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India’s fiscal authority approves favorable tax treatment for Indian employees working abroad

Executive summary 

The Authority of Advance Rulings (AAR) has determined that salary income earned by a non-resident (NR) individual for duties performed overseas is not taxable in India, even when paid into a bank account in India, and employers are not obliged to withhold tax on this.

It has also ruled that an employer can take into account credits for tax paid overseas when determining the withholding operated in India for Resident and Ordinarily Resident (ROR) employees, after exercising appropriate due diligence.

AAR rulings do not have precedent but they are persuasive and employers can take advantage of this ruling and adjust withholding practices in the right circumstances. They should, however, ensure that detailed processes are followed and documentation retained to support the positions taken.

Background

In many cases employers second employees overseas, but continue to pay their salary either through an Indian entity or into an Indian bank account. Such employees will often claim relief under a double tax treaty when filing their tax returns in India, depending on their residential status.

In the case in question, the employee was on an assignment to the US and received salary income both in India and the US, for duties performed overseas. The case considered whether the employer was obliged to operate withholding in India for salary payments made in India but not subject to tax there (when the employee qualifies as NR) and whether taxes paid overseas can be considered for foreign tax credits (when the employee qualifies as ROR) when calculating the taxes to be withheld in India.

The AAR confirmed that treaty exemptions can be taken into account by the employer when operating withholding. The place where the employee performs their duties is what is considered and not where the income is received or where the entity providing the remuneration is based. Therefore where remuneration is paid for work performed in the US, the income would be taxable in the US under the treaty and not in India. Also, unless the income is taxable in India, there is no obligation on employers to operate withholding.

Where payment is received by an employee from more than one employer during a particular year, the employee can provide details of the salary and taxes from one employer to another and the new employer can take this into account when operating withholding. Therefore, foreign tax credits for taxes paid in the US can be considered. However, the AAR has not commented on the type of taxes (such as federal or state) which can be considered for determining the availability of foreign tax credits.

It is important that employers exercise appropriate due diligence and maintain adequate documentation required for treaty claims, such as the tax residency certificate, along with ensuring that detailed process are in place to calculate the level of foreign tax credits to be claimed.

A ruling by the AAR is binding only for the case in question and does not set a precedent. However, it does have persuasive value and the Revenue does recognize the principles and ratios laid down by the AAR while deciding on similar cases.

Next steps

This ruling is welcome as it confirms that the Revenue recognizes that treaty exemptions and foreign tax credits can be taken into account by employers when operating withholding. Employers with assignees to countries with which India has a double tax treaty can make use of this ruling to take into account the impact of the appropriate treaty when operating withholding. However, they should ensure that they maintain the appropriate documentation required for any such relief.

EYG no. 00846-183Gbl

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