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Explained: Why Budget proposal on tax on Indians working abroad triggered confusion

If an Indian national lives in New Delhi but earns rental income from a house she owns in London, then, along with all other income that she earns within India, this rental income too, will attract tax.

Written by Udit Misra | New Delhi |
Updated: February 5, 2020 11:38:36 am
Budget 2020 NRI tax, NRIs taxed Budget, finance ministry clarification NRI income, Budget, Union Budget, Budget 2020, Union Budget 2020, Finance Ministry, Nirmala Sitharaman, Finance Bill 2020, Finance Bill, Budget news, Business news, Indian Express Union Finance Minister Nirmala Sitharaman, flanked by her deputy Anurag Thakur (to her right) and a team of officials, shows a folder containing the Union Budget (File/PTI Photo/Manvender Vashist)

An amendment to the Income Tax Act proposed in the Finance Bill 2020, has created confusion about Indians who primarily work and earn their living outside India.

The broad import of the amendment, as understood on February 1, was that all Indians who were working abroad and not paying any income tax in those countries — like the many Indians who work in jurisdictions like the UAE — would be liable to be taxed in India. Kerala Chief Minister Pinarayi Vijayan wrote to Prime Minister Narendra Modi recording his government’s “strong disagreement” with the provision, which he said “will hurt those who toil and bring foreign exchange to the country”.

On February 2, the Finance Ministry issued a clarification, and Finance Minister Nirmala Sitharaman sought to reassure non-resident Indians that they would not be unfairly targetted.

What is the existing law?

Two parameters determine whether India levies income tax on an individual. The first is “residency”. Unlike in the United States where citizenship also implies residency, in India, residency requires a person to actually live in the country for a specified number of days in a year.

The other parameter is the “source” of the income — the country where the income is being generated. The difference between the treatment of a resident and non-resident Indian citizen is that for a resident Indian citizen, the income tax law applies to that person’s worldwide income — that is, any income earned in any jurisdiction is used to calculate the taxable income, and such a resident Indian is required to pay tax on all of it.

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But for a non-resident Indian, the income tax law applies only to the income earned from within India.
As such, if an Indian national lives in New Delhi but earns rental income from a house she owns in London, then, along with all other income that she earns within India, this rental income too, will attract tax.

However, if an Indian citizen stays and works in London — making her a non-resident Indian — and additionally earns a rental income from a home in Delhi, then the Indian income tax would apply only to the rental income from that Delhi home.

This difference between residents being taxed on their global income and non-residents being charged only on their “Indian” income lies at the heart of the confusion.

What is the amendment proposed by the government?

The proposed amendment to the IT Act has three parts. The first cuts the number of days that an Indian citizen can stay in India without becoming a “resident”, to 120 from 182. The Memorandum to the Budget said this provision was being misused: “Individuals, who are actually carrying out substantial economic activities from India, manage their period of stay in India, so as to remain a non-resident in perpetuity and not be required to declare their global income in India.”

The second impacts the “Not Ordinarily Resident” category of taxpayers. The Memorandum has clarified that “this category of persons has been carved out essentially to ensure that a non-resident is not suddenly faced with the compliance requirement of a resident, merely because he spends more than specified number of days in India during a particular year.”

Imagine now an NRI who has stayed out of India for the past seven years and then spends 183 days at one stretch in the eighth year. The NOR status ensures that such an individual, who is “not ordinarily a resident” is not taxed as a resident. The amendment states that an NOR would be someone who has not been a resident of India for seven of the past 10 years. Under the existing law, it is nine out of the past 10 years.

The third proposed amendment is the one that created the confusion. This amendment said: “An Indian citizen who is not liable to tax in any other country or territory shall be deemed to be resident in India.”

What is the problem with this?

The amendment was seen as trying to tax non-residents as residents. As mentioned above, residents are charged income tax on their full global income while non-residents are charged only on their “Indian” income.
This led to panic because, in the absence of clarifications, all non-residents working in tax-free jurisdictions concluded that all their income in those jurisdictions will now attract the Indian income tax rate. Apart from the likely harrassment, this undermined the whole point of people leaving their homes in India to work in tax-free jurisdictions.

Why did the government propose this?

The government has clarified that its intention is not to target bona fide workers, rather to catch tax evaders who game the residency provisions to evade all taxes. “The issue of stateless persons has been bothering the tax world for quite some time. It is entirely possible for an individual to arrange his affairs in such a fashion that he is not liable to tax in any country or jurisdiction during a year.

This arrangement is typically employed by high net worth individuals (HNWI) to avoid paying taxes to any country/jurisdiction on income they earn. Tax laws should not encourage a situation where a person is not liable to tax in any country,” said the Memorandum to the Budget. Following the clarification, the government would be expected to now tweak the proposed amendment.

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