India Tax Study Material

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Training manualIndia Tax for New Hires: 2011-12 India tax returns

April 2012


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Human Capital India Tax

Training Manual

Dear participant,

Welcometo your career at Human Capital - Global Shared Services, Ernst & Young Pvt. Ltd. We areexcited to have you join us.

This course of learning is designed to lay the foundation for your work in India individual taxation.

The objective is to help you become efficient and independent preparers of India individual income

tax returns. This can be achieved only by working independently and by taking personal

responsibility for your own career development.

The following are some of your responsibilities as a participant-

Be punctual. Please participate! Pay attention to what is being taught and ask relevant questions. Keep

your mobile phones switched off.

Make sure you keep up from Day 1. Material for each new day builds on material seen inprevious days in a logical progression. If you fall behind it will be difficult to catch up. Take

your course booklet home each night and read it through so you keep up and refresh your

knowledge.

Do not hesitate to ask for help or to say that you have not understood what is beingdiscussed during the sessions.

As a learner you will have many questions. All appropriate questions must be resolved bythe person leading the session or by the Technical Mentor or Go-To person assigned to

you. Make a list of all your questions and ask them once rather than going to them every

time you come across a question.

Theory sessions will be followed by working on case studies. These exercises need to bedone independently. Mistakes are mistakes only if you do not learn from them. Please

remember it is better to make a mistake now and learn from it, rather than copying

another persons work. If you do not work independently right from the start, your

progress in India tax will be too slow. Nurture a spirit of inquiry and research which is

essential in India tax.

We appreciate that you may want to help your batch mates but please note this does nothelp them in the long run. In fact it hinders them. Participants need to do their own work

to discover in which particular areas they need additional help.

Do not sit in the pantry or waste time on the internet for long periods of time. Please do not miss any sessions and plan your personal schedules accordingly. If, due to

unavoidable reasons, you will not be coming to the office on a particular day, leave a voice

mail to Bramar S Murthy, Deepika Hoblidar and Nagaraj Saggamagunti. Do not send the

message through a friend or send a text message.


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Basic Provisions .......................................................................................................... 1

Heads of Income .......................................................................................................... 3

Income from Salary ..................................................................................................... 4

Income from House Property ..................................................................................... 12

Income from Capital Gains ......................................................................................... 14

Income from Other Sources ....................................................................................... 20

Deductions from Gross Total Income .......................................................................... 21Set off and carry forward of losses, Clubbing of income ............................................... 22Modes of Payment of Taxes ....................................................................................... 23

Employee Stock Options (ESOP) ............................................................................... 26

Concept of Double Taxation Avoidance Agreements .................................................... 30

Typical Tax Compliance Cycle .................................................................................... 36

Quality and Risk Issues .............................................................................................. 42


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Basic Provisions

Assessment Year and Previous Year (Section 3)

Assessment Year means the period of 12 months commencing from the 1 st day of April followingthe end of the respective financial year. Previous year means the financial year immediatelypreceding the assessment year.

Therefore, for the financial year 2010-11, the Assessment Year would be April 1, 2011 to March31, 2012 (referred to as Assessment Year 2011-12). The Previous Year would be April 1, 2010 toMarch 31, 2011 (referred to as Previous Year 2010-11 or Tax Year 2010-11).

Residential Status (Section 6)

An individual is treated as Resident in India during a tax year ie, April 1 to March 31, if he satisfiesany of the following two basicconditions:

He stays in India during the tax year for 182 days or more; or

He stays in India for 60 days or more during the tax year and 365 or more during the4 tax years immediately preceding the relevant tax year (in case of an Indian citizen wholeaves on employment overseas, or an Indian citizen or Person of Indian Origin who beingoutside India, comes on a visit to India, the 60 days are replaced with 182 days).

An individual is treated as a Non-resident, if he does not satisfy all the basic conditions mentionedabove.

A resident individual is treated as a Not Ordinarily Resident if he satisfies either of the followingadditionalconditions -

has been Non-resident in India in nine out of the ten previous years preceding that year; or

has during the seven previous years preceding that year been in India for a period of sevenhundred and twenty nine days or less.

Examples on residency

Example 1

X, a foreign national, has come to India on June 25, 2010 and would be staying in Indiacontinuously till March 31, 2011. During the past ten tax years he has come to India for 80 days ineach year. What would the individuals residential status be for the tax year 2010-11?

Step 1 Determine if he is Resident

Since the individual would be staying in India for more than 182 days in the tax year 2010-11(June 25, 2010 to March 31, 2011), he satisfies one of the basic conditions and would qualify asResident for the tax year 2010-11.

Step 2 Determine if he is a Not Ordinarily Resident

As the resident individual has not stayed in India for more than 729 days in the past 7 years, hesatisfies one of the additional conditions. Thus, he would qualify as a Not Ordinarily Resident forthe tax year 2010-11.


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Example 2

A, an Indian citizen, left India to take up employment with X Inc, USA on August 01, 2010. He has

not come back to India till March 31, 2011. Prior to joining X Inc. he has never been out of India.Determine the residential status of A.

Step 1 Determine if he is Resident

Since A is an Indian citizen going abroad for employment, he would need to stay in India for 182days to qualify as a Resident for the tax year 2010-11 (refer basic condition - in case of an Indiancitizen who leaves on employment overseas, the 60 days are replaced with 182 days). Therefore,since A has stayed in India for less than 182 days in the tax year 2010 - 11, he would qualify as aNon Resident for the tax year 2010-11.

Step 2 Determine if he is a Not Ordinarily Resident

You only need to go to Step 2, if a person qualifies as Resident. In this case, since the individual

qualifies as a Non-resident, Step 2 is Not Applicable.

Taxability based on residential status

Resident Non-resident

Resident

Worldwide income Income received in India; andIncome accruing or arising in India;andIncome deemed to accrue or arisein India; andIncome from business orprofession controlled wholly orpartly in India.

Income received in India; andIncome accruing or arising in India; andIncome deemed to accrue or arise inIndia.

Not OrdinarilyResident


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Heads of Income

Income is taxed under five heads of income, as follows -

- Salaries;

- Income from House Property;

- Profits and gains from business or profession;

- Capital Gains; and

- Income from Other Sources (residuary head).

The computation mechanism as well as other provisions under the aforesaid heads (other thanIncome from business or profession) is discussed in the following pages.

For every heads of Income three aspects are very important. They are:

- Chargeability (i.e. When an income can be considered under this head)

- Basis Of Charge (i.e. How an income is chargeable under this head)

- Formats & Provisions (i.e. How much is chargeable under this head)


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Income from Salary

Sections 15 to 17 of the Income Tax Act, 1961, cover the provisions of income under the headSalaries.

Broad overview of the provisions relating to Salaries

Salary is liable to tax on due or receipt basis, whichever is earlier. In this connection, an income isconsidered as salary only if it results from an employer-employee relationship as opposed to thatof a principal-agent. Judicial precedents1 have held that an employer-employee relationship is akinto a master-servant relationship and is different from that of a principal-agent in the followingmanner

- generally a master can tell his servant what to do and how to do it whereas a principal cannottell his agent how to carry out his instructions;

- a servant is under more complete control than an agent generally, a servant is a person whonot only receives instructions from his master but is subject to his masters right to control themanner in which he carries out those instructions; an agent receives his principals instructionsbut is generally free to carry out those instructions according to his own discretion.

Therefore, control and supervision is the key character to determine the employer-employeerelationship. This especially becomes a matter of essence with regard to internationalassignments.

In addition to the above, please note that salary earned by a partner of a firm from that firm is notregarded as income chargeable under the head Salaries.

Taxability of different salary components

Taxability of an individual with respect to salary income depends on the residential status of the

individual. In case of an individual who qualifies as Non-resident or Not Ordinarily Resident onlythe income pertaining to services rendered in India is liable to tax in India. Therefore, salaryreceived for services rendered outside India would not be taxable in India (unless the salary isdirectly received in India).

This is based on the deeming provisions, which state that any income for services rendered inIndia or income for the rest period or leave period which is preceded and succeeded by servicesrendered in India and forms part of the service contract of employment shall be regarded asIncome earned in India and therefore subject to tax in India irrespective of a persons residentialstatus.

In view of this, taxability of salary (and the various components) should be evaluated in the light ofthe residential status in India for the particular tax year.

Further, salary is generally divided into 3 key heads

- Wages and allowances this generally includes all monthly cash remuneration paid by anemployer to the employee like base salary, bonus, housing allowance, conveyance allowance,etc. These components are chargeable to tax in full except to the extent specifically exempt(like house rent allowance).

1Lakshminarayan Ram Gopal & Sons Ltd vs Govt of Hyderabad (25 ITR 449); Piyare Lal Adishwar Lal vs CIT

(40 ITR 17); Ram Prashad vs CIT (86 ITR 122).


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- Perquisites this includes all benefits provided by an employer to the employee like companyleased accommodation, Interest free/concessional loan, free education, etc. This representsprovision of a facility rather than an allowance for expense. These components are offered to

tax based on the value prescribed as per the perquisite valuation rules.

- Profit in lieu of salary this includes non-recurring, one-off payments received by theemployee eg joining bonus, compensation for termination of employment, etc.

We have tabulated below some of the regular salary components and their related taxability

Basic Salary orBase Salary

Salary earned for services rendered in India is fully taxable in India.

HypotheticalTaxes or HypoTax

Hypothetical taxes are a reduction from an employees salary, wherein the

notional taxes, had the assignee continued to remain in his home country, is

reduced from his salary.

The mechanism involved in this is that the assignee is paid salary in his home

country net of hypothetical tax and the entire tax liability of the assignee in

the home country as well as in the host country is borne by the employer. The

employee has no right to claim the amount of Hypo-tax retained by the

employer as it is a reduction from salary.

The purpose of deducting the notional taxes (hypo tax) is to ensure that the

assignee is not disadvantaged due to an international assignment. The same

is shown in the example below

Home Salary 100,000

Home Notional taxes (40,000)Net Salary 60,000

Based on the example above, had the assignee remained in the home country,

the net salary would be 60,000. Even in case of an international assignment,

it is ensured that the employees net salary remains the same. Thus, the

assignee is protected from any additional taxation.

Tax treatment Hypothetical taxes are netted against base salary and the net

amount is offered to tax as there is a reduction in salary and the employee

does not have the right to receive the hypothetical tax.

Bonus/Incentivepay

Bonus is taxable on receipt basis if the same was not taxed earlier on duebasis.

Further, taxability of the bonus amount should be evaluated keeping in mindthe residential status of the assignee as well as the period for which the bonusrelated to. This is explained further in the case study below.


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Case Study

- Assignee arrives into India on October 1, 2010 and qualifies as a NotOrdinarily Resident.

- In March 2011, the assignee receives a bonus of USD 120,000, pertainingto Calendar Year 2010.

The bonus liable to tax in India, for the tax year 2010-11 would beUSD 30,000, as follows

- The bonus pertains to January to December 2010.

- The proportionate bonus period for which services have been rendered inIndia is October to December 2010.

Bonus calculation = (120,000*3 months)/12 months

House RentAllowance (HRA)

House Rent Allowance is liable to tax in the hands of the employee, subject tothe exemption as per Section 10(13A). The exemption is limited to least ofthe following

a) Allowance actually received

b) Rent paid in excess of 10% of salary.

c) 50% of salary in case of metropolitan cities and 40% in case of other cities

Salary for this purpose includes basic salary as well as dearness allowance, ifthe terms of employment so provide.

LeaveEncashment

Leave Salary/encashment of earned leave refers to amount received fromemployer for the unavailed period of earned leave. Leave encashment is liableto tax in the hands of the employee, subject to the exemption as per Section10(10AA). The exemption is limited to least of the following

a) Leave at the credit of employee*Average Salary

b) 10* Average Salary

c) Maximum of Rs. 3,00,000

d) Actual leave salary

Average salary refers to total of Basic salary, Dearness allowance (if it entersinto retirement benefits) & commission based on a fixed percentage of

turnover achieved by employee for 10 months preceding the date ofretirement, divided by 10.

ConveyanceAllowance

Conveyance allowance granted to an employee for the purpose of commutingbetween the place of his residence and the place of his duty would be exemptupto Rs 800 per month. Amount in excess of Rs 800 would be fully offered totax.

Leave TravelAssistance

Leave Travel Assistance provided to an employee is fully taxable except to theextent exempt under Section 10(5). The exemption is allowed twice in a


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specified block of four calendar years for travel undertaken by the employeeand dependent family members for proceeding on leave to any place in India.

In this connection, the Leave Travel Assistance exemption is limited to -

- For journeys performed by air - economy fare of the national carrier by theshortest route to the place of destination.

- For journeys performed by any mode of transport other than by air and theplace of origin and destination are connected by rail - Air-conditioned firstclass rail fare by the shortest route to the place of destination.

- Where place of origin of journey and destination are not connected by rail -the first class or deluxe class fare on such transport by the shortest routeto the place of destination, where recognized transport system exists and,where no recognized transport system exists, the air conditioned firstclass rail fare for such distance.

Where Leave Travel Assistance is unavailed during a block of four calendaryears, one Leave Travel Assistance claim may be availed during the firstcalendar year of the immediately succeeding block of four calendars years.

SpecialAllowances

Per Diem Allowances

Allowances to meet ordinary daily charges, incurred by an employee, onaccount of absence from his normal place of duty (whether, granted on tour orin connection with transfer) can be claimed as an exemption under section10(14) read with Rule 2BB.

Relocation Allowance

Allowances to meet cost of travel on tour / on transfer can also be claimed asnot taxable under section 10(14) read with Rule 2BB. Cost of travel ontransfer includes any sum paid in connection with transfer, packing andtransportation of personal effects on such transfer

However, since the above exemptions are limited to the extent of actualexpenditure incurred, it is important to maintain robust documentation tosubstantiate the claim.

Medicalreimbursementbenefit

As per Section 17(2) of the Act, reimbursement of medical expenses isconsidered as a taxable perquisite, unless the following conditions aresatisfied -

- reimbursement of medical expenses does not exceed Rs 15,000;

- such medical expenses are incurred by the employee on self or on familymembers;

- such reimbursements are supported adequately and appropriately;

- supporting documents are submitted by the employee, in original and suchsupporting documents are only for medical items and not for cosmetic orgeneral items.


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Company LeasedAccommodation

Company leased/owned accommodation - As per Rule 3 of Income Tax Rules,least of the following would be the value of the rent free unfurnishedaccommodation which is taken on lease or rent by the employer-

a) 15% of the salary

b) Actual rent paid

If the accommodation of owned by the employer following would be the valueof the unfurnished accommodation

a) 15% of the salary (for cities having population exceeding 25 lakhs as per2001 census)

b) 10% of the salary (for cities having population exceeding 10 lakhs as per2001 census but not exceeding 25 lakhs)

c) 7.5% of the salary (for other places)

Further, in case of transfer, if the employee is provided with anaccommodation at the new place of his posting while retaining theaccommodation at the other place, the value of perquisite shall be determinedonly in respect of one accommodation with lower value upto a period of 90days. However, if the employee continues to retain both the accommodationseven after a period of 90 days, the value of perquisite shall be charged forboth such accommodations.

Hotel stay/ Service apartment - In case the employer providesaccommodation in hotel / service apartments, value of the perquisite would bethe least of the following.

a) 24% of the salary

b) Actual cost incurred

However, in case of transfer, if the number of days of stay in hotel / serviceapartment does not exceed 15 days, the value of the perquisite shall be Nil.

Salary for this purpose includes -- Base salary- Dearness Allowance(If considered for retirement benefits)- Bonus/incentives- Allowances- Any other monetary payments

Salary for this purpose excludes -- Dearness allowance unless considered for retirement benefits- Employers contribution to provident fund- Exempted allowances- The value of perquisites referred to in Section 17 of the Income Tax Act.

If any amount is recovered from the employee, the same would be reduced forthe vale of perquisite determined above.


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In case furnished accommodation is provided, the value of the perquisite wouldbe required to be computed as if it is unfurnished accommodation (as permethod provided above) plus 10% of the original cost of the furniture whenowned by the employer or actual cost of hiring the furniture.

Utilities Actual charges incurred by the employer would be computed as the value ofperquisites in respect of the following utilities -

- Electricity- Water charges- Gas charges- Servant wages

If any amount is recovered from the employee, the aforesaid determined valueshall be reduced by the amount of recovery.

Motor Car Motor Car owned or Hired by Employer

Where motor car is used partly for official and partly for private purpose andthe running and maintenance expenses are met/reimbursed by the employer

- INR 1800 per month (plus INR 900 if driver is provided) per month ifcubic capacity of car is < 1.6 litres

- INR 2400 per month (plus INR 900 if driver is provided) per month ifcubic capacity of car is > 1.6 litres

Where motor car is used partly for official and partly for private purpose andthe running and maintenance expenses are fully met by the employee -

- INR 600 per month (plus INR 900 if driver is provided) per month ifcubic capacity of car is < 1.6 litres

- INR 900 per month (plus INR 900 if driver is provided) per month ifcubic capacity of car is > 1.6 litres

Where motor car is used only for private purpose

Actual cost incurred (hire charges or 10% of actual cost of car in case owned(including chauffeur salary)Less : Recoveries from employee

Car Facility for commuting between office and residence Not taxable


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Othermiscellaneousperquisites

- Education facilitiesprovided by the employer

- Where the employer provides education facilities to any member of theemployees household, the value of perquisite shall be the actual cost

incurred by the employer reduced by any amount recovered from theemployee.

- However, where the cost of education facilities provided does notexceed Rs 1000, the value of perquisite shall be Nil.

- Interest free or Concessional loan

- Where the employer provides free or concessional loan for anypurpose, the value of perquisite shall be the sum equal to the interestcomputed on the maximum outstanding monthly balance at the ratecharged per annum by the State Bank of India as on1st day of therelevant previous year as reduced by the interest amount, if any,recovered from the employee.

- However, where the amounts of loans are small, not exceeding inaggregate Rs 20,000 for the year or where the loan is taken formedical treatment of certain specified diseases, the value of perquisiteshall be Nil.

- Use of any movable asset

Where the employee uses the assets of the employer, other than laptopsor computers, the value of perquisite resulting from such use shall be thefollowing -

- Asset owned by the employer - 10% of the actual cost of such asset.

- Asset not owned by the employer - The amount of rent or charge paidor payable by the employer reduced by any amount recovered from theemployee.

If any amount is recovered from the employee in respect of such use, theaforesaid determined value shall be reduced by the amount of recovery.

- Transfer of any movable asset

Where the employer transfers any movable asset to his employee, thevalue of perquisite resulting from such transfer shall be the amount ofactual cost of such asset to the employer reduced by the cost of normalwear and tear for that asset for each completed year, during which the

asset was put to use by the employer.

- Rate of normal wear and tear in case of computers and electronicitems is 50% per annum and a motor car is 20% per annum by reducingbalance method.

- Rate of normal wear and tear in case of other items is 10% per annumof the cost.

If any amount is recovered from the employee in respect of transfer, the


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aforesaid determined value shall be reduced by the amount of recovery.

- Free Food and Beverages

Cost incurred by the employer in providing food and non alcoholicbeverages to the employees in office premises or through non-transferablepaid vouchers to be used at eating joints is taxable to the extent such costexceeds Rs 50 per meal

- Gifts

Value of Gifts / Vouchers / tokens received in excess of Rs 5,000 is liableto tax in the employees hands

- Club expenses and Credit Card Expenses Reimbursement

Reimbursement of club expenses (including annual or periodical fee) andexpenses (including membership and annual fees) on credit card (and an

add-on card) is taxable as perquisites in the employees hands.

However, where such reimbursements are made towards expensesincurred for official purposes, such amounts would not be taxable. Further,health club / sports club facilities provided uniformly to all employees arealso not taxable.

- Expenses on telephone and mobile phones have been specificallyexcluded from the purview of perquisite taxation

Specialallowance/Taxperquisite

In case the tax payable on salary income of an employee is borne by theemployer (typical for India hosted assignees), the tax liability is required to bereported to tax as income on a gross-up basis Section 195A

The grossed up tax amount is typically reflected as special allowance and nottax perquisite to ensure compliance with Section 200 of the Companies Act,1956 that does not permit an Indian company to provide a net of tax salary toits employees.

Conversion offoreign income

- Conversion of foreign income for the purpose of TDS

Rule 26 specifies that for conversion of income (payable in foreigncurrency) for the purpose of tax deduction, the SBI Telegraphic TransferBuying Rate as on the date on which tax is required to be deducted (incase of salary, date of payment) shall be considered.

- Conversion of foreign income which is liable to tax in India

Rule 115 specifies that the foreign income (which is chargeable under the

head Salaries) shall be converted using the SBI Telegraphic Transfer Buying

Rate existing on the last day of the month immediately preceding the month in

which the salary is due or is paid in advance or in arrears.


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Income from House Property

Sections 22 to 27 of the Income Tax Act, 1961, cover the provisions of income under the headIncome from House Property (IFHP).

Broad overview of the provisions relating to Income from House Property

Income is chargeable to tax under the head IFHP if the following conditions are satisfied:

The individual owns a property that consists of buildings or lands appurtenant (ie, attached)thereto; and

The property should not be used by the owner for the purpose of any business or professioncarried on by him, the profits of which are chargeable to tax.

Therefore, ownership triggers taxability and not renting of a property.

Determination of Income from House Property

1. Annual value

Annual value is determined as follows -

a. Reasonable expected rent of a property; or

b. Where the property is let and the actual rent is in excess of the reasonable expected rent, theactual rent; or

c. Where the property is let but was vacant during the whole or any part of the previous year andowing to such vacancy the actual rent is less than the reasonable expected rent, the actualrent.

Note: Income pertaining to property situated in a foreign country would be taxed in India if theassignee qualifies as a Resident or the income is received in India directly.

Exceptions to the above valuation

- Where the property is used for self occupation of the owner or it cannot be self occupied due toemployment, business or profession carried on at other place, and he resides in the other placein a building not belonging to him, the annual value of such property is taken as Nil.

This exception is not applicable if the property has been actually let out during whole or part ofthe year and or if any other benefit is derived thereof by the owner. Further, the exception isonly available for one property, but as per the individuals choice.

- The annual value of properties other than the property in respect of which the individual hasexercised an option to claim the above exception shall be determined as if such house orhouses has or have been let (deemed let out property).

2. Deductions available from annual value

Municipal Taxes

Deduction for municipal taxes actually paid, during the previous year irrespective when it is due,from the annual value.


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If a property is situated in a foreign country, municipal taxes levied by the foreign local authorityare deductible on payment basis.

From annual value determined municipal taxes are to be reduced before claiming any additionaldeductions under section 24.

The resultant figure of Annual Value less municipal taxes is referred to as Net Annual Value.

Standard Deduction

A Standard deduction of 30 percent of the Net Annual Value is available in all cases.

Interest on borrowed capital

Interest on borrowed capital used for acquisition, construction, repairs, renewal or reconstructionis deductible to the following limits

- Upto Rs 150,000 on loan borrowed on or after April 01, 1999 for the purpose of constructionor acquisition of the property which is self occupied and the construction is completed within 3years. This limit is reduced to Rs 30,000 if loan is borrowed prior to April 1, 1999 or it is forany other purpose other than construction or acquisition.

- Actual interest paid (in case of properties other than referred to above).

Points to note

- The assessee is required to furnish a certificate from the person to whom the interest ispayable stating the purpose of such loan, amount outstanding and interest payable during thefinancial year.

- Pre-EMI interest for the period prior to previous year in which the property was acquired orconstructed, can be claimed equally in 5 annual installments, starting with the year in whichthe property is acquired/constructed.

Carry forward and set-off of loss from house property

- Loss from house property can be set-off against the income under other heads during therespective current year.

- Loss not so set-off in the respective current year can be carried forward and set-off againstIFHP in subsequent years. The loss can be carried forward for 8 consecutive years.


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Income from Capital Gains

Sections 45 to 55A of the Income-tax Act, 1961, cover the provisions of income under the headCapital Gains.

Charge of capital gains - Section 45

Any profits or gains arising from the transfer of a capital asset are chargeable to tax under thehead Capital gains in the year in which the transfer takes place. However there are certainexceptions to taxability in the year of transfer such as compulsory acquisition of land, destructionof asset and receipt of insurance monies etc., The Capital Gains are specified as short-term orlong-term depending on the period of holding. In this connection, the following terms areimportant to understand -

a. Capital asset Section 2(14)

Property of any kind held by an assessee (whether or not connected with his business orprofession) but does not include the following -

- Stock in trade, raw materials, consumable stores held for the purpose of business orprofession;

- Personal effects, excluding jewellery, archaeological collections, drawings, paintings,sculptures, or any work of art;

- Agricultural land;

- Other specified deposit or bearer bonds.

b. Short-term capital asset Section 2(42A)

A short-term capital asset is defined as a capital asset held by an assessee for not more than thirtysix months immediately preceding the date of its transfer.

Exception

Shares of a company or any other security listed in a recognised stock exchange in India, units ofUTI, units of a mutual fund are considered as short-term capital assets if held for not more thantwelve months immediately preceding the date of transfer.

c. Long-term capital asset Section 2(29A)

Any asset that is not a short-term capital asset is a long-term capital asset.

d. Transfer Section 2(47)

The term transfer is a very vide term and does not only mean sale. The term transfer includes -

- Sale, exchange or relinquishment of the asset;

- Extinguishment of any rights in the asset;

- Compulsory acquisition of an asset under any law;

- Conversion of the asset into stock in trade;


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- Any transaction involving the allowing of the possession of any immovable property to be takenor retained in part performance of a contract;

- Any transaction which has the effect of transferring or enabling the enjoyment of anyimmovable property.

Exceptions

There are various transactions that are treated as transfer under the definition of the term underSection 2(47). However, as per Section 47, certain specified transactions are deemed to be nottreated as transfer. Some of these transactions are discussed below -

- Transfer of a capital asset under a gift, will or an irrevocable trust (excluding such transfer ofspecified securities acquired under an Employee Stock Option Plan).

- Any transfer or issue of shares by the Resulting Company to the shareholders of the DemergedCompany as consideration for a demerger.

- Transfer of shares of the amalgamating company under a scheme of amalgamation providedcertain conditions are satisfied.

- Transfer of bonds or Global Depositary Receipts made outside India by a non-resident toanother non-resident.

- Conversion of specified bonds/debentures into shares/debentures.

Computation of capital gains

Short-term capital gains

Transfer of a short-term capital asset results in Short-term capital gains. A standard computationof short-term capital gains is attached below -

Particulars Amount

Sale Consideration XXXX

Less: Expenses incurred at the time of sale (xx)

Net Consideration XXXX

Less: Cost of acquisition (XXX)

Less: Cost of improvement (XX)

Short-term capital gains XXX

Short-term capital gains are not liable to tax at a fixed tax rate but included in the total income andtaxed at the progressive slab tax rate of an assignee for the respective tax year. However, short-term capital gains resulting from specified securities traded on a recognised stock exchange in


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India (and on which Securities Transaction Tax is paid) are liable to tax at a fixed rate of 15percent.

Long-term capital gains

Transfer of a long-term capital asset results in long-term capital gains. A standard computation oflong-term capital gains is attached below -

Particulars Amount

Sale Consideration XXXX

Less: Expenses incurred at the time of sale (XX)

Net Consideration XXXX

Less: Indexed cost of acquisition (XXX)

Less: Indexed cost of improvement (XX)

Long-term capital gains XXX

Long-term capital gains are liable to tax at a fixed tax rate as follows -

- 10 percent in case of specified securities without indexation benefit (at the choice of theassessee); or

- 20 percent in other cases.

With effect from October 1, 2004, long-term capital gains resulting from specified securitiestraded on a recognized stock exchange in India (and on which Securities Transaction Tax is paid)are not liable to tax.

In this connection, please note the meaning of the following terms

a. Sale consideration

This is the amount that the transferor receives or is entitled to receive as consideration for thetransfer of the capital asset. In case of non-monetary consideration (ie, consideration received inkind, the Fair Market Value is considered as the Sale Consideration).

b. Cost of acquisition

Cost of acquisition is the amount paid by the assignee to acquire the capital asset.

Cost of acquisition under special cases

As per Sections 49 and 55, in case of special cases, the cost of acquisition is considered as follows-

- Self generated assets - NIL.


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- Bonus shares - NIL.

- Rights shares - Amount actually paid for acquiring the right shares.

- Asset acquired prior to April 1, 1981 - Actual Cost or Fair Market Value of the asset as on 1-4-1981 (at the option of the assignee).

- Under a gift or will or transfer to a revocable or an irrevocable trust - Cost to the previousowner.

- By succession, inheritance - Cost to the previous owner.

c. Indexed cost of acquisition

In case of long-term capital gains, the cost of acquisition is permitted to be indexed with the CostInflation Index specified by the Central Board of Direct Taxes each year. The Indexed Cost ofAcquisition is arrived at as follows -

Cost of acquisition X Cost Inflation Index for the year of transferCost Inflation Index for the year of acquisition**

**For assets acquired prior to April 1, 1981, the Cost Inflation Index as prescribed for the tax year1981-82 shall apply. Further, in case of gifts, the indexation benefit starts from the date ofreceipt of gift or inheritance (ie, when the recipient becomes the owner).

d. Cost of improvement

- Cost of improvement includes all expenditure of capital nature incurred after March 31, 1981by an assessee in making any additions to capital assets after the date of acquisition. (Cost ofimprovement does not include expenditure incurred prior to April 1, 1981).

- It also includes any expenditure to protect or complete the title to the capital assets or curesuch title. In other words, any expenditure incurred to increase the value of the capital asset istreated as cost of improvement.

- Cost of improvement in case of specified assets (for ex. goodwill of a business or a right tomanufacture, produce or process any article or thing or right to carry on any business) isconsidered as NIL.

e. Indexed cost of improvement

In case of long-term capital gains, the cost of improvement is permitted to be indexed with theCost Inflation Index specified by the Central Board of Direct Taxes each year. The Indexed Cost ofImprovement is arrived at as follows

Cost of improvement X Cost Inflation Index for the year of transferCost Inflation Index for the year of improvement


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Exemption from capital gains Some of the important reinvestment schemes

Capital gains arising from sale of certain capital assets can be claimed as exempt if the gains or thesale proceeds are reinvested in certain specified assets. A chart of such reinvestment schemes is

provided below:

SectionRef.

Capital Gain on saleof

Type ofcapitalgains

Reinvestmentof gains in

Period and Restrictions

54 Residential Houseproperty

Long term ResidentialHouse

property.

Purchase within 1 yearbefore or within 2 yearsafter date of transfer.Construction within 3 years.

Lock in period for new asset- 3 years

54 B Agricultural Landused at least 2 years

prior to transfer

Shortterm/Long

term

Agriculturalland (rural or

urban)

Purchase within 2 yearsafter date of transfer.

Lock in period for new asset- 3 years54 EC Any long term capital

assetLong term Specified

bonds (REC) Purchase within 6 months

of date of transfer. Lock in period for new asset

- 3 years. Investment in bonds limited

to Rs 50 lakhs.

54F Any long term capitalasset (other thanresidential house)

Long Term ResidentialHouse(Net

considerationto be investedand not gains)

Purchase within 1 yearbefore or within 2 yearsafter date of transfer.Construction within 3 years.Pending utilization amountcan be invested in deposit

account under Capital Gainsaccounts scheme.

Lock in period for new asset- 3 years.

No additional property(other than the new house)should be purchased within2 years or constructedwithin 3 years from date oftransfer of the asset.

Carry forward and set-off of Capital Loss

- Capital Loss during the respective current year can be set off against other Capital Gainsduring that year as follows -

Long-term capital loss can only be set off against long-term capital gains.

Short-term capital loss can be set off against any capital gains.

Capital Loss cannot be set-off against any other income.


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- Loss not so set-off in the respective current year can be carried forward and set-off againstCapital gains in subsequent years as follows

Long-term capital loss can only be set off against long-term capital gains.

Short-term capital loss can be set off against any capital gains.

The loss can be carried forward for 8 consecutive years provided a return of income indicatingthe loss is filed within the due date for filing of the return.

Income tax rates

Capital assets

Transactioncovered by STT

Not covered by STT

Longterm

Shortterm

Long Term ShorttermWithout

indexationWithindexation

Units (equity oriented) 0% 15% 10% 20% Normal

Units (others) NA NA 10% 20% Normal

Equity shares (listed)any other 0% 15% 10% 20% Normal

Equity shares (notlisted) NA NA NA 20% Normal

Preference shares(listed) NA NA 10% 20% Normal

Preference shares (notlisted) NA NA NA 20% Normal

Debentures (listed) NA NA 10% NA Normal

Debentures (not listed) NA NA 20% NA Normal

Government securities NA NA 10% 20% Normal


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Income from Other Sources

Sections 56 to 59 of the Income-tax Act, 1961, cover the provisions of income under the headIncome from other sources.

Interest

Interest income (other than that exempt under Section 10) from any source is fully liable to tax inIndia.

Section 10 exempts certain interest income from tax, few of which are -

- Interest earned by a person resident outside India from NRE accounts.

- Interest earned by a Non-resident or Not Ordinarily Resident from FCNR accounts.

- Interest on notified securities, bonds, annuity certificates, savings certificates etc. issued byCentral Government.

- Interest on bonds issued by local authorities and notified by the Central Government in theofficial gazette.

Dividend

Dividend from shares in Indian companies and from specified mutual funds and units is exemptfrom tax as per Section 10(34) and (35) respectively. Dividends from foreign companies are fullychargeable to tax.

Miscellaneous income like lottery receipts, etc

Gross winnings from lotteries, crossword puzzles, races including horse races (other than income

from the activity of owning and maintaining race horses), card games and other games of any sortor from gambling or betting of any nature whatsoever are chargeable to income tax at a flat rate of30% (plus applicable cess). No allowance or expenditure is allowed to be claimed as a deductionfrom the gross winnings.

Deductions from Income from other sources

Deductions from Income from other sources are covered under Section 57, as under -

Any reasonable sum paid by way of commission or remuneration to a banker or any otherperson for the purpose of realizing dividend (other than dividend covered under Sec. 115 O)and interest on securities.

Current repairs, depreciation, insurance premium in case of letting out of plant, machinery,furniture and building.

In case of income in the nature of family pension, amount deductible is Rs 15,000 or one-thirdof the income whichever is lower.

Any other expenditure (not being capital expenditure) laid out or expended wholly orexclusively for the purpose of earning such income.


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Deductions from Gross Total Income

Pursuant to calculating the Gross Total Income, based on the income heads discussed above, theassessee is allowed deductions under Section 80A to 80U, in respect of specified

investments/contributions made by him during the respective tax year. The total amount ofdeduction, as calculated under these Sections, is limited to the Gross Total Income and theunclaimed/unutilized amount is not permitted to be carried forward.

We have discussed below, few important deductions -

- 80C Contribution to provident fund, life insurance premium, subscription to certain equityshares or debentures, repayment of principal part of housing loan, tuition fees, amountdeposited in five year term deposit with any scheduled bank etc.

- 80CCC Contribution to pension fund upto Rs 100,000 per annum.

Aggregate deductions under Section 80C, 80CCC and 80CCD (contribution to pension fund ofcentral government) should not exceed Rs 100,000.

- 80CCF Subscription to long-term infrastructure bonds upto Rs 20,000 (w.e,f AY 2010-11)

- 80D Payment of medical insurance premium for self paid by any mode other than cash uptoRs 15,000 per annum or if taken for senior citizens upto Rs 20,000 per annum. Additionallyinsurance premium upto Rs 15,000 per annum for parents.

- 80E Repayment of interest paid on loan taken for higher education from any financialinstitution or approved charitable organization. Deduction would be allowed for maximum of 8years or till the interest is paid whichever is earlier.

- 80G Donations made to charitable organizations, certain funds like Prime Ministers Nationalrelief fund, National Defence Fund etc. Deduction is available to the extent of 50% or 100% of

sums contributed.

The annual tax withholding circular issued by the Central Board of Direct Taxes provides clarity onthe deductions allowable to be considered by the employers at the time of withholding the taxes.


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Set off and carry forward of losses

Loss carried forward to the

next year

Income against which loss

to be set off

Number of years the loss

is carried forward

House property loss Income from House Property 8 Assessment years

Business loss Business income (non speculative / speculative)

8 Assessment years

Speculation loss Speculation Profits 4 Assessment years

Short term capital loss Short / Long term capitalgain

8 Assessment years

Long term capital loss Long term capital gain 8 Assessment years

Loss from activity of owningand maintaining race horses

Income from activity ofowning and maintaining race

horses

4 Assessment years

Clubbing of income

Generally, an assessee is taxable only on his own income. However, Chapter V of the Income TaxAct, 1961 provides an exception to the above principle and provides for clubbing of income ofother persons with the income of the assessee

Provisions under Chapter V are known as Clubbing provisions, which are covered under Section60 to 65

The intention of such provisions is to counteract tax evasion/ avoidance by assessee, who shift

their portion of taxable income to some other persons

Remuneration of spouse

Any income arising directly or indirectly to the spouse of an individual, whether in cash or kindfrom a concern in which the assessee has substantial interest. However, no such clubbing shall bedone, if the spouse possesses technical or professional qualification or experience.

Income of minor child

Any income arising or accruing to the minor shall be included in the income of that parent whosetotal income is higher. Where marriage of the parents does not subsist, the income of the minorwill be clubbed in the income of that parent who maintains the minor child in the previous year.

INR 1500 per annum or actual income of minor child, whichever is less is exempt under section 10(32)

However, no such clubbing shall be done, if the minor accrues or arises income on account of anymanual work, any activity involving application of his skill, talent or specialised knowledge andexperience.


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Modes of Payment of Taxes

The Act prescribes three modes of payment of tax for an individual -

- Tax Deduction at Source (and Tax Collection at source for prescribed transactions);

- Advance tax; and

- Self-assessment Tax;

Tax Deduction at Source Sections 192 to 206 AA

The Act prescribes that at the time of making specified payments (or credit in the books), thepayer is required to deduct/withhold tax from the amount payable and deposit the same with theGovernment treasury. In this connection, the following points should be noted -

- The rate of tax deduction varies depending on the nature of payment, the residential status aswell as the person type of the payee and the payer.

- The Payer needs to obtain a specific registration with the Revenue authorities for TaxDeduction and deposit. The registration is known as Tax Deduction Account Number.

- The Payer is required to furnish a certificate to the payee specifying that tax has beendeducted at source, the rate and the amount of tax deducted, etc. Such certificate is generallyissued following the end of the year by April 30.

- The Payer who has deducted taxes at source is required to file a return (quarterly), by theprescribed due date, detailing the amount paid/credited and details of taxes deducted anddeposited. In this connection, specific time limits have been prescribed for:

Tax deduction at Source (at the time of payment or credit).

Deposit of taxes with the Government treasury (generally within seven days from end ofthe month in which payment has been made).

Issue of certificate of tax deducted at source Form 16 (by May 31 following the end of thetax year).

Filing quarterly withholding returns (depending on nature of payment).

- Failure to comply with the Tax Deduction at Source provisions or delay in such compliancesattracts interest and penalty.

Tax Deduction at Source provisions specific to salary

Section 192 (1) of the Act requires that any person responsible for making a payment that ischargeable under the head Salaries shall deduct income tax at source at the time of payment ofsalary. The tax is deductible at the average rate of income tax computed on the estimated salaryincome of the employee for the whole financial year.


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Based on this, the following points should be noted in respect of Tax Deduction at Source fromsalaries -

- Any payment that could be regarded as chargeable under the head Salaries for the recipient is

liable to tax deduction.

- Tax is deductible at the time of payment of salary.

- Tax is deductible at the average rate of income tax computed on the estimated salary incomeof the employee for the whole financial year.

Further, an employee is permitted to declare the following income (or loss as the case may be) andinvestments /contributions made during the tax year and the employer is required to take intoaccount these details for the purpose of deducting taxes at source -

- Prescribed incomes.

- Loss from house property.

- Investments/contributions eligible for deduction from Gross Total IncomePayment of tax on non-monetary perquisites by employer

The Act specifies that in case an employer bears the tax on any non-monetary perquisite given toits employees, the tax so borne shall be exempt in the hands of the employee. In this connection,the following points may be noted -

- The restriction under Section 200 of the Companies Act, 1956 is not applicable to theemployer to the extent of tax borne on non-monetary perquisites.

- The employer will be liable to the tax payable on the same and such tax will have to bedischarged at the time when such tax was otherwise deductible ie, at the time of payment of

income chargeable under the head "Salaries" to the employee.

- Tax liability is determined at the average rate of income-tax computed on the basis of the ratesin force for the financial year, on the income chargeable under the head Salaries, including thevalue of perquisites.

- Such tax paid by the employer has to be separately reported as a line item in the Form 16issued to the employee.

- The tax paid by the employer is not allowed as a deduction from the income of the employer.

Advance Tax - Section 207 to 219

An individual is required to pay tax on the chargeable income in advance during the course of the

respective tax year.

In this connection, the Act prescribes the mode of computing advance tax as well as the due datesby which the advance tax has to be deposited into the Government treasury. Advance tax iscalculated under the following steps -

- Step 1 - Estimating the total taxable income for the tax year.

- Step 2 - Computing the tax liability on the estimated total taxable income.


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- Step 3 - Reducing the amount of tax deductible/collectible at source (if any).

The balance tax liability is the advance tax payable by the individual. Please note that advance taxis payable only if the total amount payable as per the above computation for the respective tax

year exceeds Rs 10,000.

Advance tax in case of non-corporate assessees has to be discharged in three installments duringthe tax year, as per the table below.

Installment Payable on or before Amount payable

I 15th September Not less than 30 percent of the advance tax.

II 15th December Not less than 60 percent of such advance taxpayable during the year (as reduced by the amount,if any, paid in the earlier installments).

III 15th March The whole amount of such advance tax payableduring the year (as reduced by the amount oramounts, if any, paid in the earlier installments).

In this connection, it may be noted that failure to comply with the aforesaid provisions attractsinterest as follows

- For delay/default in payment of 90 percent of advance tax during the tax year (Section 234B) -1 percent per month from the beginning of the Assessment Year, till the tax is actually paid.

- For shortfall in payment of advance tax as per the prescribed installments (Section 234C)

1 percent per month for 3 months on the shortfall in payment of the first installment (ie, 3percent of the shortfall).

1 percent per month for 3 months on the shortfall in payment of the second installment (3percent of the shortfall).

1 percent for 1 month on the shortfall in payment of the third installment (1 percent of theshortfall).

- For default in furnishing return of income (Section 234A) 1 percent per month from thebeginning of the month next to filing due date of the Assessment year, till the return is actuallyfiled.

Self-assessment tax

Where the tax liability of a particular tax year is not discharged by way of tax deduction/collectionat source or advance tax during the respective tax year, an individual is permitted to discharge theliability by way of self-assessment tax.

While paying this tax, the individual is required to compute the interest payable for delay in filingthe return, delay/default in payment of advance tax or shortfall in payment of advance tax as perthe prescribed installments, and discharge the same alongwith the outstanding tax liability.


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Employee Stock Options (ESOP)

A stock option is generally a right granted to employees to purchase shares or other securities

convertible into shares of the employer company, at a pre-determined price at a future date.

Typically, the implementation of a stock option plan involves the following stages:

Grant of options

The options are granted to an employee i.e. he receives an offer from his employer to

purchase the shares of the employer company at a pre-determined price after a pre-

determined period.

Vesting of options

The employee gets the right to exercise the options and purchase the securities at a pre-

determined rate.

Exercise of options

The employee exercises the options by paying the exercise price and acquires the necessary

securities.

Sale of securities

The securities acquired pursuant to the ESOP are sold.

Taxation of Stock Options

Effective April 1, 2009, the Finance Act 2009 has abolished Fringe Benefit Tax (FBT) and

reinstated the erstwhile taxation of ESOPs as perquisites in the hands of the employee instead ofbeing subject to FBT in the hands of the employer. The current taxation regime of ESOP income is

governed under section 17(2)(vi) of the Income Tax Act, 1961 which in brief states as follow:

the value of any specified security or sweat equity shares allotted or transferred, directly or

indirectly, by the employer, or former employer, free of cost or at concessional rate to the

assessee

As a result, income arising from Employee Stock Option Plan (ESOPs) or any other equity based

schemes, which was subject to FBT till March 31, 2009, will now be taxed as a benefit in the handsof the employees.

The value of ESOPs for the purpose of tax is determined as the Fair Market Value (FMV) as on the

date on which the options are exercised by the employee, reduced by the amount actually

recovered by the employee. FMV means the value determined in accordance with the method

prescribed in the rules issued by the Indian Government.


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In the case of internationally mobile employees, if the employee is in India on the date of exercise

of stock options, the perquisite on the same would be fully taxable (irrespective of his stay details

in India during the grant period). Grant Period has been defined as the period from the date of

grant of the option to the date of vesting of the option.

Since CBDT Circular No. 9 dtd December 20, 2007 has not been abolished, there is another view on

taxability of ESOPs granted to internationally mobile employees. Perquisite is applicable only if

the employee is based in India for any portion of the Grant Period. If an employee is based in India

only for a portion of the Grant Period, perquisite will be applicable on a proportionate basis in the

ratio of the period of stay in India to the length of the Grant Period.

For example, a Company grants 100 options to an employee on June 1st, 2007 while he is in the

US. The exercise price is Rs 25 per share. The options vest equally over 2 years i.e. 50% on May

31st 2008 and 50% on May 31st 2009. The employee is seconded to India on 1st January, 2009 for

a 2 year assignment. On 30th June 2009 he exercises all 100 options by paying the exercise price.

The FMV on May 31st 2008 and May 31st 2009 is Rs 60 per share and Rs 80 per share respectively.

The tax on perquisites will be calculated as follows

- 50 options have vested prior to the employee having spent any days in India; hence there

would be no tax liability upon exercise of these 50 options.

- Balance 50 options have vested while the employee was in India. The value of perquisites on

these 50 options would be, Rs (80-25)*50 = Rs 2750.

- Since the employee has been in India only for a portion of the Grant Period, the taxable value of

perquisites would be computed as follows:

Value of Perquisites * No of days in India

Days in Grant Period

Rs 2750 * 151/730 = Rs 569

However, on a conservative approach, the first view is always recommended.

Valuation rules for determining the FMV

The Indian Government has prescribed the valuation rules to determine the FMV. Accordingly, the

securities allotted/ transferred on or after 1 April 2009, will have to be valued as per these rules.

The valuation rules are briefly summarized below:


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Valuation in case of shares listed on a Recognized Stock Exchange in India

Where the shares of the company are listed on a Recognized Stock Exchange in India on the date of

exercise, the FMV shall be the average of the opening price and the closing price of the share on

the date of exercise on the said Recognized Stock Exchange.

However, if the shares are listed on more than one Recognized Stock Exchange in India, the FMV

shall be the average of the opening price and closing price of the share on the Recognized Stock

Exchange which records the highest volume of trading in the shares.

Further, where there is no trading in the shares on any Recognized Stock Exchange in India on the

exercise date, the FMV shall be the closing price on the date which is closest to the date of

exercise. In case the shares are listed on more than one Recognized Stock Exchange in India, the

FMV shall be the closing price on a Recognized Stock Exchange, which records the highest volume

of trading in such share, on the date which is closest to the date of exercise.

Valuation of shares not listed on any Recognized Stock Exchange in India or shares listed only

on overseas stock exchange(s)

Where on the date of exercise, the shares are not listed on a Recognized Stock Exchange in India,

the FMV of the share would have to be determined by a Recognized Merchant Banker (category I

merchant banker registered with Securities and Exchange Board of India (SEBI)).

The FMV can be determined on the date of exercise or any date that falls within 180 days prior to

the exercise date.

Illustration: A Company granted option to its employee on 2-8-2008 to apply for 100,000 shares@ Rs 80 each. All the Options were exercised on 1-8-2010 and shares were allotted on 15-12-2010. The shares of the company are listed on BSE only. Share prices at various dates are asfollows:

Date Opening Price Closing Price

Buy Sell Buy Sell2-8-2008 80.95 81.25 85.10 85.90

1-8-2010 95.34 96.05 99.86 100.5215-12-2010 135.67 135.99 123.82 124.41


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The taxable value of perquisite for the Assessment year 2011-12 would be calculated as below :FMV on the date of exercise of option = Opening Price + Closing Price

2= 96.05 + 100.52

2= 196.57 = Rs.98.285 per share

2Value of Perquisite = (Rs. 98.285 Rs.80) x 1, 00,000

= Rs. 18, 28,500/-

Note: For the purpose of calculation of perquisite, date on which the option is exercised by the

employee i.e., 1.8.2010 is relevant. However, taxability arises on the date of allotment i.e.,

15.12.2010.

Capital gains on sale/transfer of Stock Option

The tax liability at the time of sale will continue to be payable by employee as capital gains (on the

difference between the sale price and the cost of acquisition), however exemption would be

available for gains on sale of listed company shares held for more than 12 months, subject to

payment of STT. The period of holding shall be reckoned from the date of allotment or transfer of

such securities. Further, for determining the capital gains arising at the time of sale of such

shares, the cost of acquisition would be the FMV as on the date of exercise taken into account to

determine the taxable income at the time of allotment of shares.

For example, in the above illustration, if the employee sells 1000 shares on March 31, 2011 @ Rs

120 per share, the capital gains on such shares in the hands of employee would be calculated as

below:

Period of Holding : From 15-12-2010 to 31-03-2011 Short term

Sales Consideration : 120,000

Less: Cost of acquisition : 98,285

------------

Short term Capital Gain 21,715

======


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Concept of Double Taxation Avoidance Agreements

When an individual is sent on an international assignment, based on the respective domestic laws,he could be subject to tax both in home as well as the host country.

Due to this there could be considerable amount of global taxes payable by an individual withrespect to international assignments. We have explained the same in the case study below.

Case study

- An individual (X), qualifying as a Resident in India, is employed in India with a local company(Ind Co)

- X is sent on an international assignment to US on November 1, 2010.

- Xs gross salary is Rs 1,200,000 per annum

- Tax rate in India is assumed at 30 percent and in US, 40 percent

In this example, for the period November 1, 2010 to March 31, 2011, the assignees combinedIndia and US tax liability is 70 percent.

In order to counter such problems, India has entered into Double Taxation Avoidance Agreements(Tax Treaties) with various countries that help to mitigate the double taxation of an individual inmore than one country.

Generally there are two methods of relief available under a tax treaty -

- Exemption method - Under this method, income is only taxed in one of the two countries (ie, itenjoys exemption from tax in one country); and

- Tax credit method - Under this method, the income is taxed in both the countries, but one ofthe countries (ie, the country of residence) allows credit of the taxes paid in the other country.

However, before understanding these methods of relief, it is important to note the following points-

- Before applying treaty provisions, one must always check whether the tax treaty is in force forthat tax year and also, whether the person is covered under the treaty.

- For application of the tax treaty, the concerned individual needs to be a resident of one or bothof the countries. Therefore, conducting this test is crucial to apply treaty relief.

- The term resident means any person who, under the laws of the respective country, is liableto tax therein by reason of his domicile, residence, citizenship, place of management, place of

incorporation, or any other criterion of a similar nature. Few tax treaties provide that the termresident does not include any person who is liable to tax in a country only in respect of havingincome from sources in that country.

Residency under the treaty

There could be situations where an individual could qualify as resident of both the countries (i.e.,as per the domestic tax laws of the respective country). For instance, a foreign citizen onassignment to India could qualify as resident of his home country due to his citizenship and couldalso qualify as a resident in India due to his physical presence in India.


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Where an individual qualifies as a resident of two countries, it become important to ensure thatthere is clarity as to which country would grant the exemption relief and which would grant the taxcredit relief. In order to ensure that this can be determined, treaties normally contain provisions

to tie-break residency to one of the countries. The conditions to break residency are required tobe applied in a chronological order and if any one of the conditions is satisfied by an individual,there is no requirement to check for applicability of any of the further conditions.

The conditions are as under -

(a) Availability of Permanent Home: An individual is deemed to be resident of the country in whichhe has a permanent home available to him. A permanent home is any accommodation available atall times continuously for the individual's use. Even, a rented accommodation available to anindividual continuously could be considered as permanent home. As per the treaty commentaries,permanent home is said to be available if there is an underlying intention of the individual to keepthe accommodation available to him at all the times. An accommodation being available to anindividual for a short duration for the purpose of business travel, holiday purposes, etc aregenerally not considered as permanent home. In case, the individual has a permanent home

available only in one of the countries, he is deemed to be resident of that particular country and nofurther conditions are required to be analysed.

- For example, Mr. X arrived to India from US on three-year assignment.- He has a rented accommodation available in India and no accommodation available in the US,

during the period of his Indian assignment.- Since, he has a permanent accommodation available only in India; he would qualify as a treaty

resident of India.

However, if the individual does not have a permanent home available to him in either of thecountries, or has a permanent home available to him in both the countries, then we need to checkfor applicability of the next condition centre of vital interests.

(b) Centre of Vital Interests: Centre of Vital Interests refers to the individuals personal andeconomic interests. Personal and economic relations of an individual are linked to his familyrelations, his occupations, his political, cultural or other activities, his place of business, the placefrom which he administers his property, etc. The various personal and economic factors must beexamined as a whole for determining the relationship of the individual with each country. If thepersonal relations are closer to one country and economic relations are stronger with the othercountry, then the determining factor could be which country assumes greater significance to theindividual. The individual is deemed to resident of the country with which his personal andeconomic relations are closer.

- For example, Mr. X accepted a three-year assignment in India and consequently moved to Indiafrom the US, along with his family.

- He sold his car and cancelled his health plan and dropped all social affiliations in the US but didnot sell his home in the US.

- In India, Mr. X rented a house, bought a car, obtained a drivers license, and joined varioussocial clubs.

- He opened a bank account in India where his paychecks were deposited and paid income tax inIndia.

- Mr. X had a permanent home available to him both in the US and in India. However, hispersonal and economic relations were closer to India. Accordingly, he would qualify as a treatyresident of India.

If the individuals centre of vital interests cannot be determined, then the next criteria habitualabode of the individual is required to be analysed.


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(c) Habitual Abode: The term habitual abode is not specifically defined. Generally, habitual aboderelates to the country where the individual spends most of his time, regardless of the purpose or aplace which is regularly and repeatedly used by the individual over a period of time. In simple

words, a place where the individual stays more frequently based on physical presence would beconsidered as the habitual abode of that individual. The individual is deemed to be a resident ofthe country in which he has a habitual abode.

(d) Nationality: In case if the individual has a habitual abode in both countries or in neither ofthem, he shall be deemed to be a resident of the country of which he is a national.

(e) Mutual Agreement: Finally, if the individual is a national of both countries or of neither of them,the competent authorities of the both countries shall settle the question by mutual agreement.This is initiated only if none of the above criteria are satisfied.

Relief under exemption method

Dependant Personal Service Clause in the tax treaty (Article 15 or 16 in most treaties)

Clause 1 of the Article on Dependant Personal Services (relating to salary income) of most DTAAstypically states as follows -

"..salaries, wages and other similar remuneration derived by a resident of a Contracting

State in respect of an employment shall be taxable only in that Contracting State unless the

employment is exercised in the other Contracting State. If the employment is so exercised, such

remuneration as is derived therefrom may be taxed in that other Contracting State."

Therefore, Clause 1 prescribes that an individual will be taxed only in the country of residence.The individual may also be taxed in the other country provided services have been rendered in thatother country.

Applying this to our case study, X, being a resident of India will be liable to tax only in India.However, since effective November 1, 2010, he has rendered services in US, he would also beliable to tax in US.

Clause 2 provides that the remuneration of an individual may be treated as exempt in the othercountry and taxable only in the country of residence if the following conditions are satisfied -

1. The individual is present in the other country for a period not exceeding 183 days inaggregate2;

2. The remuneration is paid by or on behalf of an employer who is not a resident of the otherState; and

3. The remuneration is not borne by a Permanent Establishment (fixed base) of the employer in

the other State.

Applying this to our case, X would not be liable to tax in US, if the above conditions are satisfied inthe US. In this connection, please note that since the US tax year runs from January 1 toDecember 31, the assignee would be exempt from tax in US for the US tax year 2010. In order to

2Different treaties provide different periods during which the 183 days period is to be considered. The most

common clauses are 183 days in the fiscal year concerned and 183 days in any twelve month period.


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determine whether the assignee would be exempt from tax in US for the US tax year 2011, thesame analysis would also have to be done for that year.

In this connection, assuming that the assignee is exempt from tax in US in both 2010 and 2011, X

would only be taxed in India. Accordingly, for the period November 1, 2010 to March 31, 2011,the assignees combined India and US tax liability will only be 30 percent.

Thus, this is called the exemption method i.e., income is only taxed in one of the two countries (i.e.,it enjoys exemption from tax in one country).

Relief under tax credit method

Elimination of Double Taxation Clause in the tax treaty (Article 23 or 24 in most treaties)

Relief under the tax credit method is utilized when the relief under the exemption method is notavailable. Under this method, the country of residence will allow a credit of the taxes paid in theother country, against the tax liability in the residence country. The credit is available on theincome that is doubly taxed (i.e. taxed in both countries).

In other words, taxes paid in the other country can be set off against the tax liability of the countryof residence. However, the tax credit is limited to the amount of proportionate or attributabletaxes payable in the country of residence.

Applying this to our case, assuming that X is liable to tax in US, tax credit would be permitted asfollows -

- Income doubly taxed - Rs 500,000

- Tax paid in US @ 40 percent - Rs 200,000

- Tax liability in India on the doubly taxed income - Rs 150,000

- Tax credit available in India - Rs 150,000

Therefore, the assignee will only pay taxes for the period April 1 to October 31 in India. The taxliability for the period November 1 to March 31 will be set-off against taxes paid in the US.

Please note that it is critical to examine the definition of taxes covered under the relevant treatybefore allowing the credit (eg, under the India-US tax treaty, credit in India is allowed only for thefederal taxes paid in the USA and not the US state taxes). Therefore, in this case, if out of 40percent 15 percent is towards US State taxes, the tax credit will be limited to 25 percent ie, Rs125,000.

Further, the taxes covered do not normally include any amount payable in respect of any default oromission in relation to the above taxes or which represent a penalty imposed in relation to those

taxes.

Important note

The above case study of treaty relief has only been provided as an example to explain the concept.Practically, when applying treaty relief, one needs to evaluate the various aspects of the taxtreaty. It is a complicated exercise and should be applied after complete research and relatedback-up documentation as the Revenue authorities generally scrutinize such cases to ensure thatthe correct relief has been claimed.


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Taxability of various streams of income under the treaty

Dividend

Dividends received by an individual are taxable in his country of residence. However, in caseswhere the dividends are received from sources situated in the other country, then even the othercountry may tax the same (if the Company paying the dividend is a resident of the other country).

Usually, the tax treaties define the maximum tax rate beyond which taxes cannot be levied in thesource country on the dividend income paid to a resident of the other country.

Further, where the dividends are taxed in both countries, relief could be claimed under the taxtreaty, in the country of residence.

For example, if an individual qualifies as treaty resident of India and receives dividend income ofUSD 100 from a company resident in US, the same may liable to tax in both the countries. If UStaxes the dividend income at 25 percent and India at 30 percent, the individual would be able to

claim foreign tax credit to the extent of USD 25 (USD 100*25%) in India against the taxes payablein India, of USD 30 (USD 100*30%).

Interest

Interest received by an individual is taxable in his country of residence. However, in cases wherethe interest is received from sources situated in the other country, then even the other countrymight tax the same (if the source of interest income is in the other country).

Usually, the tax treaties define the maximum tax rate beyond which taxes cannot be levied in thesource country on the interest income paid to a resident of the other country.

In such cases, where the interest income is taxed in both countries, relief could be claimed underthe tax treaties, in the country of residence.

For example, if an individual receives bank interest of USD 100 from a bank situated in the US andhe qualifies as a treaty resident of India, the interest income may be liable to tax in both thecountries. If the tax levied on the interest income in the US is USD 15 and the tax levied in India isUSD 30, the individual can claim the USD 15 paid in the US as foreign tax credit in India, againstthe taxes payable in India.

Capital Gains

Most of the treaties provide for taxation of capital gains income either in the country of residenceor in the country of source.

Some treaties provide that capital gains would be taxable in the respective countries, based on thedomestic tax laws of each country (eg, US).

However, in case the capital gains relate to certain assets like ships, shares, etc (assets which arespecifically mentioned in the treaties), the same is taxable as per the provisions of the treaty.

In cases where both the countries tax the capital gains income, foreign tax credit can be claimed inthe country of residence, if the capital gains income arises in the other country.


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- For example X, sold a house property situated in the US for USD 100,000 and the capital gainsincome on this transaction amounts to USD 20,000.

- X qualifies as a treaty resident of India.

- The US taxes on the capital gains income amount to USD 4,000 and India taxes amount to USD6,000.

- X can claim a foreign tax credit in India to the extent of taxes paid in the US i.e. USD 4,000.

Concept of Double Taxation avoidance agreements can be summarized with the help of followingtable:

Scenario India Home/HostCountry

Method

Case 1 NR NR N/A

Case 2 ROR NR Tax CreditCase 3 NR ROR DPSCase 4 ROR ROR Tie Breaker Rule

Note: Different treaties provide different definition for residency. Hence, residency position for NOR depends on the

treaty positions between two countries.


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Typical Tax Compliance Cycle

We shall now discuss the typical tax compliance cycle that we undertake for our clients. The same

has been divided into employee related compliances and employer related compliances, and coversthe following compliances -

a. Employee related compliances

1) Conducting tax briefing for international assignees.

2) Processing the Permanent Account Number for international assignees.

3) Preparation and filing of the Indian return of income.

4) Processing Departure Clearances from the Revenue authorities.

b. Employer related compliances

1) Processing the Tax Deduction Account Number for the employer.

2) Preparation of tax withholding computations and year end withholding forms.

3) Preparation of quarterly return of salaries.

In the following paragraphs, we will try to understand these compliances and the assistance thatEY provides to the clients in greater detail.

Employee related compliances

Tax briefings

In case of international assignments, it is essential that employees, who are being deputed fromone country to another, understand and are familiarised with the regulatory compliances applicableto them in the home as well as in the host country. This helps the employer to ensure that there istimely compliance of regulations by the assignees.

In this connection, our clients engage our services in conducting such briefings. Some of theareas/topics that we typically cover in such briefings are -

- Brief discussion on taxability in India during the period of assignment.

- Appraising the assignees of the local tax registrations like obtaining Permanent AccountNumber, filing documents for registration with Foreign Regional Registration Office.

- Informing the assignees of the ongoing compliances like the India income tax return, the duedates etc.

- Appraising the assignees of the departure compliances prior to departure from India ie,obtaining Tax clearances from Revenue authorities.

- How the employer and EY will be assisting them in meeting the aforesaid compliances.

Such a briefing is also typically conducted by the other countries at the time of departure/arrival.


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Permanent Account Number

The domestic tax laws require every person taxable in India (and other specified persons) to apply

for a Permanent Account Number (registration with the Indian Revenue authorities). ThePermanent Account Number is a 10 digit alphanumeric code allotted to each person and thenumber is required to be quoted in all the documents pertaining to transactions specified underSection 139A.

Further, it is mandatory for every person receiving any amount from which tax is

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