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India ensures tax equalisation for international posting
July, 01st 2013

There are a large number of multinational companies operating in India. In case of multinational companies, it is a common practice that their employees are transferred from one country to other countries for serving offices situated in various countries. Since the rate of tax on salary income differs from country to country, therefore, whenever an employee is relocated, his prime tax liability would also be different.

In such a situation, the employer normally gives an assurance to the employee that the employee will continue to receive the same salary that he would have received had he not been relocated to another country.

This assurance is given by following the tax equalisation policy. Tax equalisation is one of the methods widely used by multinational corporations to ensure that their employees who are on international assignment do not suffer combined taxes on income (in home and host country) in excess of what they would have paid had they continued to reside in the home country.

This arrangement is quite prevalent to ensure that the employee neither suffers a financial hardship nor realise a financial windfall from the tax consequences of international assignment.

Under tax equalisation policy, the employer calculates the hypothetical tax (hypo tax) and excludes the same from the employee's pay. The hypo tax is the amount of the tax liability that the employee would have continued to bear in his home country had he not been seconded to another country. The employer then assumes the obligation of paying the actual taxes incurred by the employee at the assignment location and at home. It is always subject to the condition that the employee would not be eligible to that part of the salary which is equal to his tax liability in home country which would have arisen if he had not been transferred to another country.

The above legal issue was discussed by the Hon'ble Delhi High Court in the case of CIT v Percy Batlivala, 2010-TII-02-HC-DEL-INTL. The Hon'ble Court explained the legal position by an illustration. "This can be demonstrated by the following example: Suppose in US, gross salary is Rs 100/-, of which Rs 25/- payable as tax, net amount receivable by the assessee in US would be Rs 75/-. Likewise, suppose in India tax payable is Rs 15/-. Since, the assessee is assured net amount receivable in US, he would get Rs 75/- and the difference of Rs 10/- is treated as 'hypothetical tax'."

In the above situation, the issue which arises for consideration is whether the taxable income of the employee in India would include the amount of hypothetical tax also or not (Rs 10 in the above example).

Reference in this connection may also be made to a recent decision of Delhi Tribunal in the case of ACIT v Robert Arthur Keltz, in ITA No 3452/Del/2011. Facts in brief: Mr. Robert Arthur Keltz, an employee of United Technologies International Operation, USA (UTIO) was sent to India on assignment on April 1, 2006, under tax equalisation scheme. In return of income, the amount of hypo tax was excluded from the income of the employee.

The Ld. AO has added back the amount of hypo tax to the base salary on the contention that as no specific exemption or deduction is granted for hypo tax under the Income Tax Act, 1961 and on the erroneous understanding that the income has already accrued to the employee, hence, hypo tax forms part of the employee's taxable salary.

The Tribunal following the decision of the Hon'ble Delhi High Court in the case of CIT v Percy Batlivala, 2010-TII-02-HC-DEL-INTL held that the amount of hypo tax is not liable for tax in India. The Hon'ble Delhi High Court in CIT v Percy Batlivala (Supra) has held that it is clear that insofar as the employee is concerned, he had received Rs 90 only (in the above example, i.e. Rs 75 salary and Rs 15 taxes in India), Rs 10 was not received at all in view of the nature of the arrangement between the employer and the employee.

Therefore, there was no question of addition of this hypothetical tax to the income of the assessee and asking the assessee to pay tax thereon. There is no dispute that the assessee has paid tax on the actual salary received by him in India.

Thus, even on the application of first principle and adopting common sense approach, it is clear that the addition made by the AO on account of so called hypo tax was unsustainable.It is thus clear that Indian judicial authorities have given their approval to tax equalisation system so that the employees on international posting remain immune to differential tax rates prevailing in different countries.

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