TaxCitizenship Based Taxation

INTRODUCTION

Taxing of personal income and the system related to it is quite diverse across the globe. Different types of taxing systems can be found but when it comes to non-residents, most of the countries agree on taxing only the income earned within that country.

The idea behind it is that if a person does not reside in a country, then the only tax a person owes to that country pertains to the money made within that country. This is known as residency-based taxation of income.

Flipside of the coin, which is not very common, is the Citizenship Based Taxation. In this type of setup, tax is levied not only on the residents, but on all the citizens of the country. It does not matter whether they are residents of the country or not.

Herein below, we have analysed the concept of citizenship-based taxation and how India has put a step towards this system of citizenship-based taxation.

GLOBAL SCENARIO

Many countries in the past have tried to levy citizenship-based taxes, including Vietnam, Romania and Mexico. But most of the countries have abandoned this form of taxation and follow residency-based taxation.

One of the benefits of the citizenship-based taxation is the phenomenon of short-term migration wherein the influx of the tax will be a continued process. But mostly, the setup of citizenship-based taxation has been an area of controversy because of its draconian nature.

Non-residents may be subject to taxation in some countries for a brief time after moving abroad, for example citizens migrating from Sweden are liable to be taxed in Sweden for five years. But there are very few countries in the world that follow a lifelong citizenship-based taxation. United States of America (USA) is the top name amongst them. Till the date, USA taxes the income of its non-residents living worldwide. They must pay the same rate of taxes as the USA residents which implies that USA is the only country in the world where all the citizens have to follow the same tax regime, regardless of their location.

Even though the USA is world’s largest economy, this draconian setup of citizenship-based taxation has existed there for a long time. When income tax was first introduced in the USA during 1861, at that point of time the USA followed residency-based taxation instead of citizenship-based taxation. The citizenship-based taxation in the USA was introduced in the year 1913.

Another country that follows citizenship-based taxation regime (although not as strict as USA) is Eritrea. This country follows what is known a “diaspora tax” or “expatriation tax” where it charges a tax of 2% on all the Eritrean citizens living outside the country. Eritrea has received a significant amount of criticism across the globe for this method of taxing non-residents.

Hungary is also in the same league but its rules are more relaxed compared to the USA and Eritrea. In Hungary, if the citizens have a registered address in Hungary, even if the non-resident has dual citizenship, that person will be taxed [Unless Hungary has a Double Taxation Avoidance Agreement (DTAA) or a Double Taxation Treaty (DTT) with that country].

China also follows a similar regime where it taxes the global income of people who have a domicile in China and the domicile covers all those people who hold a passport from China.

To conclude, many countries in the world have tried citizenship-based taxation regime and a few still follow it. Recently India also took a step towards it and the same is discussed hereunder.

INDIAN SCENARIO

Recently, vide Finance Act, 2020 an amendment was made to the Income Tax Act, 1961 (‘the IT Act’). Prior to the amendment, citizens were taxed on the basis of residency. As per Section 6 of the IT Act, an individual can be classified into Resident, Not Ordinarily Resident and Non-Resident. This status is decided based upon his or her presence in India during the previous year, depending upon which category that person fits in, the tax is levied according to Section 9 of the IT, Act.

The major issue involved with respect to this regime was that the High Worth Net Individuals (‘HWNI’) arrange their affairs in a way that they will not be taxed in any of the countries. For example – Many countries in the world including India requires the person to spend at least 182 days in the country to be declared a resident. So, if the person spends 130 days in three countries and the countries have requirement of spending a minimum of 182 days to be declared a resident, he or she would not have to pay tax in any of the countries. This outcome is very undesirable as it leads to double non-taxation i.e. a person does not pay tax in any of the countries.

This led to the amendment to the IT Act by introduction of Finance Act, 2020. Important amendments were:

1. Amendment to Section 6(1)(b) – Section 6(1)(b) states that “An Indian citizen or a Person of Indian Origin, who is visiting India, stays in India for > 120 days but < 182 days in the previous year and has an income > fifteen lakh rupees would be deemed to be a Non-Ordinary Resident.”
2. Sub-section 6(1A) was added – Section 6(1A) states that “Notwithstanding anything contained in clause (1), an individual, being a citizen of India, having total income, other than the income from foreign sources, exceeding fifteen lakh rupees during the previous year shall be deemed to be resident in India in that previous year, if he is not liable to tax in any other country or territory by reason of his domicile or residence or any other criteria of similar nature.”

Therefore, according to this amendment if a citizen of India is not liable to be taxed in any other country or territory because of the residence, domicile status or residence or any other criteria of similar nature, the person becomes a deemed resident of India and is liable to be taxed in India.

One of the drawbacks of this amendment is that it prescribes a threshold income of Rupees 15 Lakhs from Indian source during the previous year for its applicability. This implies that there is a requirement to calculate the income of a citizen whose status of residence is uncertain; that is sourced in India.

The same is very challenging taking into consideration, the Double Taxation Avoidance Agreements (DTAA) with over 80 countries. Because of this new amendment, there is a chance that income might be taxed in both the countries in the question as the amendment says that income of a citizen is taxed in India if he is not liable to tax in any other country or territory. This amendment might create confusion because the mechanisms of taxation of personal income differ across the world.

AMLEGALS REMARKS

The purpose behind this Amendment is to make a shift from residency-based taxation to citizenship-based taxation. The reason for introducing limited citizenship-based taxation in India is to widen the ambit to include citizens who circumvent the residency rules of IT Act to avoid paying taxes.

One of the top benefits of citizenship-based taxation would be increased personal tax revenue. But it can also have some cons; one of them being the citizens might consider renouncing the citizenship of India to escape the draconian nature of this regime.

In addition to this, the step is taken to increase the personal tax revenue. But taking into consideration the draconian nature of citizenship-based taxation, whether this amendment is the right way to go or not is debatable.

–Team AMLEGALS, assisted by Ms. Pragya Dhanjika (Intern)

For any queries or feedback, please feel free to get in touch with chaitali.sadayet@amlegals.com or aditi.tiwari@amlegals.com.