India has undoubtedly emerged as an attractive destination for investment, with FDI inflows in FY22 at an all-time high of $83.5 billion. However, as of October, none of the top 50 Fortune 500 companies have chosen to locate their Asia-Pacific headquarters in the country. No Indian city finds its way into the top 15 significant financial centres expected by 2024, or the top 10 list of Asia-Pacific cities of the future. Singapore and China remain preferred destinations for global conglomerates.

As India sets its sights on becoming a global financial hub, it can benefit from emulating the investor-friendly business environment of its Asian competitors. In particular, India stands to gain from liberalising its stringent income tax laws for foreign nationals. Singapore and China have set an international benchmark with their liberal income tax regimes for expats. In 2003, Singapore announced a tax exemption for residents on their foreign-sourced income.

Since 2019, expats in China only pay taxes on global income if they have held tax resident status for six consecutive years. This period restarts from zero if the individual leaves China for a consecutive period of 30 days or a 90 days cumulatively within a year. By contrast, foreign-domiciled individuals in India are subject to taxes on their global income if they live in India for over 182 days, as they are assigned OCI status after this period. This period can be extended by amending Section 6 of the Income Tax Act, 1961 in line with applicable provisions in Singapore and China.

This tax policy change would be beneficial for three reasons. Firstly, it would attract foreign direct investment. In both Singapore and China, the introduction of a liberal tax policy regime for expats was associated with a significant increase in FDI inflow across all sectors.

A decisive factor that drives a company headquarters’ location decision is the ease of living and doing business in the host country.

If investors setting up new enterprises are able to stay for extended periods without being subject to taxes on global income, they are better able to manage their investments effectively. Additionally, the key managerial personnel of these companies are likely to consist of expats who also seek relief from dual taxation.

The positive spillovers of FDI are well-documented. Besides bringing in capital, FDI is a non-debt financial resource that promotes economic growth, generates new jobs, enables access to international markets and promotes competition in domestic markets. It facilitates the transfer of technology, skills, and organisational and managerial practices, as local employees are trained and domestic firms are integrated into production processes.

India’s FDI to GDP ratio currently stands at 2.7 per cent of GDP, and has largely stagnated around this figure in recent years. By comparison, China received 6.2 per cent at its peak.

Secondly, a significant loss of tax revenue due to this policy change is unlikely, as the beneficiaries of the exemption are not domiciled in India. Since locally-sourced income would continue to be subject to the Indian tax regime, the domestic income generated by FDI would augment government revenue through the taxation of the wages and profits of foreign-owned companies in India.

Preventing misuse

There are concerns over tax revenue loss due to high net-worth Indian citizens taking up foreign citizenship to avail of the tax exemption. To prevent such misuse, the exemption may be provided to foreign-domiciled individuals who have not been citizens of India for a significant period of time, such as 3-5 years.

Thirdly, while expats can already avail of double taxation avoidance treaties to serve the same purpose, several practical challenges make this process cumbersome. If the tax rate of their home country or the country where their income is generated is lower, they would end up paying higher taxes when their global income is taxed in India. They may be unable to avail of tax credit benefits due to mismatched financial years, as India follows the April-March schedule while most other countries follow the calendar year.

They are likely to face greater subjectivity in tax assessments by Indian tax authorities, given the incorporation of the new principal purpose test since India’s signing of the Multilateral Instrument. Additionally, they would be exposed to risks arising from reporting requirements, as the smallest error in reporting foreign assets would incur heavy penalties.

It is no wonder that India remained in the bottom 40 per cent of global economies in the 2020 edition of the “Paying Taxes Ranking”, which ranks the administrative burden of paying mandatory contributions and complying with post-filing procedures in different countries. Given India’s bid to become a $5 trillion economy by 2029, substantial and lasting foreign investment is more vital than ever. The need of the hour is a favourable tax policy regime and robust business environment for foreigners planning to stay in India.

Jain is Senior Visiting Fellow, and Ganguly is Research Assistant, at Pahle India Foundation

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