
    countries especially in year of return
  • Specific issues Pension, severance pay etc
  • FRINGE BENEFIT TAX OBLIGATIONS

18
ESOP- inbound and outbound employees
  • Issues
  • Employees based in India- between the date of the
    grant and date of vesting- subject to FBT
    corresponding relief under the other country?
  • For Outbound employees the local law of the
    relevant country to decide the tax liability
  • Ex- US treatment of the Capital gains as US
    sourced Income

SCENARIO CONSEQUENT TO REMOVAL OF PROVISO U/S
17(2)(iii)(c)
19
Some interesting decisions-
  • (1993) 202 ITR 64 (Cal)
  • It can be said that the pension would accrue at
    the same place as that of the salary. Therefore,
    pension would be deemed to accrue in India if the
    pensioner has rendered services in India.
  • AAR Ruling -P-12 of 1995 1997-228 ITR 61
  • The taxability of withdrawals from the individual
    retirements arrangement (IRA) of an NRI was
    discussed. Contributions made to the IRA were tax
    deferred i.e. they were tax deductible at the
    time of contribution but liable to tax at the
    time of withdrawal. As the applicant planned to
    shift to India, he intended to invest part of his
    IRA funds in a non-resident non-repatriable rupee
    deposit (NR-NR-RD) scheme. It was held that no
    Indian Income-tax would be payable on withdrawals
    from NR-NR-RD account as such withdrawals do not
    at all constitute income in his hands.

20
Uttaranchal High Court Sedco Forex International
Drilling Co. Ltd. (264 ITR 320)
  • Section 9(1) reads, "The following incomes shall
    be deemed to accrue or arise in India... " And
    (ii) therein reads, income which falls under the
    head salaries' if it is earned in India... '
  • Ronald Grey, a resident of the United Kingdom,
    entered into an employment contract with Sedco
    Forex International Drilling Co., a company
    incorporated in Panama. Grey worked on oil rigs
    in India for a 35-day on period, followed by a
    28-day off period in the United Kingdom.
  • The HC held that amounts paid to Grey for the off
    period were taxable in India as part of his total
    salary and that no distinction could be made
    between on-period and off-period salary (the
    concerned Asst year was 93-94)
  • HC decision Over ruled by Supreme Court

21
Supreme court decision Sedco..
  • with effect from April 1, 2000,a new explanation
    under Section 9(1)(ii) had clarified for the
    removal of doubts' that "the rest period or leave
    period which is preceded and succeeded by
    services rendered in India and forms part of the
    service contract of employment shall be regarded
    as income earned in India."
  • The High Court proceeded on the incorrect
    hypothesis that the field breaks were limited to
    the training of the employees to render them more
    fit for service in India.
  • The High Court did not address itself to the
    other aspects of the field break, namely, the
    readiness of the employees for service anywhere.
  • The employees in this case had not in fact
    served' in India during the field break period,
    but they earned the income in UK as UK residents
    the consideration for the salary being the
    undergoing of training or updating of knowledge
    and being in a state of readiness to serve
    anywhere .
  • The contract does not mention that the salary was
    for a well-earned rest.
  • But the second clause relating to the salary paid
    by the appellants to its UK employees for the
    field break was not earned in India'.
  • Therefore, the salary paid for the field breaks
    in the UK was not for service rendered in India'
    within the meaning of the 1983 Explanation to
    Section 9(1)(ii) of the Act, said the Supreme
    Court.

22
Foreign case study - severance pay
  • Facts
  • Dutch employee transferred to employers UK
    branch
  • He worked for 20 years in Holland and 2 years in
    the UK
  • Dismissed from service in UK after residence
    established
  • Issue
  • How Tax Treaties applies to severance pay.
  • Principles laid out by the Hoge Raad
  • If payment is not sufficiently connected with
    former employment, not taxable income in Holland.
  • Could be taxable in both states if severance
    payment is for cumulative work performed by the
    employee.
  • Taxable as pension if payment intended to support
    the employee upto retirement or add to
    insufficient pension.

23
Foreign case study - severance pay
  • Principles laid out by the Hoge Raad (Cont)
  • If payment cannot be categorized as above,
    taxation must be divided between time spent in
    each state.
  • Formula developed by Hoge Raad takes into
    consideration only year of severance and for
    preceding four years.
  • Formula on arbitrary basis???

24
Fringe Benefit Tax- extract from CBDT
clarification circular
  • 14. Whether FBT is payable by foreign companies
    deputing personnel to India for short duration
    under technical supervision contracts? Whether
    expenses incurred for the various purposes
    enumerated in clauses (A) to (P) of sub-section
    (2) of section 115WB is liable to FBT if such
    expenses are reimbursed by the Indian entity to
    the foreign company or the Indian entity directly
    b ears the expenses incurred by the expatriates?
  • A foreign company deputing personnel to India for
    short duration under a technical supervision
    contract is liable to FBT in India if
  • 1. The salary, as defined in section 17 of the
    Income-tax Act, of such employees is liable to
    income tax in India or
  • 2. The company has employees based in India other
    than those deputed to India for a short duration.
  • Further, if the foreign company incurs
    expenditure and claims reimbursement for such
    expenditure, the foreign company would be liable
    to FBT on expenditure so incurred for the
    purposes enumerated in sub-section (2) of section
    115WB.
  • However, if the Indian entity bears the expenses
    of such personnel deputed by the foreign company
    and includes those expenses under the appropriate
    head in clauses (A) to (P) of sub -section (2) of
    section 115WB, such expenses will be subjected to
    FBT since it is a presumptive tax.

25
Fringe Benefit Tax contd.
  • 15. Whether FBT is payable by a foreign company
    even if its employee (s) are not taxable in terms
    of the Article relating to dependent personal
    services in any treaty?
  • If a foreign company has employees based in India
    and the remuneration received by all its
    employees is not taxable in India in terms of the
    Article relating to dependent personal services
    in any treaty, such foreign companies would not
    be liable to FBT in India.

Challenge- FBT on ESOPs- INBOUND AND OUTBOUND
26
Typical tax treatment table
ITEM EMPLOYEE EMPLOYEE EMPLOYER
TAX NON TAX Deductible FBT
Salary, bonus, commission Y Y
Moving Expense N Y Y
Transfer Allowance Y Y
Shipment of Household Goods N Y
Storage of Household goods Y Y
Travel business Exp N Y Y
Transportation while on Assign Y Y
Company Car N Y Y
Language Training for employee N Y Y
Salaries tax borne by employer Y Y
Currency Risk Y Y
Tax Equalisation Y Y
Tax Reimbursement Y Y
27
Some scope for planning
  • Education Deposit directly paid to the
    Educational Institution
  • Per Diem Allowance (controversial FBT circular)
  • Health care, Life and Disability premium payments
    by employer
  • Lease Deposit for the House
  • Club membership
  • Hypothetical Tax deduction (Refer recent Mumbai
    Tribunal Decision in
  • Roy Marshalls case) (watch out for distinction
    between Hypothetical tax vs tax equalization)
  • Retention Pay (not taxable as held in Indo Nissan
    case- Ban Tri- doubtful post Section 17 amendment
    bringing into tax any money from present or past
    employers.

28
AAR ruling BRITISH GAS INDIA LTD
  • Limited Question Should the company deduct tax
    from salary paid to its employee who is on
    deputation to the Parent Company (UK).
  • Employees temporarily work at overseas locations
    with BG Group companies- stayed for 88 days in
    the previous year.
  • During the period of deputation they would
    continue to be on the payrolls of the India co
    and receive salary in India. India Co recover
    from the UK Parent the Indian Salary. Employees
    also received commodities and service allowances,
    expatriate allowances and relocation allowance
    from UK Parent and Taxed in UK.
  • Assignment letter specified that for the period
    of the overseas assignment, you will be employed
    according to the terms and conditions of
    employment as specified in your contract of
    employment and the international assignment
    documents. Whilst on assignment, your terms and
    conditions will be governed by the law of India.
  • AAR ruled that the salary so paid by Ind co is
    not taxable in India in accordance with the DTAA,
    provided the same is taxed in UK.

29
AAR ATS India Pvt Ltd
  • Reimbursement of salary cost to foreign company
    for assigning its employees for India operations
    is taxable as fees for technical services
  • ATS India had two agreements with its Parent
    collaboration Agreement and Secondment Agreement.
    Employees to work under the direct control of the
    India Co. Parent Co continue to pay salary but
    get the same reimbursed from India Co.- two
    clauses in the agreement were picked up by AAR-
    the employees at any time be recalled by the
    Parent Co and India Co cannot alter the salary.
    Based on this the AAR held that India Co are not
    the employers.
  • AAR held that the compensation is taxable as Fees
    for Technical Services

30
Lessons from ATS decision
  • Which entity is the employer- Identify employer
    early -saves time and expense later
  • no offer letter amendments
  • avoid dual employment
  • ensure clean employment files
  • comply with Country specific customs and
    practices,
  • avoid at will employment
  • AND ABOVE ALL
  • a well drafted secondment letter PROPERLY
    SUPPORTED By Formal Contracts between the
    employee and Host Country company with specific
    declaration of
  • location,
  • Governing Law of the State of Host,
  • integration clause,
  • IP benefit to the Host Country,
  • notice period/ severance clauses,
  • employer related contributions,
  • statutory social insurance charges,
  • mandatory customary vacation days (example -
    mandatory holidays like Independence day etc,
    sick and statutory holidays as per Factories
    Act)

31
Employees obligation
  • True and fair disclosure of taxable income in
    both countries
  • Entry and exit counselling with tax experts
  • Surrender of Green Card or Citizenship status
    with expert advise- exit considerations

32
PERMANENT ESTABLISHMENT- extract from Indo US
DTAA
  • Permanent establishment
  • 1. For the purposes of this Convention, the term
    permanent establishment means a fixed place of
    business through which the business of an
    enterprise is wholly or partly carried on.
  • 2. The term permanent establishment includes
    especially
  • a place of management a branch an office a
    factory a workshop
  • supervisory activities in connection construction
    for a period of more than 120 days in any
    twelve-month period
  • the furnishing of services, other than included
    services as defined in Article 12 (Royalties and
    Fees for Included Services), within a Contracting
    State by an enterprise through employees or other
    personnel, but only if
  • (i) activities of that nature continue within
    that State for a period or periods aggregating
    more than 90 days within any twelve-month period
    or
  • (ii) the services are performed within that
    State for a related enterprise within the
    meaning of paragraph 1 of Article 9 (Associated
    Enterprises).
  • 3. Exclusion - the maintenance of a fixed place
    of business solely for the purpose of
    advertising, for the supply of information, for
    scientific research or for other activities which
    have a preparatory or auxiliary character, for
    the enterprise

33
PERMANENT ESTABLISHMENT - exclusions
  • (a) the use of facilities solely for the purpose
    of storage, display, or occasional delivery of
    goods or merchandise belonging to the enterprise
  • (b) the maintenance of a stock of goods or
    merchandise belonging to the enterprise solely
    for the purpose of storage, display, or
    occasional delivery
  • (c) the maintenance of a stock of goods or
    merchandise belonging to the enterprise solely
    for the purpose of processing by another
    enterprise
  • (d) the maintenance of a fixed place of business
    solely for the purpose of purchasing goods or
    merchandise, or of collecting information, for
    the enterprise

34
Options considered by MNCs
  • Secondment
  • Dual Employment Status
  • Use of third country manpower company
  • Transfer Pricing issues
  • Body shopping by Indian software companies
  • Cost pool and margin

35
Secondment- Global issues
  • If employees are physically transferred with the
    activity to the new location, the issue is
    whether the transfer qualifies as a secondment or
    a permanent position
  • Where the transfer is a temporary one and in the
    process technology transfer and services are
    rendered, where otherwise, the payment would have
    required a technology payment, would be treated
    as an extension of the foreign company in the
    host country.
  • Employees of high management level seconded to
    other country run the risk of PE- people
    functions are more important than formal risk
    allocation in inter-company contracts.
  • Business transferred along with Secondment and
    outsourcing the business - requires a BUY OUT
    PAYMENT before OUTSOURCING
  • Some countries provide specific secondment rules
    EX- GERMANY

36
Notable decisions on Service PE
  • DIT v Morgan Stanley Co
  • In this case, one of the issues before the
    Supreme Court of India (SC) was whether the FE
    could have a PE in India on account of deputation
    of personnel to its Indian affiliate. The SC,
    while ruling that the FE had a service PE, laid
    down the principle that for a service PE to be
    constituted the FE should be responsible for the
    work of the personnel on deputation.
  • The employees should either
  • continue to be on the payroll of the FE or
  • they should have lien on their employment with
    the FE.
  • The ruling emphasises the need for the FE to
    review its deputation arrangements to assess the
    PE risk and ensure proper documentation to defend
    a PE challenge by the Indian tax authorities.

37
Notable decisions on Service PE
  • Rolls Royce Plc v DDIT
  • The Tribunal held that Rolls Royce PLC, a UK
    company engaged in the supply of aero engines to
    Indian customers, had a PE in India under the
    basic rule, because its employees visited India
    frequently and the premises of one of its
    affiliate companies was occupied and used during
    such visits.
  • While the OECD Commentary recognises that no
    formal or legal right to use a particular place
    is required for a place to constitute a PE, the
    Commentary also states that mere presence of an
    enterprise at a particular location does not mean
    that the location is at the disposal of the
    enterprise.

38
SPECIFIC COUNTRY - USA
  • TAXATION OF INBOUND ALIEN
  • Physical Presence Test
  • 31days in current year
  • 183 days equivalent test
  • 100 current year days
  • 1/3 rd Prior year days
  • 1/6th second prior year days
  • US sourced interest and dividends to be taxed in
    US
  • Capital Gains on ESOPs
  • Tax Credits to avoid Double Taxation
  • Shadow Pay Roll
  • State Taxation - TAXABLE IN A STATE WHERE YOU
    LIVE OR WORK

39
SPECIFIC COUNTRY - USA
  • TAXATION OF OUTBOUND
  • Citizenship based Taxation
  • Exclusion of Foreign earned income
  • Foreign Tax Credit
  • Issues behind surrendering Green Card
  • New Heroes Earnings Assistance and Relief Tax Act
    of 2008 (the HEART act). The HEART act contains a
    new expatriation tax regime that applies to
    individuals who expatriate from the US on or
    after June 17 2008- certain high net worth
    individuals cannot renounce their US citizenship
    or terminate their long-term US residency in
    order to avoid US taxes.
  • A covered expatriate is an expatriate (1) whose
    average annual net income tax for the five
    taxable years preceding expatriation exceeds
    139,000 (as adjusted in 2008 for inflation) (2)
    whose net worth is 2 million or more on the date
    of expatriation

40
QUESTIONS?????
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