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Hypothetical Tax deductible from salary income in India
December, 21st 2012

In an order that will have a bearing on globally mobile employees, a division bench of Bombay High Court held that the hypothetical tax paid by an employee should be deducted from the income offered to tax in India.

The hypothetical tax was part of a Tax Equalisation Agreement signed between the employer and the employee. Under the agreement between taxpayer Jaydev H Raja and his employer Coca-Cola USA, tax liability arising out of his foreign assignment was to be borne by the company, but restricted only to the extent of liability arising out of such foreign assignment.

Therefore, the tax that would have been paid by the employee had he remained in his home country (known as hypothetical tax) was deducted from the salary. The tax that had to be paid over and above this amount was paid by the employer. The taxpayer offered his income which included his salary and the tax reimbursed by the company to the tax authorities.

The salary income of the taxpayer received in India during the relevant year was Rs 77 lakh, after the tax of Rs 50 lakh. The tax amount of Rs 50 lakh was reimbursed by the employer as per the agreement. However, the taxpayer did not offer the entire reimbursed amount, Rs 50 lakh, for tax in India.

He offered for tax the Rs 77 lakh he received in India as salary and only Rs 35 lakh, out of the Rs 50 lakh reimbursed by the company by way of reimbursement. This was on the premise that the remaining Rs 15 lakh had been already deducted from his salary as hypothetical tax.

The Indian tax authorities declined to permit the deduction of Rs 15 lakh, holding that deduction of hypothetical tax was an act after the accrual of income. The Income-tax Appellate Tribunal (ITAT) had upheld the taxpayer's argument and held that the taxpayer had already borne the tax burden to the extent of the hypothetical tax paid by him. The High Court, upholding the Tribunal order, ruled that only the incremental tax borne by the employer should be brought to tax in India.

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