TAXATION OF EXPATRIATES- Structuring and Planning Presentation at the IFA SEMINAR - HYDERABAD

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

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

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 thenumber 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 employer’s 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

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 Marshall’s 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 – AT&S India Pvt Ltd • Reimbursement of salary cost to foreign company for assigning its employees for India operations is taxable as “fees for technical services” • AT&S 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 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 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?????