March 28, 2009
Expat salaries: Supreme Court expands scope of
withholding tax on split salaries
From Vodafone1 to
Clifford Chance2 and other
similar cases currently being scrutinized by the tax
authorities, the issue of extra-territorial application of
taxation laws has emerged as one of the key issues in
international taxation having a tremendous influence on the way
the world does business with India. The Supreme Court of India,
in a recent decision3 disposing
off 104 appeals from the Delhi High Court, has provided new
insights on the extent to which tax authorities can pursue
transactions and income sources that materialize beyond the
territorial limits of India.
Factual background
The facts in each of the 104 cases are broadly the same and
revolve around the applicability of the withholding tax
machinery to foreign-earned salaries received by certain
expatriate employees working in India.
In the case of Eli Lilly & Co, a Dutch company seconded
4 expatriate employees to its Indian joint venture entity in an
arrangement whereby the employees remained on the rolls of the
Dutch company. While the salary was essentially paid by the
Indian joint venture entity, the Dutch company continued to
deposit a home salary into the foreign bank accounts of the
expat employees. The tax authorities claimed that the Indian
joint venture entity should have withheld tax on the domestic
salary paid by it to the expat employees as well as on the home
salary paid by the Dutch entity outside India.
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Similarly, in the case of Ericsson Communications Ltd.
the tax authorities argued that an Indian subsidiary of a
Swedish company should have withheld tax on certain child
education incentive payments made outside India by the Swedish
company to certain expat employees who were then working with
the Indian company. In the case of
Mitsui & Co. as well, the Indian project office of a
Japanese company was directed to withhold tax on certain
retention payments made by the head office to various expat
employees working in the said project office.
The broad issue that emerged from the 104 cases was whether the withholding
provisions under the Income Tax Act, 1961 (“ITA”) applied to
payments in the nature of salaries made abroad by a foreign company.
Under section 9(1)(ii) read with section 5 of the ITA, any
income received in relation to services rendered in India would
be deemed to accrue in India and hence taxable in India.
Further, section 192(1) of the ITA provides that any person
(employer) responsible for paying salary income taxable in India
would have to withhold tax at the applicable rates on an
estimate of the salary income of the tax payer (employee) for
the relevant financial year. The failure of the employer to
withhold the whole or any part of such taxes would trigger
interest and penal consequences under sections 201(1A) and 271C
of the ITA.
Supreme Court’s decision
From a combined reading of section 192(1) (machinery provision)
and section 9(1)(ii) (charging provision) of the ITA, the
Supreme Court held that the obligation of the Indian employer to
withhold tax extends to any salary income earned by the expat
employee (even if earned outside India) as long as it is earned
in relation to services provided by the expat employee in India.
The Court made it clear that the charging provisions and the
machinery provisions of the ITA essentially constituted an
integrated code.4 In light of
this the Supreme Court observed that the ITA would have
extra-territorial operation to the extent permitted by the
machinery provisions that seek to enforce its various charging
provisions.
While perusing the specific facts in the various cases brought
before it, the Supreme Court noticed that the expat employees
did not provide any services to the foreign companies. However,
the total remuneration inclusive of the home salary / special
allowances paid abroad by the foreign company was found to be in
consideration of services rendered in India. Accordingly, the
Supreme Court held that the Indian employer was liable to
withhold tax on the domestic as well as offshore components of
the salaries received by the employees.
Conclusion
While it may seem that the Supreme Court’s construction of the
scope of extra-territoriality of domestic tax laws does contain
an element of ambiguity, the Court had clarified that its
decision is strictly confined to the withholding tax obligations
arising from salary disbursements. Further, the withholding
obligation of the Indian employer should not cover offshore
payments having no nexus with the services provided by the
employee in India.
Given the issues of
enforceability, it would be interesting to examine the extent to
which the withholding tax framework can effectively apply to
non-residents.
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1.See, the decision of the Bombay High Court,
(2008)220CTR(Bom)649. The SLP filed before the Supreme Court was
dismissed and the matter has been relegated back to the tax
authorities
2.2009, 176 Taxman 458 Bom
3.Decision of the Supreme Court of India,
dated March 25, 2009 in Civil Appeal No. 5114/2007 and others.
4.The Court reiterated its earlier view in
the case of Srinivasa
Chetty, (1981) 128 ITR 294.
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