Improving tax compliance of the ultra-rich

Resident-based taxation system leads to leakage of income tax when HNIs migrate

In 2017, 7,000 high net worth individuals (HNIs) migrated overseas from India, a 16 per cent increase from 6,000 in 2016. Australia was the top country for HNI inflows in 2017 with 10,000 ultra-rich shifting base to the country from across the world, beating out its main rival, the US, for the third year running.

Indian tax authorities are concerned about the high rate of migrating HNIs. This is because Indian income-tax laws provide for the taxability of an individual on the basis of his/her residential status in the country. Global income is taxed only of those individuals who attain the status of resident as per the criteria specified in the law, which is determined by an individual’s period of stay in India.

This resident-based taxation system leads to the leakage of income tax in India, especially from HNIs shifting their residence to foreign jurisdictions. This way, they qualify as non-resident Indians, liable to tax only on the income arising in India.

Citizenship-based taxation

Unlike India, many jurisdictions follow the citizenship-based taxation system wherein global income of an individual is taxed only if she becomes a citizen of such jurisdiction. HNIs can plan their affairs so that they do not get taxed in a foreign jurisdiction owing to the fact that they are not citizens of that country or that country is a tax haven that doesn’t tax migrating HNIs.

At the same time, India also doesn’t have any taxing right over an HNI once he becomes a non-resident Indian. Additionally, once his status turns into non-resident for tax purposes, he can also refrain from reporting the details of his foreign assets and income in his Indian tax returns. The complex nature of HNIs enables them to evade taxes in India as well as such other jurisdictions, leading to nil tax in both the jurisdictions.

The US, on the other hand, retains the taxing right over all its individual citizens, whether physically present in the US during a financial year or not.

Accordingly, they remain liable to tax on their worldwide income, irrespective of their residential status.

In India, however, the residential status of an individual is determined by his physical stay in India, which is calculated on a yearly basis. Indian taxpayers may escape taxes in India and the US by merely changing their residential status.

Cues from abroad

HNIs pose serious challenges to tax administrations mainly owing to the complexities of their affairs, revenue contribution, opportunity for aggressive tax planning and the impact of their compliance behaviour on the integrity of the tax systems.

Tax authorities are gathering and analysing a wide range of publicly available information that contain details on the lifestyle, properties, personal interests and the location from which an HNI conducts business. Also, they obtain information from other government and regulatory bodies that may maintain asset registers for properties, aircraft, shares and securities.

Firm action, when combined with good compliance and service, can significantly improve compliances by HNIs. In this direction, a Working Group had been formed to find a solution to the double non-taxation of HNIs migrating to foreign jurisdictions. It would be interesting to see what changes the group would suggest in the tax laws to plug this tax leak.

Cues can be taken from the measures implemented by other countries. To protect the interest of the revenue at the time of surrender of tax residence/citizenship, certain countries impose tax on such migrating HNIs on the unrealised gain attributable to the period of their residence/citizenship.

For instance, the US imposes an exit tax upon surrender of citizenship. Similarly, Canada levies departure tax and Spain levies exit tax on an individual’s change of residential status.

The writer is Partner, Nangia & Co.

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