Author: Peter Harper

An earlier blog on POEM started with a discussion on the determinants of residential status of a foreign corporation in India. The Indian tax law defines “place of effective management” as a place where key management and commercial decisions that are necessary for the conduct of business of an entity as a whole are, in substance made. But the Indian revenue department issued subsequent circulars to explain the determinants of the POEM.

For family offices and global enterprises with presence both in India and the US, the pressing issue is to determine the residence of their US or other foreign corporation in India. A strategic review of business structure can help the global entrepreneurs to focus on optimizing their resources towards their growth rather than reinvesting profits to add to their budgeting costs. The tax exposure for a foreign corporation, if determined as having residence in India, can be really high. The compliance costs to run can add as an item on your annual budgeting.

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In guiding our readers to understand if there may be a possible exposure, we have prepared a flow chart on the Indian POEM analysis. As the POEM is to be applied based on fact on every case, this chart is a high-level understanding and it would be in the best interest of the reader to consult us if you would like to know more on the applicability of POEM to your business.

Expanding business operations into the U.S. can be a lucrative opportunity to grow business if the structural decisions are made at the right time by the owners. The choice of the entity to undertake the U.S. operations should be aligned to the commercial objectives.

The owners of the family-owned businesses may classify an entity as a corporation, partnership or a disregarded entity for U.S. tax purposes, which creates planning opportunities. All business entities that have not been per se classified as corporations for federal tax purpose may elect to be treated as disregarded entities for U.S. tax purposes. Our whitepaper titled “United States entity considerations in the Trump era” discusses the “check-the-box” (CTB) regime and how the Trump reforms reshape the way businesses and private clients analyze entity choice within the U.S. and other countries.

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The entity classification under the laws of the U.S. and India may not be the same, and the understanding of the laws of both countries can be a game-changer for a business structure. For example, a U.S. partnership firm is taxable for its profits at partners’ level and the firm is considered as a flow-through. However, an India partnership firm is taxable for its profits at partnership firm-level and partners are not taxed for their share of profits. The business owners should also be mindful of the strict anti-avoidance rules provided under the U.S. and India. These rules often give huge powers to the revenue officers to question the structure and require the owners to be able to document the business purpose to support their choice of doing business in the U.S. or India. Our whitepaper titled Interaction of Indian and U.S. Tax Laws harps the importance of addressing the structuring needs before you plan to enter the U.S. markets from India and otherwise.

A nonresident alien of the United States will be subject to U.S. taxation if they have income that is “effectively connected” with a U.S. trade or business (“ECI”). This applies to both nonresident individuals and entities alike, as they can both have ECI.

Remember here, that if an individual is either a resident alien or a nonresident citizen, then they will be taxable on their worldwide income, from whatever source derived. Accordingly, this rule pulls in persons and entities who would not normally be subject to taxation in the U.S. and makes them taxable on the U.S. sourced profits arising from their trade or business operations in America.

So, what exactly counts as ECI? Well, under the Internal Revenue Code, ECI will be generated where income is produced by U.S. assets in, or held for use in, the conduct of the U.S. trade or business. Thus, a retailer will generate ECI if they hold inventory within the U.S. inventory for the purposes of selling or leasing them to customers within the U.S. ECI may also be produced where a retailer sells a part interest or whole interest in their U.S. business. Additionally, income will be effectively connected with a U.S. trade or business even if the trade or business is service-based, as it is U.S. profit that is tied to the performance of personal services within the U.S.

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Luckily ECI is limited to the earnings and profits of the U.S. trade or business. So, for example, if a foreign company has $1,000,000 of earnings and profits and $2,000,000 of ECI, then they will only be liable to pay and report U.S. tax on $1,000,000 of the ECI under this limitation.

While this analysis seems quite simple, it can actually be quite complex as the Code does not provide a definition of what entails a “U.S. trade or business.” We will dive into this concept, however, in our next blog post so be sure to check back.

Under the Internal Revenue Code a Person is liable for fulfilling their U.S. tax obligations if they are a “resident” of the United States. This begs the question, what is a resident, and does the Code’s definition stray from our common sense definition of it? The term “resident” is generally defined as a person who lives somewhere on a long-term basis. It would be hard to legally determine who to tax based upon a subjective idea of what classifies as long-term, so instead, the Code turns the definition to an objective one by codifying three residency tests. As such, the Code’s definition doesn’t stray too far away from the general definition, but it requires a person to undertake a thorough analysis of whether their status under each resident test.

Green Card Test

Under the green card test, if a person has a U.S. green card then they are automatically a U.S. resident. This applies even if you do not have your primary residence in the U.S.

Substantial Presence Test

Under the Substantial Presence Test (SPT) a person is a resident if they are physically present in the U.S. for at least 183 days; accordingly, the SPT is also commonly known as the 183-day rule. However, to be a resident under this test, the 183 day count must be fulfilled in the following manner:

1. 31 days in the current year; and
2. 183 days in the three year period that includes the current year and the two years immediately prior, counting:

• All of the days present in the current year,
• ⅓ of the days present in the first year prior to the current year; and
• ⅙ of the days present in the second year prior to the current year.

The SPT also outlines a few exceptions to the day count, including days that a person is present in the U.S. for less than 24-hours and days that a person is with an exempt individual. Accordingly, this day count can get quite complicated, especially if a person has failed to keep track of their U.S. travels.

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Election Test

Under this test, a person may elect to be a U.S. resident if, for the taxable year for which the election is being made:

1. The person is a nonresident alien; and
2. Either, the person is married to a:

• U.S. Citizen, or
• Resident alien.

To make the election, the person must attach a statement of residency election to their joint federal income tax return and do so in a timely manner. A person will not be able to elect U.S. residency, however, if they had previously made an election and it was later terminated by either spouse.

I wanted to take the chance to break down some of the big picture topics mentioned in the article, The Expansion of “United States” Taxpayers: How the TCJA Drags Unassuming Foreign Companies and Individuals under its Scope. However, to set the stage, it is important to understand how the US has historically operated as a worldwide tax system and its recent move towards a territorial one. So, this blog post will introduce you to these two variations of tax systems used internationally and give you an overview on how the new US regime fits into the mix. Please note that both of these systems apply only to income tax structures, and not to other tax arrangements such as a consumption tax structure.

Worldwide Taxation

In a traditional worldwide tax regime, the country to which you are a resident of applies a tax to all of your income regardless of where it was sourced. For example, if you are a US resident and have income from the US and from Australia, then under this system, the US would tax you on both your US-sourced and your Australia-sourced income. One thing to note here is that the term “resident” may not align with your common sense understanding of the word. Instead, most tax regimes base residency on whether you qualify as that country’s resident under statutory tests; which, as you could guess, can get quite complicated depending on the country and your particular living circumstances.

Territorial Taxation

On the other hand, a country using a traditional territorial tax system will only tax you on income sourced from operations located within its geographical boundary, or “territory.” So, using the previous example, if you are a US resident and have both US and Australian income, then the US would only tax you on your US income. While this appears to be the more attractive option for taxpayers, it is important to note that most countries with this system have other taxes in place to “make up for” the decrease in income, such as a supplementary consumption tax.

The U.S.’s New “Territorial” System

Under the Tax Cuts and Jobs Act (TCJA), the overarching system of US taxation has shifted from a worldwide one to territorial one. However, this is not a complete shift as the TCJA still allows the government to tax foreign-derived income of US residents in certain scenarios. One scenario is where a US resident is a shareholder of a controlled foreign corporation (CFCs). Thus, the US’s tax system might be said to hit somewhat of a middle ground between worldwide and territorial taxation. A middle ground that can weigh more heavily in one direction based on your particular circumstances.

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Stay up to date with our blog posts as we navigate through this shift and be sure to read our article for a comprehensive outlook on the Tax Cuts and Jobs Act of 2017.

Members of wealthy Australian families who relocate to the US, or members of US-based families moving to Australia, are often doing so without being fully aware of, or advised about, the stringent reporting and filing requirements on foreign assets, financial accounts and holdings they will be subject to on becoming a US person for tax purposes. This invariably results in the taxpayer seeking to enter into a remediation program to limit or mitigate penalty exposure on misreporting and non-compliance with the IRS.

Deciding which program is best for a taxpayer is imperative and can now result in further penalty exposure where a lack of analysis of the facts and circumstances surrounding the non-compliance is conducted. Prior to entering into a remediation program, a taxpayer should seek a comprehensive analysis of their particular circumstances and an analysis of which program is the most appropriate for them.

The remediation options include following procedures/program:

• Streamlined Procedures – including the Streamlined Domestic Offshore Procedures (SDOP) and the Streamlined Foreign Offshore Procedures (SFOP); and
• Updated Voluntary Disclosure Program (UVDP).

A taxpayer will be ineligible for any of the remediation options if:

• the taxpayer is already under examination or investigation by the IRS or a law enforcement agency; or
• the taxpayer has been notified by the IRS of its intent to examine or investigate.

In our earlier blog post “What is the new voluntary disclosure program” we discussed the UVDP and when this option would be best suited to a taxpayer.

The Streamlined Procedures provide an avenue for compliance with the IRS in circumstances where the taxpayer has been non-wilful in failing to file or disclose information with respect to foreign assets, bank accounts and interests. Under the Streamline Procedures, the penalties associated with failing to file can be completely eliminated to substantially reduced.

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Whether a taxpayer falls within the SDOP or the SFOP is dependent on (amongst other things) how much time they have spent in the US over the most recent 3-year period and if they satisfy the non-residency requirement.

If you believe that you or one of your clients have misreported information or income from foreign assets, reach out to the team at Asena Advisors to determine whether you are eligible for the IRS remediation options and determine which option is best for you.

With the new wave of global information exchange, governments are placing international tax compliance on the forefront. Nations across the globe have made very intentional and continuous efforts to ensure compliance and reporting for global businesses, high net worth individuals (HNWIs) and family offices with global asset holdings.

The Organization for Economic Co-operation and Development (OECD) is pushing the issue with the creation of a new global standard of information reporting through the development of the Common Reporting Standard (CRS) which was framed off of the US Foreign Account Tax Compliance Act (FATCA). The CRS is supplemented with a range of initiatives designed to take a calculated approach. This is being achieved through the implementation of International Exchange of Information (EOI) which is facilitated by Governments participating in OECD programs such as the Joint International Taskforce on Shared Information & Collaboration (JITSIC), the introduction of the Multilateral Instruments (MLI) implemented under the OECD Base Erosion and Profit Shifting (BEPS) initiatives, and more recently and separate to the OECD initiatives is the J5 alliance entered into by the US, UK, Canada, Australia and the Netherlands.

The aim of each of the new programs and intergovernmental agreements is to combat tax evasion, compliance and misreporting or failing to report assets for tax purposes previously achieved because of policy and legislative mismatch between global jurisdictions.

The initiatives allow governments to automatically exchange financial information between countries in which assets and bank accounts are held to the country of residence of taxpayers. Taxpayers around the globe are now realizing that income that may have inadvertently been misreported may be subject to compliance and tax reporting.

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In our experience, Australian families and expatriates that become US persons for tax purposes are inadvertently misreporting or failing to report assets, bank accounts and certain holdings due to being unaware of filing requirements.

Historically, taxpayers were able to “fly under the radar” due to lack of information exchange. This is no longer the case.

If you believe that you or one of your clients may have misreported Australian asset holdings or financial accounts from a US compliance perspective, please feel free to reach out to the team at Asena Advisors for an initial consultation to determine the filing requirements and discuss the potential remediation options.

The new wave of information reporting is shaping the way global economies work together to tackle tax avoidance and financial crimes. As a residual effect of this, internationally mobile executives and wealthy family groups with a U.S. taxpayer presence are increasingly and unwittingly coming afoul of information and reporting disclosure requirement with respect to non-US assets and financial accounts.

To address this issue, the Internal Revenue Service (IRS) has released a number of voluntary disclosure programs over the years to allow taxpayers that have failed to file tax returns, misreported global income or have unreported foreign assets, to get into compliance and limit or eliminate associated penalties. A key feature of these programs is that the IRS is able to close the programs at any time, which can leave taxpayers without any opportunity to mitigate penalties for non-compliance.

Members of wealthy Australian family offices that relocate to Australia or members of U.S based families moving to Australia, are often doing so without being fully aware of or advised about the stringent reporting and filing requirements on foreign assets, financial accounts and holdings they will be subject to upon becoming a U.S. person for tax purposes. This invariably results in the taxpayer seeking to enter into a remediation program to limit or mitigate penalty exposure on misreporting and non-compliance with the IRS.

In our previous article titled “Voluntary disclosure options for US taxpayers with Australian assets” posted in the The Tax Specialist in February 2017, we discussed the remediation programs available for U.S. taxpayers with Australian assets and the ability for the IRS to close the Offshore Voluntary Disclosure Program (OVDP) at any time. The OVDP was a voluntary disclosure program for taxpayers that do not meet the “non-wilful” requirement to be eligible for the Streamline Procedures and allowed taxpayers to come into compliance whilst avoiding criminal liability and limiting their penalty exposure. This program has since been closed by the IRS.

This IRS has since released an updated version of the program with some significant operational and procedural changes that can impact taxpayers both positively and negatively. The key question is determining which remediation process is right for a taxpayer remains: have you been willful?

There are some significant differences between the process involved with the UVDP and the OVDP. Importantly, the memorandum procedures allow for significant discretion to the IRS case agent with respect to penalties, so those with significant penalty exposure should consider a timely voluntary disclosure to mitigate potential penalties. The memorandum specifically states “Proper penalty consideration is important in these cases. A timely voluntary disclosure may mitigate exposure to civil penalties. Civil penalty mitigation occurs by focusing on a specific disclosure period and the application of examiner discretion based on all relevant facts and circumstances including prompt and full cooperation during the civil examination of a voluntary disclosure.”

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What next?

The introduction of the UVDP provides a welcomed avenue for compliance in circumstances where the fact and circumstances of as particular taxpayer may be complex and determining willfulness is not straightforward.

Determination as to whether a taxpayer should file under the streamline procedures or the UVDP is an extremely important assessment and should be undertaken by an experienced international tax attorney. The professional fees, penalties and exposure to potential criminal liability of getting the application wrong far outweigh the cost of an initial assessment by an experienced advisor. An initial assessment should be undertaken to take a deep dive into a taxpayer’s particular fact pattern and circumstances to determine their eligibility to the various programs assist with the compliance.

The IRS released a memorandum containing procedures for the Updated Voluntary Disclosure Practice (UVDP) on November 29, 2018. Similar to the OVDP, the UVDP provides taxpayers concerned that their conduct is wilful with a program to make voluntary disclosures and avoid criminal prosecution. The UVDP allows the voluntary disclosures for both domestic and offshore disclosures, whereas the OVDP provided for offshore disclosures only.

There are some significant differences between the UVDP and the OVDP. Importantly, the memorandum procedures allow for significant discretion to the IRS case agent with respect to penalties, so those with significant penalty exposure should consider a timely voluntary disclosure to mitigate potential penalties. The memorandum specifically states “Proper penalty consideration is important in these cases. A timely voluntary disclosure may mitigate exposure to civil penalties. Civil penalty mitigation occurs by focusing on a specific disclosure period and the application of examiner discretion based on all relevant facts and circumstances including prompt and full cooperation during the civil examination of a voluntary disclosure.”

The memorandum steps out the procedural framework of the program summarized as follows:

1. All taxpayers seeking to enter the program must first seek pre-clearance from IRS Criminal Investigations (CI). A pre-clearance request is made using IRS Form 14457 which will serve as the basis for determining eligibility.
2. Once pre-clearance has been granted the taxpayer must submit and disclose all required information to CI relating to non-compliance. The information must be accompanied by a comprehensive narrative of the facts and circumstances, assets, entities, related parties and also professional advisors involved.
3. Preliminary acceptance is then provided by CI and CI will forward all information to the IRS’s Large Business and International division (LB&I) for preparation.
4. LB&I will route the case for assignment and examination.
5. The relevant IRS Business Operating Division will take the assignment and will follow standard examination procedures. On the assumption the taxpayer fully cooperates, the voluntary disclosure will be resolved by agreement and payment of full taxes, interest and penalties associated with the disclosure period.
6. Taxpayers that disagree with the assessment of the exam retain the right to go to appeal.

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What next?

The introduction of the UVDP provides a welcomed avenue for compliance in circumstances where the fact and circumstances of a particular taxpayer may be complex and determining willfulness is not straightforward.

Determination as to whether a taxpayer should file under the streamline procedures or the UVDP is an extremely important assessment and should be undertaken by an experienced international tax attorney. The professional fees, penalties and exposure to potential criminal liability of getting the application wrong far outweigh the cost of an initial assessment by an experienced advisor. An initial assessment should be undertaken to take a deep dive into a taxpayer’s particular fact pattern and circumstances to determine their eligibility to the various programs assist with the compliance.

In our whitepaper, Interaction of Indian and U.S. Tax Laws, we examined and explained the interaction of Indian and U.S. laws. In doing so, an underlying goal of ours was to make readers, such as high net-worthIndians and business owners, aware of their compliance requirements as they move from home country to another host country. While it may be difficult for high net worth Indians to imagine how the changes to both Indian and U.S. tax return filings are going to play out, they should take the Black Money (Undisclosed Foreign Income and Assets) and the Imposition of Tax Act, 2015 (Black Money Act) seriously.; especially given how effective the Foreign Account Tax Compliance Act (FATCA) has been in ensuring compliance of U.S. citizens.

FATCA requires financial institutions, like banks, to report the relevant information to the Internal Revenue Service, i.e. a tax administering authority in the U.S. Under FACTA, relevant information includes the details of all accounts held directly or indirectly by U.S. Persons (i.e. U.S. citizens or residents). It is important to note here, that the U.S. has entered into Inter-Governmental Agreement with various countries, including India. As such, Indian financial institutions are required to report certain tax relation information for U.S. Persons to the Indian tax authorities; they are also periodically required to transmit this information to the U.S. authorities.

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Indian financial institutions who fail to collect such information can be levied a 30% withholding tax on any U.S. sourced income. For additional information, please reference the whitepaper titled, Interaction of Indian and U.S. Tax Laws, as it emphasizes the need for HNW individuals and business owners to become more aware of their tax and information reporting obligations in their home and host countries. The paper also highlights additional reporting obligation,such as the obligation to file a Report of Foreign Bank and Financial Accounts (FBAR) in the U.S. Under FBAR, U.S. citizens and residents must report their interest in, or signature or other authority over, foreign financial accounts with an aggregate value exceeding $10,000 at any time during the U.S. calendar year.

Under the U.S. tax laws, foreign trusts (i.e., non-U.S. trusts) may be classified as grantor or nongrantor trusts. Generally, nongrantor trusts are not taxable in the U.S. absent any U.S. sourced income. On the other hand, grantor trusts are taxable in the U.S. since all of the trust income is attributed to the grantor for federal income tax purposes. The U.S. grantor will also be under an obligation to comply with the U.S. information reporting and tax filing requirements.

A foreign trust may be considered as a grantor trust where the grantor:

• retains a certain degree of dominion and control over the trust’s income, credit and deductions, as to classify the grantor as the owner of the trust; or
• makes a gratuitous transfer of property to a foreign trust with one or more U.S. beneficiaries, or potential U.S. beneficiaries.

Our whitepaper, Interaction of Indian and U.S. Tax Laws, discusses the U.S. tax implications of Indian families, or Indian family-business owners, who are moving to the U.S. with assets in India.

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It is important to consider the U.S. tax implications of the grantor trust rules if you are in the process of a high net worth individual in the process of tax and estate planning before immigrating to the U.S. Our whitepaper titled Interaction of Indian and U.S. Tax Laws discusses the interaction of the U.S. tax rules on grantor trusts with the Indian tax rules on the taxation of contributions made by a settlor to a trust and subsequent distributions of trust income and trust property. Through this discussion, our whitepaper aims to provide you with an understanding behind why using a trust structure in an estate or tax plans may be beneficial.

Generally, under U.S. tax law, a foreign corporation may be classified a controlled foreign corporation (CFC) where it has U.S. shareholders. Additionally, a foreign business owner who has recently relocated to the U.S. is likely to be considered a U.S. shareholder of a CFC. Unfortunately, the U.S.’s latestreforms on the taxation of CFCs have failed toprovide these business owners with enough time to perform their newly imposed tax obligations. As such, these business owners must either struggle to quickly come into compliance, or face a punishment for failing to do so.

Additionally, foreign business owners may become reluctant to relocate to the U.S. due to the widening scope of foreign entities being classified as CFCs under the last tax reforms in the U.S. The issues such as taxation of their profits under GILTI provisions (i.e. a formula to tax profits of foreign enterprises which have not been not included under Subpart F income) and the retrospective tax on profits parked in offshore subsidiaries are game changing as global effective tax rates may rise. These provisions mean that it will be very easy to see a situation in which GILTI and Subpart F income derived by Indian-owned CFCs will be attributed to and taxable to high net worth Indians who own a minority stake in non-U.S. corporate groups.

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Our whitepaper titled Interaction of Indian and U.S. Tax Laws describesthe interaction of U.S. and Indian tax laws through an application of the U.S. CFC provisions. In doing so, it provides an analysis on various questions, including whether an Indian corporation with Indian and U.S. subsidiaries will be classified as a CFC and, with regards to Indians who have relocated or plan to relocate to the U.S., and which Indian and U.S. reporting and tax requirements they will be subject to.

Trusts or foundations have been the most widely used entity form to pool, protect and administer assets. Our whitepaper, Interaction of Indian and U.S. Tax Laws, discusses the various forms of trusts and tax treatment of foreign and Indian trusts.

The different parties in a trust are settlor, trustee and beneficiaries. A trust distributing capital or corpus settled in by a high net worth Indian settlor is not taxed in India. However, income distribution by a trust is taxable in India in the below manner:

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Trust structures offer asset protection and beneficial governance mechanisms to Indian families with Indian residents and nonresidents members. However, foreign trusts should be mindful of their tax residence in India where such trusts are wholly or partially managed by Indian residents in India. . Our whitepaper, Interaction of Indian and U.S. Tax Laws, covers the taxation of Indian family assets and businesses held through Indian and foreign trust structures.

Under Indian laws, a trust is an unincorporated entity and may be public or private in its form. The various aspects in relation to Indian and foreign trusts and tax implications in Indiaare covered in our whitepaper, Interaction of Indian and U.S. Tax Laws.

To summarize, a public trust is a trust that has been registered under the Indian Trust Act, 1882, and is typically set up to fulfill a charitable purpose. Subject to certain conditions, a public trust that is registered under Indian tax law is exempt from Indian tax. A private trust is a trust that has not be registered under the Indian Trust Act, 1882. Instead, the trust’s deed may be registered in the state where the trust is created. This trust deed lays out the details of the private trust’s form, the settlor, the trustee, and the beneficiaries; it also lays out the settlor’s duties to perform acts on behalf of the trust.

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As I have stated in my other blogs that India lays out reporting requirements based on the residence of the taxpayer. The U.S. states reporting requirements on the basis of citizenship in addition to residence. This means a natural person who is a U.S. citizen and an Indian resident will be covered under reporting requirements for both the countries.

The blogs on Black Money Act and FATCA precisely cover the reporting requirements that are applicable in India and the U.S.Further efforts by the Indian government including its support of the OECD/G-20 lead Base Erosion Profit Shifting (BEPS) project and the objective shows its idea to foster transparency.

In demystifying the erosion of income and wealth out of India, it has been constantly working on extending the application of reporting requirements to certain nonresidents in India. This does not give room to defaulters to evade tax in the home and host jurisdictions. Out whitepaper titled Interaction of Indian and U.S. Tax Laws covers the various measures taken by the Indian government that are aligned to ensure that high net worth individuals migrating to other countries continue to make sure that their compliance is up to date.

With coordinated efforts undertaken by various countries joining hands under FATCA, BEPS project and exchange of information agreements, there will be a time when territory restrictions to obtain data on a taxpayer will have no significance.

As consultants / advisors for our clients, we have been constantly making our clients aware of the reporting obligations and assisting them to get back into compliance.

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Continuing from the last blog on capital gains, this blog specifically addresses how capital gains are to be taxed in case of nonresident Indians under the Indian tax law.This blog covers key capital gains tax issues for nonresident Indians.

Capital gains taxable in India

After reading our whitepaper titled Interaction of Indian and U.S. Tax Laws and blogs on Residence, and Basis of taxation in India, readers would now understand that nonresidents are taxable in relation to their income received, accrued or earned in India. In addition, a deeming provision taxing capital gains arising to a nonresident on transfer of capital asset located in India even when the transfer and income arises outside India. For example, capital gains on transfer between nonresidents of a residential house property located in India is to be taxed in India as the capital asset is located in India.

Another deeming provision taxing capital gain arising on indirect transfer of a capital asset between nonresidents even when capital asset is located outside India, but the value of such capital asset is derived from capital asset(s) situated in India. This clause was retrospectively inserted to tax indirect transfers in India to outweigh the decision of the Supreme Court of India in the case of Vodafone that held that transfer of shares of foreign entity is decided not to tax such capital gains in India as there is no Indian nexus.

Inflation index benefit

Unlike the resident Indians, nonresident Indians do not get indexation benefit for computing capital gains on transfer of certain capital assets which were bought in foreign currency. These assets include shares in an Indian corporation (whether public or closely held), debentures of an Indian public corporation, deposits with Indian banks and public companies, any security issued by the Indian federal government or other assets specified by the federal government.

An exemption of capital gains (in proportion to is allowed if the capital gains are reinvested in the above assets) is available to nonresidents. However, the exemption is withdrawn if thenew asset is sold within three years from the date of its purchase.

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Capital gains tax rate

Nonresidents can opt for special tax rates under the Indian tax law for certain capital gains. If the tax treaty rate is more beneficial, then the individual has the option to choose such tax rate.

Nonresidents may plan and structure their investments in India from tax perspective. Capital gains on transfer of assets depend on the nature, term of holding, applicable tax rate and exemption available.

Our whitepaper titled Interaction of Indian and U.S. Tax Laws lays out a brief outline on capital gains tax in India. A resident or non-resident Indian is taxed on capital gains derived from transferring, selling or exchanging capital assets in India unless those gains are specifically excluded from taxation. Gifts or bequests under a will are specifically excluded from the definition of transfer of a capital asset.

In determining the capital gains tax impact on transfer of a capital assets following questions have to be answered:

• who is the taxpayer – natural person, corporation or any other?
• what is the period of holding the capital asset?
• what is the nature of the capital asset?
• what will the taxpayer do with capital gains or processed received on transfer?
• what is the residential status of the taxpayer?

The first four questions set out the computation of capital gains and determine if any exemption is available. The last question largely impacts the capital gain tax rate to be applied. In this blog we are scoping the first four questions and the last question will be addressed in the following blog.

The Indian tax law prescribes certain capital gains to be exempt to tax if proceeds are invested in specific ventures by certain taxpayers. This also covers the question regarding the taxpayer’s intention to invest the capital gains. For example, following capital gains are exempt to tax for individuals, subject to satisfaction of conditions.

In computing capital gains the nature and period of holding of the capital asset are important. A capital asset held for not more than 36 months is a short-term capital asset. The term is reduced to 24 months for certain capital assets and is further reduced to 12 months in case of certain specific assets. Below is a table of capital assets with their period of holding.

The computation of capital gain is generally the difference between net consideration and acquisition cost (including improvement cost). For capital assets held for long term, the acquisition and improvement costs have to be indexed to cover the effect of inflation. But A capital asset means property of any kind held by a taxpayer with few exceptions like stock-in-trade, personal effects, agricultural land in India.

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The Indian currency is restricted, that is, remittance in or outside India are regulated under the Indian exchange control law. Foreign Exchange Management Act, 1999 (FEMA) is an important legislation governing trade and remittance of funds in or outside India. The federal bank, i.e., the Reserve Bank of India (RBI) administers foreign exchange regulations in consultation with the Government of India to set out exchange-control policy and issues rules and regulations.

FEMA applies to citizens of India, associate branches or subsidiaries of corporations registered or incorporated in India, all branches, offices and agencies outside India owned or controlled by a person who is a resident of India. FEMA classifies foreign exchange transactions into two:

• Capital account transaction: A transaction that alters the assets or liabilities, including contingent liabilities, in or outside India of a person resident outside or in India, respectively. RBI in consultation with the Government of India has listed out permissible capital transactions, for example, an investment in foreign securities outside India by a person resident in India, transfer of immovable property outside India by a person resident in India or in India by a person resident outside India subject to conditionalities.
• Current account transaction: A transaction other than a capital account transaction is a current account transaction.

The RBI regulations may place conditions or have limitation with regards to the nature, amount or nationality of the individual carrying out a transaction. It is therefore important that correct forms and right approvals are sought from the RBI on the inward or outward remittances for the above transactions as FEMA sets out rigorous penalty(ies) for an offence.

The term under the foreign exchange law cannot mean the same as under Indian tax law unless specifically mentioned. As I have discussed the term “resident” under the Indian tax law earlier, but the definition is not same as under the foreign exchange law. The later places an additional test of “intent” of the individual. Under FEMA, a person will be a nonresident if such person is leaving India for the purposes of taking an employment outside India, carrying on any business outside India or where the intention to stay outside India is uncertain during the financial year. Similarly, a person is an Indian resident where he comes to India for the purpose of employment in India, carrying on business in India or where the intention to stay in India is uncertain. However, under the Indian tax law, a person moving out of India for the purpose of employment will be an Indian resident if he resides in India for 182 days or more. Refer to our whitepaper titled Interaction of Indian and U.S. Tax Laws to understand in further detail the application of foreign exchange law to funds flowing in and out of India with sections on RBI.

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India has entered into information sharing agreement with the United States (U.S.) under the Foreign Account Tax Compliance Act (FATCA). This has been in place since 2014.

A widely publicized manifesto item that the current government has been highlighting is the eradication of corruption from India. In light of this, Black Money (Undisclosed Foreign Income and Assets) and the Imposition of Tax Act (2015) (Black Money Act) was enacted. Black Money Act deals with the problem of black money by levying tax on the undisclosed income and assets held by Indian residents abroad and Indian-sourced income of non-resident Indians invested in assets abroad.

From April 1, 2016 a tax of 30% is charged of the total undisclosed foreign income and asset in a previous year. A penalty of up to 90% and a rigorous imprisonment is given if there a person is found guilty of non-disclosure. In general, the terms whether specifically defined or not under the Black Money Act are assigned the same meaning as under the Income-tax Act, 1961, i.e. the Indian income tax law.

Circular nos. 13 of 2015 dated July 6, 2015 and 15 of 2015 dated September 3, 2015 has set out questions to exemplify situations where an Indian resident is or is not required to declare foreign income and assets in India. The questions set out in these circulars have given certain relief to the taxpayers who were anxious on the applicability of the wide scope of the Black Money Act. The Indian government has been proactively making efforts to deal with the menace of black money by various efforts in addition to the Black Money Act, like constituting Special Investigation Team on Black Money, information from the financial scandals abroad and using Locational Banking Statistics in collaboration with Bank for International Settlements. The taxpayers who are currently covered or may be covered under the Black Money Act should be careful in complying with the reporting requirements as there is a huge cost of tax and penalty that may apply consequently.

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Our whitepaper titled Interaction of Indian and U.S. Tax Laws covers a section on Black Money Act at the beginning of the paper to highlight the measures taken by the Indian government to change the behavior of high net worth individuals from being discreate to disclosing information of their assets around the world. The government has been proposing to take measures that stops the menace of corruption and eroding money out of India to foreign banks. In addition to resident Indians required to comply with reporting their worldwide assets in India, nonresident Indians with taxable income of more than INR5 million (approx. USD77,000) are required to report certain movable or immovable assets in India.

The leak of confidential financial information as part of various scandals have alarmed governments around the world to keep a check on the wealth that its residents / citizens are enjoying vs. reporting. The efforts to coordinate with other countries have been a boon as it eases the task to trace the defaulters. Accordingly, high net worth individuals and global businesses have to be compliant with the law and its ignorance can be no excuse as streamline procedures generally require a non-willful or non-reckless excuse to not file the tax and information returns in a country.

An entity incorporation in India depends on the long-term objective of the business founders, viz. to earn profits or secure gains from selling the business. A repatriation of dividend does not require permission from the federal bank, i.e. Reserve Bank of India (RBI) subject to compliance with certain other conditions like payment of dividend distribution tax (DDT), discussed below.

A foreign entity may set up either a branch office (BO), liaison office (LO), wholly owned subsidiary corporation (WOSC) or a limited liability partnership (LLP) depending on the activities to be carried out in India. These entities are taxable in India for their operations in India.

In setting up a LO or BO, the foreign entity should obtain a permission from the RBI. Further, a LO or BO can be set up only to carry out certain permissible activities. A LO cannot remit any income to its parent from Indian operations. A BO is allowed to remitits income to foreign parent entity after paying taxes in India. It is to be noted that RBI regulates the term of an entity to function as an LO or BO in India.

Where foreign parent sets up either a WOSC in India, dividends received by the shareholders from Indian resident corporations are not taxable. There is no withholding tax on dividends but WOSC must pay dividend distribution tax (DDT) at the rate of 20.36%. In essence, the Indian corporation pays around 45% tax on its profits before distributing to its shareholders (i.e. considering lowest base tax rate of 25% and additional 20.36%). It is for this reason most foreign investors consider to set up an LLP in India as there is no DDT.

In case of a deemed dividend (i.e. amount given to the shareholders in the form of loan or any other payment that may be deemed to be a dividend), the base rate is 30%. There is an additional tax to DDT at the base rate of 10%that the Indian company is required to if dividend is received by another Indian company, individual, or firm. Effectively, if a foreign individual owner is paid dividend by an Indian company, the base tax rate may be 25%. However, in case of buy-back of shares, the corporation pays an additional income tax at the rate of 10%, of such amount is more than INR 1million (approx. USD 15,000). Additionally, the owner should pay capital gains on surrender of shares. Thus, buy-back of shares may seem a more tax effective system than paying out dividends but if yearly return is expected and complying with Indian corporate law conditions to buy-back shares may seem a burden than dividend.

In the U.S., the latest tax reforms have substantially reduced base corporate tax rate to 21% and exempted U.S. corporations to be taxed for dividend received from foreign subsidiaries.

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Our whitepaper titled Interaction of Indian and U.S. Tax Laws captures the interaction of Indian and the U.S. tax laws. The dividend repatriation from an Indian subsidiary corporation to a corporation in the U.S. implies higher tax in India compared to having an LLP in India. The effective tax liability is further increased if the owner of the Indian entity is an individual as the dividend deduction is only available for corporate entities in the U.S. Therefore, the effective base tax rate increases to 65.71% (45.36% in India and 20.35%, assuming taxed in the U.S. in the highest tax slab). More importantly, the latest tax reforms taxes profits of foreign subsidiaries classified as controlled foreign corporations in the U.S. even if there no actual distribution of profits. This additional tax cost if ignored may result in huge costs to the parent entity.

A wide tax rate differential between foreign and Indian resident corporations in India may allure external businesses to operate in India either by setting a branch office, liaison office, wholly owned subsidiary corporation or a limited liability partnership. We have discussed the different forms of entities set up in India in our whitepaper titled Interaction of Indian and U.S. Tax Laws and an earlier blog [#insert link India Blog 13.Establishing an Indian base].

Drawing an acceptance to foreign investment in India with favorable policy measures, foreign investors are funding information technology start-ups in India. Mostly foreign parent entities licenses know-how to group entities that allows it to penetrate markets worldwide. The group entities are generally required to withhold tax on royalty payments to the parent entity. This may result in parent entity to submit tax returns in various jurisdictions of the group entities. For instance, the entity is required to file tax return in India to claim refund of the tax withheld in India. This administrative process to claim refund may take time but a checklist item for foreign entities to comply and it serves as a proof for tax paid in India.

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A foreign (non-resident entity) in India may carry out business activities with Indian resident related or third parties. Where it does business with a third party, then the third party is to be taxed for the income from such business. However, doing business with a related party may require the transaction to be at arm’s length and requires analyzing if the related Indian party a permanent establishment (PE) of such foreign non-resident entity.

As the name suggests a PE is a fixed place of business. The term has been defined in further detail under the tax treaties. The Indian domestic tax law nomenclatures the PE concept as “business connection” of the foreign entity in India. The recent amendments has expanded the scope to specifically include entities in the digital economy if they have an economic presence. This economic presence test has been added in the last budget for entities that could escape being taxed in India as there was no physical presence. Perhaps, the Indian domestic law allows a taxpayer to take the advantage of either the treaty or domestic law provision that may be more beneficial, but it could not rule out the chaos to design a tax framework for such digital entities globally to determine its taxability in a specific jurisdiction.

I had written in an earlier blog that residential status is key determinant when computing individual income tax liability in a jurisdiction. So, what is means if a foreign entity has a PE in India?

A double tax avoidance agreement (Tax Treaty) between two countries sets out the rules of different forms of PE along with list of conditions and exceptions. The concept of PE generally lays out a country’s taxing right in relation to a foreign entity’s business operations in a specific jurisdiction either because of the existence of a fixed place, an agency or a service PE. A tax treaty also lays out the rules in relation to allocation and attribute the profits to PE and establish the taxing right to such jurisdiction where the PE exists.

• PE should obtain tax and other registration number, as applicable;
• appropriate profits of the entity attributable to the Indian PE should be taxed in India;
• PE’s profits should be determined at arm’s length;
• PE’s profits are taxable at the base rate of 40% of the profits after claiming deduction for expenses allowed as per the Indian tax law;
• PE should maintain proper books of accounts as per the law.

Our whitepaper titled Interaction of Indian and U.S. Tax Laws discusses that the recent amendments under the Indian domestic law has widened the scope of foreign entities to be taxable as PE, which shows India’s strong support to uproot the erosion of profit shifting between countries by taxpayers. The G-20/OECD Base Erosion Profit Shifting (BEPS) initiative has scaled the PE aspect in three action plans viz. addressing the challenges of the digital economy (Action Plan 1), preventing the artificial avoidance of permanent establishment status (Action Plan 7) and multilateral instruments (Action Plan 15). A change in tax policy will be helpful to put at rest the quantum of pending cases in India that seem to be overburdening the tax tribunals and courts on the interpretation and application of PE concept. The foreign entities have an option to seek advance ruling to provide a reasonable certainty on tax issues before any assessment proceedings have been initiated by the revenue authorities in India. This may however be an expensive route and a discussion with an advisor is preferable.

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It is to be noted that the anti-avoidance rules generally give wide powers to revenue authorities in many countries to initiate tax proceedings under thedomestic tax laws questioning a transaction that had the principal objective of evading tax. A taxpayer taxable in say two countries,say India and the U.S.,may have to be vigilant of the tax compliances in both countries. The interaction of the tax laws between two countries may offer tax credits but compliances cannot be ignored which may result in additional tax, interest and penalties.

An ideal form of entity depends on the purpose of the entity. For example, an ideal entity to pool assets of a high net worth individual would be trust in comparison to corporation or limited liability partnership. The boarder constitution can be outlined in two forms: corporate entities and unincorporated entities. Corporate entities are generally corporations formed and registered under the Indian corporate law like a C Corp in the U.S. Unincorporated entities generally include limited liability partnership (LLP), partnership firm, trust and Hindu Undivided Family (HUF).

Key features of a corporation, LLP and trust are listed below:

The above chart presents few features of the entities but in deciding the form of an entity to carry on Indian operations or pooling Indian assets, global investors or high net worth individuals must consider the objective and activities of such entity. Further, the restriction of funds to be invested in and out of India are governed under the Foreign Exchange Management Act, 1999, notifications and circulars issued by the Reserve Bank of India and foreign policy issued and updated from time to time. Our whitepaper titled Interaction of Indian and U.S. Tax Laws configures the tax and foreign exchange requirements in a manner that the readers will be able to understand their significance.

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The latest tax reforms under the Trump administration seem to despise the global entrepreneurs. The increasing disclosure requirements, allocation and attribution of profits of foreign entities in the U.S. irrespective of their actual distribution, retrospective tax of profits of foreign holdings have given small room for tax planning to the owners of foreign entities who are looking to become the U.S. residents. The blog apprises the readers to be aware of the consequences and reconsider their decision to move to the U.S. unless you are ready to bear the additional tax costs.

The controlled foreign corporation (CFC) regime has been there for quiet sometime. To put it in simple words, the CFC regimes taxes profits of a foreign entities profits if there is a direct, indirect or construction ownership of a U.S. person (i.e., a U.S. citizen or a U.S. resident. The recent tax reforms have expanded the rules of including entities to be qualified as a CFC under constructive ownership test and part of profits which were not previously covered are now included to be taxed. Our whitepaper titled Interaction of Indian and U.S. Tax Laws, discusses the tax exposure that global business owners may face as a consequence of moving to the U.S. This clearly does not disintegrate the movement to the U.S. But analysis to streamline and mitigate tax costs would be helpful before taking the decision.

The whitepaper titled Interaction of Indian and U.S. Tax Laws also highlights the consequent reporting requirements for the Indian residents pursuant to the Black Money Act in the India and the U.S. residents in the U.S. have been covered in detail in two separate blogs (link). It is important for residents to comply with the compliance requirements as the penalties are huge and the governments are extensively working to coordinate the efforts with other governments to trace the undisclosed funds that have not been reported by the resident taxpayers of a country.

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There has been an increase in the movement of high net worth individuals from India to the U.S. Having covered the residence rules under Indian tax law, it is important to shed some light on the residence rules under the U.S. tax law. In this blog, the readers will find that the residence test under the U.S. tax law is as objective under the Indian tax law. The U.S. taxes a U.S. person on a worldwide basis and non-residents on their U.S. sourced income. A U.S. person means a U.S. citizen or a U.S. resident. A natural persons is considered as a U.S. resident if he is a green card holder or meets the requirements of the substantial purpose test (SPT) or elects to be taxed as a U.S. person.

An individual meeting all requirements under SPT is a U.S. person, i.e. such individual must be in the US for at least:

1. 31 days of the current tax year; and
2. 183 days during the three years including the current year and immediately preceding two tax years determined as below:
   • 1/3rd of days in the year before the current tax year; and
   • 1/6th of days in the two years before the current tax year.

For ease, the above SPT requirements have been presented in a time graph below:

There are exceptions and exemptions from the above SPT rule. Few examples of exceptions to count the number of days to determine SPT are: days a person commutes to work in the US from a residence in Canada or Mexico (if a regular commute from Canada or Mexico), days a person who is in the U.S. for less than 24 hours (when in transit between two places outside the US), days a person is in the U.S. as a crew member of a foreign vessel, and days a person who is unable to leave the US because of a medical condition that develops while you are in the US.

Few examples of exemptions to calculate the day count to determine SPT include following individuals who are temporarily present in the US:

• a foreign government-related individual under an “A” or “G” visa, other than individuals holding “A-3” or “G-5” class visas;
• a teacher or trainee under a “J” or “Q” visa, who substantially complies with the requirements of the visa;
• a student under an “F,” “J,” “M,” or “Q” visa, who substantially complies with the requirements of the visa;
• a professional athlete competing in a charitable sports event.

Please note that the above exemption list may not rule out the requirement of not filing tax return in the US.

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The rules clarify the first day of residence and may be useful in determining residence start day in certain cases. For example, when a person is granted green card, the first day is the date such person enters the US.

The interaction between the tax residencyrules of two countries like U.S. and India clearly show how two democracies cover the taxpayers under its tax territory with the day count test. However, the U.S. steps ahead to tax its citizens irrespective of their stay in the U.S. This implies that once a high net worth individual moves from India to the U.S. and receives U.S. citizenship after surrendering Indian citizenship, then such individual is taxable in the U.S. irrespective of the fact that he wants to move anywhere in the world. Our whitepaper titled Interaction of Indian and U.S. Tax Laws covers important tax implications that high net worth individuals and global entrepreneurs need to note on becoming U.S. tax residents.

In addition to individual and corporate taxation, unincorporated entities are also taxable in India. Few examples of unincorporated entities are limited liability partnerships (LLP), partnership firms and association of persons. Entities such as LLPs and firms are governed under the Indian law on LLPs and partnerships. The residence is determined on similar basis as of a trust, i.e. an unincorporated entity is an Indian resident where the management and control of the operations is located wholly or partly in India.

LLPs havebeen a preferred choice where foreign entities have a subsidiary or presence in India. The flexibility in its administration and remittance of profits is more attractivechoice than a corporate form of subsidiary with a comparatively lower cost of establishment and maintaining

Foreign entities investing in India should do a comparative analysis of the pros and cons of the various types of entities to determine the ideal structurefor their business in India. But the choice of entity may be restricted where the specific regulatory requirements or tax benefits are restricted to a specific form of entity.

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A trust is considered an Indian resident where the control and management are wholly or partially located in India. The use of Indian trust structures for global citizens is often used to house particular assets to mitigate tax and provide asset protection.

India recognizes offshore trusts and places no restrictions on it having non-resident trustees or beneficiaries in an Indian trust. In the case of revocable offshore trusts where the settlor has a power to resume assets, any income derived by the trust is taxable to the settlor as if directly arisen to him. In case of an irrevocable trust certain considerations in case of an irrevocable trusts are outlined below:

• a trustee of an offshore trust is taxed in a representative capacity and comply with tax and reporting requirements if all beneficiaries are Indian residents.
• a mix of resident and nonresident Indian beneficiaries results in only Indian beneficiaries taxable for their distributions received from an offshore trust and the trustee has no representative role in India.
• an offshore trust partly having control and management in India may be taxed as an association of person in India.

The nuances with regards to trusts taxation are primarily based on the residence of the settlor, trustee or beneficiaries. The residence is an important determinant not only to calculate the tax liability but also to comply with the reporting obligations. Our whitepaper titled Interaction of Indian and U.S. Tax Laws discusses in further details regarding the use of trusts structure by high net worth individuals and how it helps in tax planning.

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In our whitepaper titled Interaction of Indian and U.S. Tax Laws, I had discussed different forms of trusts in India. Basic forms include public or private trusts. In India, there are generally three parties in a trust, settlor, trustee and beneficiary.

A public trust is generally categorized for charitable or religious purposes and may be exempt from tax in India, provided it carries out specific activities, adheres to specific conditions and registered under the provisions of Indian tax law.

Private trusts are set up under the Indian Trust Act and are required to be registered under the Registration Act, 1908. A private trust, as the name suggests, is generally used as a family trust. A private trust may be set up as a revocable trust, i.e. the settlor sets up trust with the intention of revoking the trust after the purpose for it which has been created will be fulfilled. A private trust may also be an irrevocable trust, i.e., settlor sets up the trust for lifetime without a power to revoke the trust. A trustee of a discretionary (irrevocable) trust that isestablished in India will be taxed as a representative taxpayer of the beneficiaries of such trust. However, if it’s a foreign trust, then a trustee may be a representative taxpayer of the beneficiaries if all the beneficiaries are Indian residents. A determinant (irrevocable) trust is a fiscally transparent entity but a trustee may be assessed to tax in a representative capacity.

The interplay between the US and Indian trust taxation rules are important, whether before or after the trusts have been created in India. The form of the trust, regulatory permission to remit the money outside India and tax implications under the Indian and US tax laws have to be considered in deciding the efficacyof creating a trust. When transitioning assets into the trusts with family members both in and outside India, the primary decision of where the trust should be created rests on the decision of the family members with respect to use or sale of assets and long-term intention to stay in or outside India.

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Oliver Wendell Holmes said, “Put not your trust in money, but put your money in trust.”

Trusts or foundations are common forms of entities that are used for protecting family or business assets and proper administration. Global families often use trusts or foundations as models to insulate Indian family assets. This is because India doesn’t have a controlled foreign corporations (CFCs) regime or similar provisions such as transferor trust or grantor trust regime as under the U.S. tax law.

The global movement of Indians around the world with assets situated in India does not void the need to protect and efficiently administer the assets which is achieved and managed with trusts created in India. There are various forms of trusts and the tax treatment depends on the creation of trust as a revocable or an irrevocable trust.

While a trust structure offers protection of assets and good governance mechanisms, there’s a real risk that any foreign structure will be classified as an Indian resident entity if it’s managed and controlled by people in India. Understanding and managing the risk associated with foreign assets to ensure they do not fall into the Indian tax net is imperative with the new age of foreign information exchange.

Our whitepaper titled Interaction of Indian and U.S. Tax Laws covers the different forms of trusts in India and taxation of Indian and foreign trusts in India.

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On November 24, 2016, the OCED/G-20 lead Base Erosion Profit Shifting (“BEPS“) introduced the formulation of Multilateral Instruments (“MLI“) in an effort to close gaps in international tax laws. In doing so, MLI incorporates key tax issues such as hybrid mismatch, treaty abuse, permanent establishment, and dispute resolution.

The MLI went into force on July 1, 2018. Accordingly, where two countries have a double tax avoidance agreement (“DTAA“) and both are signatories to the MLI, the MLI supplements their DTAA, and their DTAA becomes a Covered Tax Agreement (“CTA“).

The MLI

When addressing the residency status of foreign corporations, the MLI suggests that tax treaties should incorporate one of three residency rules in an effort to address treaty abuse.

Countries that are signatories to the MLI are to implement one of the following three minimum standards:

1. A principal purpose test (“PPT”);

2. A PPT supplemented with either a simplified or a detailed limitation on benefits (“LOB”) provision; or

3. A detailed LOB provision, supplemented by a mutually negotiated mechanism to deal with conduit arrangements not already dealt with in tax treaties.

The PPT sets out as a default test, providing that no benefit under the CTA shall be granted if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit.

India’s Position

On June  2, 2017, India signed the MLI Convention. Typically, to determine whether a foreign company is a resident of India, India’s rules on the place of effective management (“POEM”) apply. (click here to learn about India’s application of POEM rules to foreign companies). Now, however, where the foreign company is a citizen of a signatory country, the MLI minimum standard will apply to determine the application of benefits of the tax treaty with India. Under this analysis, India has decided to utilize the minimum standard of utilizing a simplified LOB provision in its CTA. India has also considered supplementing the LOB provision with the PPT, and because India is one of 12 countries to apply a simplified LOB, it is likely that India will do so.

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Notes 

Note, however, that the residency tie-breaker rules found in international tax treaties will remain applicable for countries who are signatories to the MLI, but reserve its application to its CTAs, such as Singapore, France, and Luxemburg. Additionally, the MLI rules will be inapplicable to countries that are not signatories, such as the US. Accordingly, when determining benefits under US tax treaties, the mutual agreement procedures will still apply.

Whitepaper: The Interaction of Indian and US Tax Laws

To learn more, please read our whitepaper titled, Interaction of Indian and U.S. Tax Laws, which highlights the interaction of U.S. and Indian tax obligations for ultra-wealthy Indians in the US, Indian businesses expanding into the US, and vice versa.

The last blog discussed the determination of residential status of a corporate entity in India. A corporate entity is considered an Indian tax resident if either:

• it was formed and registered under the Companies Act, 2013; or
• its place of effective management (POEM) is in India at any time during the financial year.

The concept of POEM states that an entity has POEM in India where its key management and commercial decisions that are necessary for the conduct of its business as a whole are, in substance made in India. The key principles outlining this concept are:

• POEM is presumed to be outside India where a corporation is engaged in active business outside India and majority of its board meetings are held outside India. However, where an Indian holding corporation or a person resident in India is makingthe decision instead of the directors or management, then POEM is likely to be in India. In determining the active business outside India, the corporation needs to analyze assets, employees and other aspects for consecutive three years including the current financial year.
• POEM is analyzed for corporations other than covered above on the basis of two prong test, i.e., identification of the persons who actually make the key management and commercial decision for the corporation’s business as a whole and the place where such decisions are made. This determination is not on isolated facts and illustrated with examples in the documents issued by the CBDT.

The POEM analysis is therefore factual and depends on the facts and circumstances of each case. The corporation therefore should have clarity in its active business operations carried out inside or outside India for application of POEM. This annual determination of a corporate entity having a POEM in India, however, does not apply to corporations having turnover less than INR500 million (approx. USD 7 million) in a tax year.

Our whitepaper titled Interaction of Indian and U.S. Tax Laws brings out the differential tax rates for resident and foreign corporations in India. An Indian domestic corporation is an Indian tax resident entity and taxed depending on its turnover from base rates of 25% or 30%. But a foreign corporate entity with POEM in India is taxed at base rate of 40%.

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The tax residential status in India of a corporate entity that the individuals collaborate to form is different from such individual owners. The Indian tax residence rules for corporate entities have been under scrutiny and amendments have expanded its scope.

Under Indian tax code, a corporate entity includes a company formed and registered under the Companies Act, 2013, company formed under corporate laws of another country, or an institution, association or body declared by general or special order of the Indian tax department i.e. Central Board of Direct Tax (CBDT).

The residential status of a corporate entity directly affects basis and rate of tax. Generally, a nonresident corporate entity is taxable at the rate of 40% and resident company at the rate of 30% (which varies based on the turnover of the entity).

A corporate entity is an Indian tax resident if it is formed and registered under the Companies Act, 2013, or its place of effective management (POEM) is in India at any time during the current tax year. Broadly, POEM means the place where key management and commercial decisions necessary for the business as a whole, are in substance made. The CBDT has also issued guiding principles for determining POEM of a foreign company in 2017.

Our whitepaper titled Interaction of Indian and U.S. Tax Laws discusses how often directors, shareholders, or partners who reside out of India, but continuing to exercise control and management with no physical presence in India, results in corporate entity being an Indian tax resident and taxed in India. It further highlights the difference in the base tax rates, for example, a foreign corporate entity considered as a nonresident is taxable at a base tax rate of 40%%compared to a resident corporate entity with base starting tax rate of 25%.

Under Indian tax law, foreign entities having a “business connection” in India are taxable in India. The term is defined to include agency relationship where the agent habitually plays a principal role leading to the conclusion of contracts. This recent amendment to the definition reflects the definition adopted for the Multilateral Instruments (MLI) the G-20 and Organization for Economic Co-operation (OECD) lead Base Erosion Profit Shifting (BEPS) initiative to include digitized business environment. This growing physical presence vs. significant economic presence test will impact the determination of permanent establishment as countries like the U.S. have not adopted it.

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Our readers would now know that India follows residence-basedtaxation. Our whitepaper titled Interaction of Indian and U.S. Tax Laws further illustrates the broad basis of income taxable to a resident, not ordinarily resident and nonresident in India.

Broadly, an Indian tax resident, not ordinarily resident and nonresident are taxable as under:

• resident is taxable on worldwide income;
• not ordinarily resident is taxable on income received or accrued or arisen in India; and
• nonresident is taxable on income sourced in India.

Individuals exiting India (who become nonresidents) may still be taxable on income in India even after moving out of India. Similarly, individuals entering India (who become an Indian resident)are taxable on their worldwide income. In both these situations, tax planning will help in mitigating taxes and meeting the compliance requirements specifically required by residents, not ordinarily residents and nonresidents. So, when to start planning?

An individual who is coming to India (assuming he has never resided in India) will be a nonresident Indian unless he resides in India for more than 181 days. Where such individual continues to be in India for less than 182 days in a year such that his day count is less than 365 days in four years, he will continue to be a nonresident. In essence, this gives such nonresident individual four years to plan his Indian tax implication on his worldwide income if he is considering to stay or return to India in long-term.

Similarly, an individual planning to exit India will continue to be taxable on his worldwide income unless he resides in India for less than 182 days. Consequently, when leaving India, such individual should plan whether to transfer or contribute assets in India in a manner that the tax is mitigated and converged with tax implications that may arise after moving to another country.

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In our whitepaper titled Interaction of Indian and U.S. Tax Laws we have covered how tax planning for high net worth individuals and global investors is important. A word for thought for high net worth individuals is to consolidate the list of assets including business interest to plan whether they would like to distribute their Indian assets by transferring or contribute in a trust as income from such assets will be taxable in India and may further be taxed in the country where they may choose to move. For global investors, it is important to plan their business interests in Indian entities as they may become taxable on profits of the Indian company upon becoming a U.S. resident whether or not the entity is making actual distributions.

Though tax treaties between countries often prescribe the taxing rights to one of the countries, however the compliance under domestic law cannot be ignored. With changing tax regulations to congruent tax policies around the world, it is important that high net worth individuals and global investors do their tax planning before outrightly moving to another country as the stakes may be high and so the increasing compliance costs to streamline into the system after the offence has been committed.

Out whitepaper titled Interaction of Indian and U.S. Tax Laws discusses the residence rules in India and the U.S. In this blog, I will cover the individual residence rules in India.

The tax code in India, like in the United States, sets out objective determination of the tax residence of an individual based on the number of days such individual resides in India. But this determination may be complex and requires facts to be analyzed in further detail in accordance with the rule or regulations that elaborate the main legal provision. .

An individual residential status is to be determined for each tax year separately. The annual tax year in India is called the assessment year and generally follows the financial year beginning from April 1 to March 31 in the next year. An individual may either be a resident, nonresident or not ordinarily resident in India during a tax year. In principal the fundamental residence rules are:

1. An individual is an Indian tax resident if he resides in India:
   • for 182 days or more during the current tax year; or
   • for 60 days or more in India during the current tax year and for 365 days or more during 4 tax years preceding the current tax year. The period of 60 days is replaced by 182 days where an Indian citizen or a person of Indian origin (i.e., a person who’s either parents or grand-parents were born in undivided India) comes on a visit to India, but not for a permanent stay.
2. An individual is a not ordinarily resident in India if he:
   • has been a nonresident in India for 9 out of 10 tax years preceding the current tax year; or
   • has been in India for 729 days or less during 7 years preceding the current tax year.
3. An individual is a nonresident Indian is he does not satisfy any of the above requirements during the tax year.

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India follows residence-based taxation, i.e. the income is taxable in India based on the residence. Taxation is not based on citizenship as is the casein the U.S. An Indian resident is taxable on his worldwide income like a U.S. citizen or resident. However, a nonresident Indian is only taxable for the income received, accrued or derived from India, unlike in the U.S. where even if the U.S. citizen even if residingoutside the U.S., he will still be considered as a US resident and taxable on his worldwide income.

Indian residents who are moving to the U.S. should take into consideration that the income from Indian sources will be taxable in India. Further, if they become US residents, then such income is also taxable in the US. The US tax authorities have been making constant efforts to educate taxpayers to be compliant with tax filing and reporting requirements.

The mobility of individuals has been in high concentration as students, expats and business owners and investors are increasingly relocating from their home country to another country. I have experienced this myself as I moved from India to pursue graduate course at Georgetown University Law Center and became an expat to work at Asena Advisors. It was not only an offer to gain an exhilarating experience to study tax laws beyond Indian borders but also to personally connect with people from around the world.

With good opportunities in the expat world, there is a greater need to plan taxes as no two countries have same tax laws. For example, In India, an Indian resident (irrespective of his citizenship) is taxable on his worldwide income from April 1st to March 31st of the following year. In the U.S., a U.S. citizen, whether or not residing in the U.S. is taxable on his worldwide income from Jan 1st to Dec 31st. The fact the basis of taxation of an individual change from one country to the other, I have been making it a priority question in my meetings with senior executives and global investors – what is your residential status or day count in a country?

So, if I miss this question, it means there is missing analysis. This further means you may rake over the coals for not meeting the compliance requirements had you known your residence in a country which otherwise may result in huge tax, interest and penalties. For example, the number of Indians holding green cards in the U.S. by 2014 was estimated to be 13.2 million.1 Generally, green card holders are considered U.S. tax residents and required to comply with annual tax and information tax returns reporting their worldwide income, foreign bank and financial accounts. How many of the 13.2 million actually report their worldwide income, accounts and assets? I may not have number with me, but U.S. tax authorities under the Foreign Account Tax Compliance Act closely work with governments of other countries in a targeted effort to combat failure to report foreign assets and income.

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A residential status is therefore an underlying derivative specifically when taxing rights are invoked in a jurisdiction based on your residence. The rules for determining residence may be either objective (similar to countries like India and US) or subjective (like Australia).

Our whitepaper titled Interaction of Indian and U.S. Tax Laws sets out the rules for determining residence in India and the U.S. The interaction of the U.S. and Indian will offer an insight to high net worth individuals, global business owners and senior executives about the key issues to be looked into before planning a move from their home country to the host country.