Global mobility is a dynamic arena that often throws up new challenges for even the most seasoned professionals. However, one question that has been around for a long time is: Can employers consider tax treaty relief while determining withholding taxes for their employees? While there are strong technical arguments in favor of considering the tax treaty relief at the time of determining withholding taxes by an employer, there has been ambiguity on whether this could be practically implemented and also uncertainty on whether this claim would be accepted by the Revenue authorities.
The Authority for Advance Rulings (AAR) in its recent rulings has laid to rest the uncertainties around the matter to a large extent. These are welcome decisions, which indicate that the Revenue authorities recognize the approach of considering tax treaty relief at the time of withholding taxes. While a ruling by the AAR is binding only with respect to the specific transaction under consideration and not in other comparable cases, it certainly has persuasive value in similar matters. Now, let us try to understand what the rulings were and what they mean to employers that have globally mobile employees.
Under the normal assignment model, employees are seconded to foreign countries while their payroll continues to remain in India and the employees receive certain allowances outside India. Thus, the employees receive the salary for services rendered outside India into their Indian bank accounts. This results in the employees being taxed in India on account of the salary being received in India irrespective of their residential status in India. The employees then claim tax treaty relief while filing their India tax returns – either income exemption in case of non-resident (NR) employees or foreign tax credit (FTC) in case of resident and ordinarily resident (ROR) employees. This meant excess taxes were paid to the Revenue authorities and the employees would have to await refund of such taxes for a considerable time.
The AAR in its rulings held that treaty relief for both NR and ROR employees could be considered by the employer while determining withholding taxes. This would mean that the salary paid to an NR employee (outbound from India) for services rendered outside India would not be taxable in India even if the salary was paid to the employee’s Indian bank account. It was held that the place where the services are rendered is what is important and not the place where the salary/income is received by the employees. Thus, where the salary is paid in India for the work performed by the employees in a foreign country, the income would be taxable in such foreign country and not in India. Further, the AAR also ruled that FTC could be claimed for ROR employees at the time of determining withholding taxes with respect to the foreign taxes paid for these employees.
An employer is required to deduct taxes on the income that is chargeable to tax in India under the head salaries. Accordingly, since the income chargeable to tax is arrived at after giving effect to treaty relief, the employer would have no liability to withhold taxes in India on the entire salary paid to the employees especially when the income may be fully exempt or below the taxable threshold after the tax treaty relief is claimed. However, the employer is required to exercise due diligence in claiming treaty relief at the withholding stage.
Some of the precautions that need to be taken with respect to claiming treaty relief at the withholding stage are outlined below:
► The employees’ residential status should be determined accurately and revisited from time to time.
► The employees should be educated on this model and its tax implications. The employees should intimate the employer in case there is any change in the assignment dynamics.
► In case income exemption is claimed for NR employees, it is essential that a tax residency certificate is obtained from the foreign country.
► The employer should ensure that taxes have been paid in the foreign country before claiming FTC.
► Form 67 has to be submitted for FTC claims. Failure to do so could result in loss of the FTC claim.
► Robust documentation should be maintained for the position taken for each employee.
► The payroll systems should be modified to be able to support the tax treaty claim at the withholding stage.
Although the AAR has passed favorable rulings, it must be noted that the Revenue authorities have several arguments against the claim of tax treaty relief for NR and ROR employees at the withholding stage. Hence, while employers can consider implementing treaty relief at the withholding stage, they should be cognizant of the risks to be taken, exercise adequate due diligence and also maintain appropriate documentation.
The author of the blog is Amarpal Chadha, Tax Partner and India Mobility Leader, People Advisory Services, EY India
The co-author of the blog is Ammu Sadanandhan, Manager, People Advisory Services, EY India
 AAR No 1217 of 2011 and AAR No 1299 of 2012 dated 29 January 2018