Foreign Salary  Taxability from Resident's Perspective

                                                                                                                                                                                                                                                                                                                                                                                                               

Introduction

Today India is known in whole of the world for its immense pool of highly talented and well qualified human resource. Big multinationals are not only setting up their shops in India but to manage and run their resources all over the world they are always in look out for Indian talent. Many young Indians go abroad on high profile jobs.Among many other tax issues that arise due to taxability of salary in two countries , one issue that arises is the taxability of the salary in case of a Resident of India earning and receiving salary abroad due to exercise of employment abroad.

Suppose a person ,who is resident of India, goes abroad to a country , with whom India is having a Double Taxation Avoidance Agreement, and exercises employment in that other country. He earns and receives salary abroad and that other country gets right to levy tax on his salary earned there. It is assumed that remuneration is borne by employer resident of the source state. However,the said person stays in India for more than 183 days during the relevant financial year and remains resident of India as per the provisions of the Income Tax Act,1961 and hence also becomes liable to tax in India on his global income.

Another form that question of taxability of such income takes is that whether such income would be taxable in both the countries of residence and source and then eligible for elimination of double taxation by credit system of elimination in the country of residence or that such income would be taxable only in one country and other country loses its right to levy tax as per Double Avoidance Tax Agreements.

Many a times it happens that employment is exercised in a low or no tax jurisdiction and salary packages are finalized taking into account the taxability of the same in the source country. Now if a person becomes liable to tax in his home country also due to retaining of his ordinary resident status in the home country, all his calculations can go bizarre.

Basics of Taxability

The issue that we intend to discuss in this article is about taxability of salary earned and received by a person resident of India while exercising employment abroad. This topic involves discussion on Section 5(1) ,Section 90(2) of the Income Tax Act vis a vis Article on Dependent Personal Services/Income from Employment of UN/OECD Model Tax Convention along with available legal jurisprudence on this issue.

 

a)      Scope of Article 15 (Income from Employment/Dependent Personal Services):-Income from employment is dealt with in Article 15 of OECD/UN Model. Article 15 of UN Model reads as follows:-

1.    Subject to the provisions of Articles 16, 18 and 19, salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived there from may be taxed in that other State.

 

2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if:

(a)  The recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in any twelve-month period commencing or ending in the fiscal year concerned; and

(b)  The remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and

(c)  The remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State.

 

3. Notwithstanding the preceding provisions of this Article, remuneration derived in respect of an employment exercised aboard a ship or aircraft operated in international traffic, or aboard a boat engaged in inland waterways transport, may be taxed in the Contracting State in which the place of effective management of the enterprise is situated.

 

Paragraph 1 of the Article 15 lays down the basic principle about the taxability of income derived by a person as salary in respect of an employment. It is taxed in the state of residence. Exception to this rule is that it 'may be taxed' in the other state i.e. source state if the employment is exercised in that other state. This is the basic rule.

Paragraph 2 carves out an exception to the basic rule laid down in Paragraph 1 and gives the right of taxation only to the residence state if an employee spends a short period abroad i.e., a period less than 183 days, and remuneration is not paid by an employer who is resident of that other state and is not borne by a permanent establishment which the employer has in the other state.

 

b)      Scope of Section 5(1)  of the Income Tax Act,1961 :- Sec 5(1) of the Income Tax Act - Scope of total income - reads as follows:

 

" Subject to the provisions of this Act, the total income of any previous year of a person

who is a resident includes all income from whatever source derived which-

(a)    is received or is deemed to be received in India in such year by or on behalf of such

person ; or

                      (b)  accrues or arises or is deemed to accrue or arise to him in India during such year ; or

                      (c)  accrues or arises to him outside India during such year :

 

Provided that, in the case of a person not ordinarily resident in India within the meaning

of sub-section (6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession

set up in India."

 

Section 5(1) of the Income Tax Act enunciates the scope of total income for a person resident in India. Section 5(1)(a) and Section 5(1)(b) lays down that all income ,from whatever source derived, which is received or deemed to received in India or which accrues or arises or is deemed to accrue or arise in India is taxable in India.

 

Section 5(1)(c ) further enlarges the scope of total income in case of person resident in India by laying down that all income ,  from whatever source derived, which accrues or arises to him outside India would also be included in the total income of the said resident.

 

 

c)       Section 90(2) states  that where the Central Government has entered into an  agreement with the Government of any country outside India or specified territory outside India, as the case may be, under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee

 

 

Now restricting ourself to the topic of our discussion in this article relating to the taxability of salary earned and received abroad by a person who is resident of India, it is clear from Section 5(1)(c ) that global income of the person resident in India is taxable in India. Hence salary earned and received abroad by a person resident in India would be taxable in India. However , the Government of India provides relief from Double Taxation through Double Taxation Avoidance Agreements entered into with various countries and as per Section 90(2) of the Income Tax Act,1961, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to the assessee.

 

Hence, for salary earned and received abroad by a resident, though taxable as per Section 5(1)(c ) of the Income Tax Act, its actual taxability and relief would be determined by the Article relating to Income from Employment/Dependent Personnel Services of the relevant tax treaty.

So to determine the taxability of salary earned abroad by a person resident in India, we would have to analyse the Article 15 of Model Treaty.

 

Analysis of Article 15 :

We are going to analyse the Article 15 by treating and substituting the residence state with  'India' and other state with the 'source state' where employment has been exercised and salary has been received and earned by the person resident in India. Article 15(1) of UN Model Tax Convention would read as follows:-

 

(1)    Subject to the provisions of Articles 16, 18 and 19, salaries, wages and other similar remuneration derived by a resident of a India in respect of an employment shall be taxable only in India unless the employment is exercised in the Source State . If the employment is so exercised, such remuneration as is derived there from may be taxed in Source State.

 

 

Paragraph 1 of Article 15 establishes that as a general rule income from employment is taxable in the State where employment is actually exercised. It states that salary derived by a resident of India would be taxable in India unless the employment is exercised in the source state and if employment is so exercised, such remuneration 'may be taxed' in source state.

 

Now in current situation since the employment has been exercised in the source state hence it may be taxed in the source state as per Article 15(1)  and the source state acquires right to tax such income. Since the words used in this Article are 'may be taxed' whether India loses its right to tax the said salary income or both the states retains right to tax the said income is the main point of our discussion in this article.

 

But before we discuss the said situation let us analyse Paragraph 2 of Article 15. Again substituting India for the state of residence , the article would read as follows;-

 

(2)    Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of India in respect of an employment exercised in the Source State shall be taxable only in India if:

 

(a)  The recipient is present in the Source State for a period or periods not exceeding in the aggregate 183 days in any twelve-month period commencing or ending in the fiscal year concerned; and

(b)  The remuneration is paid by, or on behalf of, an employer who is not a resident of the Source State; and

(c)  The remuneration is not borne by a permanent establishment or a fixed base which the employer has in the Source State.

 

Hence Article 15(2) gives the exclusive right of taxation to India i.e. residence state if the above three conditions are satisfied. It has to be kept in mind that for the remuneration to be exempt in the source state ,all the three conditions must be satisfied. Now applying the provisions to the case in hand , the assessee is present in source state for period less than 183 days, hence first condition is satisfied. The remuneration is borne by the employer who is resident of the source state hence second condition is not satisfied. Now since all the three conditions in the given case are not being satisfied together , India does not get exclusive right to tax the remuneration derived by the person resident in India in respect of employment exercised in source country . Therefore Article 15(2) would not be applicable to the circumstances of the case. 

Since Paragraph 2 would not be applicable , hence we return of Article 15(1). Now  in present case as per Article 15(1), as we have already discussed, source state may tax the income earned in that state. Now question arises that since the words 'may be taxed' have been used, whether only source country is eligible to tax the salary in the present case or residence country i.e. India also has right to tax the same . This question becomes a lot bigger if source country , like UAE , does not actually exercises its right to tax the salary earned therein. In that case , can India tax the salary on plea that source country has not actually exercised its right to tax the salary.

 

While analyzing  the said situation, we have to understand the scheme of taxation of DTAAs. On an analysis of various articles contained in the Model Tax Convention and various rulings given by Indian Courts, we can see that the scheme of taxation is divided broadly in three categories:

 

The first category includes Article 7 (Business profits without P.E. in the other State);Article 8 (Air transport and Shipping); Article 13 (capital gains other than mentioned in 13(1),(2),(3),(4)); Article 14 (Independent Personal Service without fixed base in other state) Article 15(2) (Dependent Personal services); Article 19 (Pensions) which provide that income shall be taxed only in the State of residence.

 

The second category includes Article 6 (Income from immovable property); Article 7 (Business profits where PE is established in other contracting State); Article 15(1)(Income from dependent personal services under certain circumstances); Article 16 (director's fees); Article 17 (income of artists and athletes); Article 18(b) (Government service) which provide that such income may be taxed in the other contracting State, i.e.,State of income source.

 

The third category includes Article 10 (Dividends); Article 11 (Interest); Article 12 (Royalty and fee for technical services); Article 13 (capital gains on other properties) which provide that such income may be taxed in both the contracting States.

 

The term 'may be taxed' gives sovereign right of taxation to source country in case of second category as enumerated above. There are some countries ,like UAE, which does not levy any tax on individuals but that does not mean that such country does not have right to tax such person. The fact that they have sovereign right as per treaty to tax such person and whether they actually tax it or not is their own will. But in case they do not actually tax it, other country  does not get the right to tax the same. This analysis is substantiated by following judgements.

 

Legal Jurisprudence

a)      In the case of Ms. Pooja Bhatt vs. DCIT¹ ,Hon'ble  ITAT Mumbai analysed the above scheme of taxation and meaning of the phrase "may be taxed" thread bare. The brief facts of the case is as follows:-

The assessee was a film artiste who had participated in an entertainment show performed in Canada in the year under consideration and had received a sum of US Dollars 6,000. The tax had also been deducted at source in Canada equal to the sum of US Dollars 900. The assessee claimed in the course of assessment proceedings that a sum of Rs. 1,86,000 (US Dollars 6,000) could not be taxed in India in view of Article 18 of the Indo-Canada Treaty. However, her contention was rejected by the Assessing Officer. It was found by the Assessing Officer that the assessee was a resident of India and, consequently, it was held by him that her entire global income was taxable under the provisions of the Income-tax Act.

Held:- The scheme of taxation is contained in Chapter III of the Double Taxation Avoidance Agreement (DTAA)/Indo-Canada Treaty. On an analysis of various articles contained in Chapter III, it is found that the scheme of taxation is divided in three categories. The first category includes Article 7 (Business profits without P.E. in the other State); Article 8 (Air transport); Article 9 (Shipping); Article 1 (capital gains on alienation of ships or aircrafts operated in international traffic); Article 15 (Professional services); Article 19 (Pensions) which provide that income shall be taxed only in the State of residence. The second category includes Article 6 (Income from immovable property); Article 7 (Business profits where PE is established in other contracting State); Article 15 (Income from professional services under certain circumstances); Article 16 (Income from dependent personal services where employment is exercised in other contracting State); Article 17 (director's fees); Article 18 (income of artists and athletes); Article 20 (Government service) which provide that such income may be taxed in the other contracting State, i.e., State of income source. The third category includes article 11 (Dividends); Article 12 (Interest); Article 13 (Royalty and fee for technical services); Article 14 (capital gains on other properties) and Article 22 (other income) which provide that such income may be taxed in both the contracting States. For example, paragraph 1 of Article 11 provides that dividend income may be taxed in other contracting State, while paragraph 2 provides that dividend income may also be taxed in the State of residence. Similarly, Article 14(2) and Article 22 provide that income may be taxed in both the countries. The above analysis clearly shows that intention of parties to the DTAA is very clear. 

Wherever the parties intends that income is to be taxed in both the countries, they specifically provides so in clear terms. Consequently, it could not be said that the expression 'may be taxed' used by the contracting parties gave an option to the other contracting States to tax such income. The contextual meaning has to be given to such an expression. If the contention of the revenue was to be accepted then the specific provisions permitting both the contracting States to levy of the tax would become meaningless. The conjoint reading of all the provisions of Articles in Chapter III of the Indo-Canada Treaty, leads to only one conclusion that the expression 'may be taxed in the other State', authorizes only the contracting State of source to tax such an income and by necessary implication the contracting State of residence is precluded from taxing such an income. Wherever the contracting parties intends that income may be taxed in both the countries, they specifically provides so. Hence, the contention of the revenue that the expression 'may be taxed in other State' gave the option to the other State and the State of residence was not precluded from taxing such an income could not be accepted.

The reliance of the revenue on Article 23 was also misplaced. It had been contended that Article 23 gives credit of tax paid in the other State to avoid double taxation in cases like the present one. Such provisions have been made in the treaty to cover the cases falling under the third category mentioned in the preceding paragraph, i.e., the cases where the income may be taxed in both the countries. Hence, the cases falling under the first or second categories would be outside the scope of Article 23 since income is to be taxed only in one State.

In view of the above discussion, it was to be held that the assessee could not be taxed in respect to the sum of Rs. 1,86,000 under the provisions of the Income-tax Act in view of the overriding provisions of the DTAA between India and Canada. The order of the Commissioner (Appeals) sustaining the addition was to be set aside and, consequently, the Assessing Officer was to be directed to exclude the same from the total income of the assessee. 

The above ruling further lays down clearly that even when Article 23 of the DTAA provides for elimination of double taxation by way of credit method , this provision would not come in way of providing relief by exemption method  as income under first and second category is taxable only in one state.

 

b)      Honourable Supreme Court held in PVAL Kulandagan Chettiar's²  case that once an Indian resident's income is taxed abroad by a treaty country, it cannot be taxed again in India. The view taken above also stands fortified by the decision of Madras High Court in the case of VR. S.R.M Firm³ which has been affirmed by the Apex Court in the case of P.V.A.L Kulandagan Chettiar(supra) and again approved in the recent decision in the case of Torqouise Investment & Finance Ltd⁴.In the case before the Hon'ble Madras High Court, the assessee was resident of India who had earned profit on sale of immovable property in Malaysia. Article 6 of Indo-Malaysia Treaty provided that such income may be taxed in the State in which such property was situated. The assessee claimed that he was not liable to pay tax on such income in view of Article 6 of the treaty. The revenue took the same stand as taken in the Pooja Bhatt case. The court rejected the same by observing as under :

 

"The contention on behalf of the Revenue that wherever the enabling words such as "may be taxed" are used there is no prohibition or embargo upon the authorities exercising powers under the Act, from assessing the category or class of income concerned cannot be countenanced as of substance or merit. As rightly pointed out on behalf of the assessees, when referring to an obvious position such enabling form of language has been liberally used and the same cannot be taken advantage of by the Revenue to claim for it a right to bring to assessment the income covered by such clauses in the agreement, and the mandatory form of language has been used only where there is room or scope for doubts or more than one view possible, by identifying and fixing the position and placing it beyond doubt."

Since the above decision has been affirmed by the Apex Court, there is no scope for taking a different view. Although, the Apex Court observed that the decision of the Madras High Court was being affirmed for different reason but the conclusion remains that income cannot be assessed in the State of residence where the agreement provides that income may be taxed in the source country. In this context, it is pertinent to observe that the identical issue arose before the Hon'ble Madhya Pradesh High Court in the case of Torqouise Investment & Finance Co. and the court, following the decision of the Madras High Court in the case of VR.S.R.M. Firm , held that income arising on the sale of immovable property in Malaysia could not be taxed in India. The matter again reached the Supreme Court and the Apex Court has affirmed the view of the Hon'ble Madhya Pradesh High Court following its earlier decision in P.V.A.L. Kulandagan Chettiar(supra).

 

c)       In a recent judgement by ITAT Mumbai Bench in the case of ESSAR oil Limited Vs. Deputy Commissioner of Income Tax⁵,  it was the plea of the assessee that under section 5 of the Income Tax Act, 1961 (the Act) the world income of a resident entity is liable to tax in India. However, as per section 90(2) of the Act, in case where India has entered into a Double Tax Avoidance Agreement (DTAA) with any country, then the provisions of the Treaty would over-ride the provisions of the Act insofar as the Treaty provisions are more beneficial to the assessee. The assessee submitted that since it had a permanent establishment in both the countries and since as per the DTAA, the income earned through such permanent establishment has to be taxed only in the other country. The emphasis by the assessee was on the expression "may be taxed" and according to the assessee it is only the country where the permanent establishment is situated that has the right to tax and not the country in which the assessee is resident. The Tribunal held as follows:

 

"We are of the view that the reliance placed by the learned D.R. on the aforesaid decision does not help the plea of the revenue before us. The expression "may also be taxed" in Article 7 of the DTAA between India and Qatar is followed by the words "in the state of residence" as is found in Article 11(2) of the DTAA between India and Canada. As laid down in the case of Pooja Bhatt (supra), the intention of countries to the DTAA is to be seen. Article 11 (2) of the DTAA between India and Qatar specifically provides that dividend can also be taxed in the State of which the company paying dividend is a resident. Article 12 of the DTAA between India and Qatar similarly provides right to both the source country as well as the resident country to tax interest income. Wherever the parties intended that income is to be taxed in both the countries, they have specifically provided in clear terms. Consequently, it cannot be said that the expression "may also be taxed" used in the DTAA gave option to the other Contracting States to tax such income. As laid down in the decision in the case of Pooja Bhatt (supra) contextual meaning has to be given to such expression. If the contention of the Revenue is to be accepted then the specific provisions permitting both the Contracting States to levy the tax would become meaningless. In our view, by using the expression "may also be taxed in the other State", the contracting parties permitted only the other State, i.e. State of income source and by implication, the State of residence was precluded from taxing such income. Wherever the contracting parties intended that income may be taxed in both the countries, they have specifically provided. Hence, the contention of the revenue that the expression "may also be taxed in other State" giving the option to the other State and the State of residence is not precluded from taxing such income cannot be accepted."

 

The consequence of the judgement in Chettiar's case and other above referred cases is that wherever India has signed a Double Tax Avoidance Treaty, when Indian resident earn income from those countries, there will be no tax in India in the case of first and second category of scheme of taxation ,as discussed in Ms Pooja Bhatt case,  where phrase 'may be taxed' has been used. And hence in the country of source , if rate of tax is zero or lower then income will be taxed at lower or nil rate. For example in case of UAE ,irrespective of whether or not the UAE actually levies taxes on non-corporate entities, once the right to tax UAE residents in specified circumstances vests only with the Government of UAE, that right, whether exercised or not, continues to remain exclusive right of the Government of UAE. This view is further substantiated by the ruling of Mumbai Tribunal in the case of ITO vs Mahavirchand Mehta⁶.

 

 

As per the analysis of above judgements India cannot even include the said income taking shelter of Section 5(1)(c ) and then give credit of taxes paid, if any, in the foreign country.

On the basis of above legal jurisprudence it is clear that the phrase "may be taxed", as used in Article 15(1), contemplates that if employment is exercised in the source country and remuneration is also received in the  source country then such remuneration would be taxable only in the source country and India would be precluded from taxing such income.Moreover, the fact whether tax is actually paid on such remuneration in source country, like UAE,  is of no relevance as being 'liable to tax' in the Contracting state does not necessarily imply that the person actually be liable to tax in that contracting state by the virtue of an existing legal provision but would also cover the cases where that other contracting state has the right to tax such persons â€" irrespective of whether or not such a right is exercised by the contracting state.

 

Government has issued Notification No. 91/2008 dated 28th August, 2008. This notification provide that even if an Indian resident's income is taxed abroad, it shall still be taxable in India. Double Tax will be eliminated as provided in the Double Tax Avoidance Agreement which is mostly credit based method. However,in our view,this notification cannot override the law of the land laid down by Supreme Court. Hence, there is little practical impact of this notification.

 

Conclusion

In light of  the above discussions it is clear that there are some basic concepts on which system of Elimination of Double Taxation is based. Though India, in its Double Taxation Avoidance Agreements has mostly adopted credit system in the Articles relating to Elimination of  Double Taxation but that does not mean that "Exemption Method" cannot be used at all where the context requires. As held in the case of Ms Pooja Bhatt (supra), Article 23 relating to credit system of elimination  would not be applicable wherein context requires taxability only in one state though the phrase 'may be taxed' has been used.Hence in view of the analysis of various provisions of the Act , Articles of Model Tax Conventions and Legal Jurisprudence , it can be concluded that in case of person resident of India, earning and receiving salary abroad , would be liable to pay tax only in the source country and not in India though the litigation on this point is likely to go on for some more time in view of government notification against the said view.

 

 

 

Reference to Judgements

                1.(2008) 26 SOT 574(Mumbai)

                2.(2004)137 Taxman 460 (SC)

                3.(1994) 208 ITR 400 (Mad)

                4.(2008)300 ITR 001

                5.(2011) 13 Taxmann.com 151 (Mum-Trib)

                6.(2011) 11Taxmann.com 194 (Mum)

               

 

CA.ARUN GUPTA
Ex-Chairman Ludhiana Branch of NIRC of ICAI
Ex-Secretary Distt Taxation Bar Association,Ludhiana
09814104273
www.cagds.in
arunaru@yahoo.com