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.
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.
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.
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.
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.