Will Modi Govt Succeed in Nabbing Indian ‘Tax Nomads’?

India has been concerned with tax abuse, which has been typically employed by Indian high net worth individuals.

In this world, nothing is certain except death and taxes. The ‘tax nomads’, or ‘stateless persons’, as the Indian Tax Department calls them, would not agree. They avoid paying taxes in any country.

There are two generally used systems for taxing income: territorial-based and residence-based.

In a territorial-based taxation system, countries such as Singapore tax individuals only on income from sources inside the country’s borders. Under residence-based taxation, countries like India tax their residents on all income earned from both local and foreign sources. For non-residents in these countries, only income earned locally is taxed.

• The ‘tax nomads’, or ‘stateless persons’, as the Indian Tax Department calls them, avoid paying taxes in any country.
• A country has the right to tax an individual in case the individual qualifies as a resident (for tax purposes) under the domestic law of that country.
• India, like the rest of the world, has been very concerned with this tax abuse which has been typically employed by Indian high net worth individuals (HNWI).
• This has been sought to be curbed by the Finance Bill, 2020 by introducing a provision in Section 6 of the Income Tax Act dealing with residency provisions.

How Tax Systems Work

While most of the countries employ either the territorial or residence taxation, the US has citizenship-based taxation system. Then there are the tax havens who do not charge any tax at all. They include: The Cayman Islands, St Kitts and Nevis, Dubai, Monaco, The Bahamas, Bermuda, Vanuatu, The Turks & Caicos Islands, and Anguilla.

A country has the right to tax an individual in case the individual qualifies as a resident (for tax purposes) under the domestic law of that country.

If the person is not a tax resident in any country, according to those countries’ domestic rules, it’s totally possible to be a tax resident of nowhere. And therefore, not pay taxes at all. Or if they are residents of tax havens, they don’t pay taxes. These persons are consequently not liable to tax.

India’s Step Against Tax Abuse

India, like the rest of the world, has been very concerned with this tax abuse which has been typically employed by Indian high net worth individuals (HNWI).

This has been sought to be curbed by the Finance Bill, 2020 by introducing a provision in Section 6 of the Income Tax Act dealing with residency provisions.

It reads: “An Indian citizen who is not liable to tax in any country or territory shall be deemed to be resident of India.” As stated earlier, this would imply that he would be taxed in India on his global income, not only domestic.

The Memorandum explaining the provision states: “The issue of stateless persons has been bothering the tax world for quite some time. It is entirely possible for an individual to arrange his affairs in such a fashion that he is not liable to tax in any country or jurisdiction during a year. This arrangement is typically employed by high net worth individuals (HNWI) to avoid paying taxes to any country/ jurisdiction on income they earn. Tax laws should not encourage a situation where a person is not liable to tax in any country. The current rules governing the tax residence make it possible for HNWIs and other individuals, who may be Indian citizen to not to be liable for tax anywhere in the world. Such a circumstance is certainly not desirable; particularly in the light of current development in the global tax environment where avenues for double non-taxation are being systematically closed.”

The ‘Dubai’ Tax Haven Conundrum

Any proposal in the Budget is thought through thoroughly. Or at least it should be. Both the upside and the downside need to be carefully assessed, and then an informed decision taken. All consequences need to be factored in. Even the unintended ones. The language needs to capture the intention of the proposal accurately.

Dubai is a tax haven. Residents are not liable to tax on personal income.

Interestingly, in the original Tax Treaty signed with UAE on 18 November 1993, the definition of ‘resident’ meant any person who, under the laws of UAE, was liable to tax therein by reason of his domicile, residence, place of management, place of incorporation or any other criterion of a similar nature. This definition applied to both India and UAE. However, on 28.11.2007, the definition changed.

While it remained the same for India, for UAE it read as – “an individual who is present in the UAE for a period or periods totaling in the aggregate at least 183 days in the calendar year concerned, and a company which is incorporated in the UAE and which is managed and controlled wholly in UAE”. Gone was the phrase – ‘liable to tax’, because no tax was being levied.

Since the present proposal encompasses persons who are not liable to tax, clearly Dubai was also covered.

The issue is – was it even meant to be covered? With a huge diaspora of Indians there, constituting the largest percentage of expatriates, all of them, with possibly a few exceptions, being genuine bona fide residents, was it even prudent to go there? It doesn’t appear that Dubai was on the radar.

That’s why it was shocking to note that the drafting of the proposal to charge tax on the world income of NRIs, not paying taxes abroad, included in its embrace Dubai as well. The outrage that followed, justifiably so, forced the government to issue the first clarification – within a day of the Budget presentation.

Stopping Tax Evasion: Indian Govt’s Intention Vs Outcome

The drafting of the provision should have reflected the exclusion clearly.

But what was more bizarre was the clarification issued. It was knee-jerk. Obviously the outcry amongst the diaspora in Dubai rung alarm bells in North Block, necessitating an immediate clarification, but that doesn’t justify the baffling clarification; to wit, the proposal was not meant for bona fide workers in other countries, and would not be taxed in India on the income they have earned there. In interviews given by the Finance Ministry, it was clarified that the proposal was meant to tax only their Indian income. An example of rental income from India was mentioned.

So, what’s new? Indian income is anyway taxable in India even for NRIs, and has been so since the beginning.

So, what was the purpose of re-stating what is already a law and using it as a justification for the proposal?

In any case, if bona fide workers were not to be taxed in India, why didn’t the provision reflect it?

Simply speaking, it appears that the intention of the government was to tax such itinerant tax evaders who hop from country to country and ensure that by staying there for such periods of time that doesn’t make them ‘tax residents’, they escape taxation altogether — and to tax such persons who reside in tax havens with which India has no tax treaty. Dubai is an outlier among the tax havens. It may be a tax haven but the Tax Treaty with it ensures that non bona fide persons don’t get to misuse it. So, there was a need to exclude Dubai, by appropriate language, from the ambit of the proposal.

How Would Govt Define ‘Bona Fide’?

By invoking the phrase ‘bona fide’ in the clarification, which phrase can be as subjective as they come, the government has dug a massive hole. They could have qualified it by tagging it to the Tax Treaty. By leaving it open-ended, they would need to use the same yardstick for other tax havens too, because in the clarification they have mentioned other countries too, instead of restricting it to Dubai.

If Goldman Sachs employs an NRI, a finance man, to oversee its offshore funds in Cayman Islands, where tax is zero, will the proposed provision kick in? Isn’t he a bona fide resident doing a genuine job, albeit, in a tax haven?

How’s the NRI in Dubai ‘genuine’, but not the one in Cayman Islands?

So how would the Government define ‘bona fide’? Should it leave it to the wisdom of the tax officer? Should it be defined at all? Where will it be defined? The Income Tax Act, already hugely complicated, can’t be made more so. Rules? Maybe? Or let the provisions of General Anti Avoidance Rule, already in the Act, take care of this issue too?

The proposal is a laudable objective. All countries are also seeking to do it. But poor drafting, a poorer clarification, introducing unnecessary concepts like ‘bona fide’ and extending it to other countries as well (read: other tax havens) makes the objective illusory and subject to litigation, uncertainty and misuse.

(Ajay Mankotia is a former IRS Officer and presently runs a Tax and Legal Advisory. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for them.)