Expatriate Taxation - Sampath Raghunathan.ppt

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TAXATION OF EXPATRIATES-

Structuring and Planning

Presentation at theIFA SEMINAR - HYDERABAD

On 12THDECEMBER 2008

By

Sampath Raghunathan
http://www.answers.com/topic/acquisition-costhttp://www.answers.com/topic/shareholder


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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


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TAXATION OF EXPATRIATES- abrief background


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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


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Policy Issues - examples

Type of Assignment Possible Policy Approach

Nine month assignment to Switzerland to start anew project- Project Management

Continued home base compensation package withfull reimbursement of host living expenses.

Junior engineer on IT platform conversion projectin SingaporeTechnical Services

Localization - Reimbursement of some local livingexpenses.

55 year old engineer whose skills are needed onproject in Germany.

Balance sheet approach- RepartriationLongtermbuilding up a set of compensation andallowanceskeeping in view that the employee onleaving would not opt for any future employment.

Executive to New York to head up US subsidiary Localized package with relocation package.


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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


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TAXATION OF EXPATRIATES-treaty and tax law provisions


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Extract from IndoUS DTAASituation 2.Notwithstanding the provisions of paragraph 1,

remuneration derived by a residentof a Contracting State (INDIA) inrespect of an employment exercised in the other Contracting State

(USA) shall be taxable onlyin 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 employerwho is nota resident of the other State (USA);AND

(c) the remuneration is not borne bya permanent establishment or a fixedbase or a trade or business which the employer has in the otherState(USA). (some treaties use terms "deductible" or "claimed

as deduction)

Employer economic or legal


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BORNE BY. SC DECISION..ECONOMIC

EMPLOYER?

The word borne by is not defined in the DTA. Para 2 of Article 3, containingGeneral definitions of the DTA is the residuary clause stating any term notdefined therein shall, unless the context otherwise requires, have the meaningwhich 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 liableto discharge or the actual sum paid by him in discharge of that liability. But inthe 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 theproviso to section 23(1) of the Act and not the latter one. The reason for takingthis view flows from the scheme of the Act itself - CIT v. Dalhousie PropertiesLtd. [1984] 149 ITR 708 (SC).


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Rendering of services or Provision of

services If it is Rendering of Servicesto be considered under Dependent Personal Services

if it is provision of servicesto be considered under Fees for technical services

Tests-

Which entity bears the responsibility or risk for the results produced by the individualswork;

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 theindividual;

Which entity provides the tools and materials required to perform the work at theindividual's disposal and

Which entity determines thenumber and qualification of the individuals performing workon an application of the above conditions, one would have to determine who is the "realemployer". The tests to determine the real employment in generally applied only toprevent Treaty abuse.


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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 aperiod 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 anyprevious year for the purposes of employmentoutside India, instead of 60 days 182 days be considered

(b) being a citizen of India, or a person of Indian origin being outsideIndia, comes on a visit to India in any previous year, instead of 60 days

182 days be consideredLeaving India for the purposes of employment outside India

Different situations


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Leaving India different situations

1. an Indian employee leaving India in the course of his existing employment ona 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 hisexisting employer; (e.g. on deputation). He continues to be on the payroll ofthe Indian company

ENTITLEDto the benefit of the explanation.

3. an Indian employee leaving India for taking up a new employment with hisexisting employer; (e.g. on deputation). His payroll is transferred to thepayroll of the overseas entity.

ENTITLEDto the benefit of the explanation.

4. an Indian employee leaving India for taking up a new employment, with anew employer

ENTITLEDto the benefit of the explanation


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Employer obligations

Test residential status - 60 days testto determine whether the employee is on tour 182 days test- to determine whether the employee is on transferwhether the employee leaves

India for the purpose of employment outside India (as distinguished from for or in connectionwith 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 yearfinancial year mismatch throwing

Residential Status in both the countries especially in year of return Specific issuesPension, severance pay etc FRINGE BENEFIT TAX OBLIGATIONS


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ESOP- inbound and outbound employees

Issues:

Employees based in India- between the date of the grant and date ofvesting- subject to FBTcorresponding relief under the other country?

For Outbound employeesthe local law of the relevant country to

decide the tax liability Ex- US treatment of the Capital gains as US sourced Income

SCENARIO CONSEQUENT TOREMOVAL OF PROVISO U/S 17(2)(iii)(c)


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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 toaccrue 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 taxdeferred i.e. they were tax deductible at the time of contribution but liableto 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 IndianIncome-tax would be payable on withdrawals from NR-NR-RD account assuch withdrawals do not at all constitute income in his hands.


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Supreme court decisionSedco..

with effect from April 1, 2000,a new explanation under Section 9(1)(ii) had clarified `forthe removal of doubts' that "the rest period or leave period which is preceded andsucceeded by services rendered in India and forms part of the service contract ofemployment shall be regarded as income earned in India."

The High Court proceeded on the incorrect hypothesis that the field breaks were limitedto 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, thereadiness 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 salarybeing the undergoing of training or updating of knowledge and being in a state ofreadiness 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 employeesfor the field break was not `earned in India'.

Therefore, the salary paid for the field breaks in the UK was not for `service rendered inIndia' within the meaning of the 1983 Explanation to Section 9(1)(ii) of the Act, said theSupreme Court.

F i d


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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.

F i t d


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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???


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Fringe Benefit Tax- extract from CBDT

clarification circular

14. Whether FBT is payable by foreign companies deputing personnel to India forshort duration under technical supervision contracts? Whether expenses incurredfor the various purposes enumerated in clauses (A) to (P) of sub-section (2) ofsection 115WB is liable to FBT if such expenses are reimbursed by the Indianentity to the foreign company or the Indian entity directly b ears the expensesincurred by the expatriates?

A foreign company deputing personnel to India for short duration under a technicalsupervision 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 liableto income tax in India; or

2. The company has employees based in India other than those deputed to India for ashort duration.

Further, if the foreign company incurs expenditure and claims reimbursement forsuch expenditure, the foreign company would be liable to FBT on expenditure soincurred for the purposes enumerated in sub-section (2) of section 115WB.

However, if the Indian entity bears the expenses of such personnel deputed by theforeign 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 FBTsince it is a presumptive tax.


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Fringe Benefit Tax contd.

15. Whether FBT is payable by a foreign company even if itsemployee (s) are not taxable in terms of the Article relating todependent personal services in any treaty?

If a foreign company has employees based in India and theremuneration received by all its employees is not taxable in India in

terms of the Article relating to dependent personal services in anytreaty, such foreign companies would not be liable to FBT in India.

Challenge- FBT on ESOPs- INBOUND AND OUTBOUND


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Typical tax treatment tableITEM 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


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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 Hypotheticaltax 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 frompresent or past employers.


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AAR rulingBRITISH GAS INDIA LTD

Limited Question : Should the company deduct tax from salary paid to itsemployee 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 theIndia co and receive salary in India. India Co recover from the UK Parent theIndian Salary. Employees also received commodities and service allowances,expatriate allowances and relocation allowance from UK Parent and Taxed inUK.

Assignment letter specified that for the period of the overseas assignment, youwill be employed according to the terms and conditions of employment asspecified in your contract of employment and the international assignment

documents. Whilst on assignment, your terms and conditions will be governedby the law of India.

AAR ruled that the salary so paid by Ind co is not taxable in India inaccordance with the DTAA, provided the same is taxed in UK.


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AARAT&S India Pvt Ltd

Reimbursement of salary cost to foreign company for assigning itsemployees for India operations is taxable as fees for technicalservices

AT&S India had two agreements with its ParentcollaborationAgreement and Secondment Agreement. Employees to work under the

direct control of the India Co. Parent Co continue to pay salary but getthe same reimbursed from India Co.- two clauses in the agreementwere picked up by AAR- the employees at any time be recalled by theParent Co and India Co cannot alter the salary. Based on this the AARheld that India Co are not the employers.

AAR held that the compensation is taxable as Fees for TechnicalServices


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Lessons from AT&S 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 theemployee 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)


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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- exitconsiderations


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PERMANENT ESTABLISHMENT -

exclusions

(a) the use of facilities solely for the purpose of storage, display, oroccasional delivery of goods or merchandise belonging to theenterprise ;

(b) the maintenance of a stock of goods or merchandise belonging to theenterprise solely for the purpose of storage, display, or occasional

delivery ;

(c) the maintenance of a stock of goods or merchandise belonging to theenterprise solely for the purpose of processing by another enterprise ;

(d) the maintenance of a fixed place of business solely for the purpose ofpurchasing goods or merchandise, or of collecting information, for theenterprise ;


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Secondment- Global issues

If employees are physically transferred with the activity to the newlocation, the issue is whether the transfer qualifies as a secondment ora permanent position

Where the transfer is a temporary one and in the process technologytransfer and services are rendered, where otherwise, the paymentwould have required a technology payment, would be treated as anextension of the foreign company in the host country.

Employees of high management level seconded to other country runthe risk of PE- people functions are more important than formal riskallocation in inter-company contracts.

Business transferred along with Secondment and outsourcing thebusiness - requires a BUY OUT PAYMENT before OUTSOURCING

Some countries provide specific secondment rulesEX- GERMANY


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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 deputationof personnel to its Indian affiliate. The SC, while ruling that the FE hada service PE, laid down the principle that for a service PE to be

constituted the FE should be responsible for the work of the personnelon 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 deputationarrangements to assess the PE risk and ensure proper documentationto defend a PE challenge by the Indian tax authorities.


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Notable decisions on Service PE

Rolls Royce Plc v DDIT

The Tribunal held that Rolls Royce PLC, a UK company engaged inthe supply of aero engines to Indian customers, had a PE in Indiaunder the basic rule, because its employees visited India frequentlyand 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, theCommentary also states that mere presence of an enterprise at aparticular location does not mean that the location is at the disposal of

the enterprise.


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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 1/6thsecond 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


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QUESTIONS?????

Expatriate Taxation - Sampath Raghunathan.ppt

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