Tax laws too soft on non-residents

The origin of the current tension between the Western world (custodians of technology) and the developing world (custodians of huge population and who thus constitute the emerging markets for the former) is the source rule of taxation supported by the UN Model of taxing a non-resident. This is at odds with the OECD model that gives primacy to the resident rule of taxation.

In simple terms, the source rule sets store by the nexus principle — if the non-resident has had any direct or indirect connection with India pro tanto, his income would be taxable in India. Pursuant to this rule, India taxes the income received and earned abroad by a non-resident to the extent it is attributable to the presence of a selling agent in India for its products or services.

More daringly, India taxes the royalty income of foreign companies without having to prove any business connection in India. The very fact that such royalty has been paid for using them in India to earn any income is sufficient to tax the foreign company, and the Indian resident is required to deduct tax at source from such royalty.

Over-reach and retreat

The Indian Government went overboard when it tried to reach out to a non-resident’s salary from his employer abroad by saying that salary is earned where the services are rendered. This gave rise to the ludicrous spectacle of an expert from a petroleum company from the US, dousing the oil fire raging in India, being called upon to pay tax on the salary that he got from his employer abroad — to the extent it related to the period he was dousing the Indian fire.

There was a howl of protest following this and similar instances of overreach and the Indian Government had to retreat by saying that a foreign technician’s stay in India up to 90 days will not give rise to any tax liability in India on his foreign income.

The ‘emperor’ (read the US) struck back with a resident-based taxation while signing the double-taxation avoidance treaty with India.

Thus, for example, a US airline company does not pay income tax in India, no matter how much cargo it lifts from the Indian airports or how many passengers it takes off with from the Indian airports. It pays income tax in its home country on Indian income as well. Which one is fairer — the source-rule-based or resident-rule-based taxation?

Well, the answer would depend upon the country whose cause you are championing or espousing. The government, whose subjects earn substantial income from their products and services abroad, would obviously espouse the cause of resident rule-based taxation.

On the other hand, a country such as India, which depends considerably on foreign technology and capital, would plump for source rule-based taxation. The source rule of taxation that is being demonised by the Western world is not without a rationale. What is wrong in India saying that if you earn any income abroad, thanks to a business connection in India, you willy-nilly have to cough up tax in India — the argument proffered by the Indian tax administration before the Bombay High Court successfully in the Vodafone case, that, however, did not find favour with the apex court?

The US government intuitively would plump for the source rule-based taxation, should the air-traffic volume turn in favour of Indian airline companies — they picking up more traffic from the US airports than the US airline companies picking up traffic from the Indian ports.

Chickening out at home

In this context, it is amazing to find Indian tax laws, which talk tough to the non-residents abroad, making a tame surrender to non-residents admittedly earning and receiving their income in India.

The reference is to the copious share market gains made by the FIIs since 1992 till date by being allowed to operate in the Indian bourses.

They have been spared of any tax liability in India on the specious plea that what they earn in India is capital gains that is immune from Indian tax if the earner happens to be a resident of Mauritius.

In the first place, the income earned by them is, by no stretch of imagination, capital gains. It is business income, pure and simple.

The counter to this argument is business income presupposes existence of a permanent establishment in India.

In this day and age, one does not need a permanent establishment to operate in the Indian bourses. Communication and computing facilities are so advanced that one can do business in India of buying and selling shares from the comfort of one’s office in another country.

And why should India give foreigners such a wide berth to avoid tax by entering into a patently invidious tax treaty that has tax evasion writ large on it?

It is amazing to find commentators and editors springing to the defence of the Indo-Mauritius treaty in the context of India’s attempt at writing in anti-tax evasion measures.

It doesn’t redound to any country’s credit to accelerate foreign investment through a surreptitious route that encourages even residents to don the robes of a foreigner.

The short point is while India has every right to bristle at any suggestion of demonisation of the source rule, it should retrospect honestly about the wisdom and desirability of letting off foreign income earned in India from taxation.

(The author is a New Delhi-based chartered accountant. blfeedback@thehindu.co.in )

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