Globe-trotting on work, alongside its advantages, also gives rise to a host of taxation issues due to different laws in different countries. Generally, when individuals go abroad on work, they open social security/ retirement fund accounts in the host countries (e.g., 401K and IRA in the US) and income from such contributions is tax deferred to the year of withdrawal/closure of such accounts in those countries.
However, in a majority of cases, the Indian employees seconded to other countries are non-resident in India in the year of opening the accounts/making contributions whereas at the time of maturity/closure, such employees are already back home and tax residents of India. Taxation of income from such contributions poses major challenges for such employees in India, difficulty in availing Foreign Tax Credit being the most conspicuous.
Taxation modalities
Taking cognisance of this difficulty, the Finance Act, 2021, introduced section 89A in the in the Income-tax Act, 1961, from FY 2021-22 onwards to reduce such hardship. The section provides that income accrued to a specified person in a specified account shall be taxed in such manner and in such year as may be prescribed. A specified person for this purpose is a person resident in India, who has opened a specified retirement benefit account in a notified country (the US, the UK, or Canada) while being non-resident in India and resident in that country.
To take this forward, CBDT recently prescribed the manner of taxation of income referred to in section 89A by introducing Rule 21AAA in the Income-tax Rules, 1962. Under Rule 21AAA, these specified persons are given an option (from FY 2021-22 onwards) to tax the income accruing to them in specified accounts, in the year in which such income is taxed on withdrawal/redemption in the respective countries. If any income is already offered to tax in India on accrual basis or was not so taxable owing to the person’s tax residency or treaty benefits, such income would be excluded from taxability in the year of withdrawal/redemption.
A taxpayer has to exercise the option for a particular year by filing Form 10-EE. Such option has to be exercised in respect of all the specified accounts, and once exercised, the option cannot be subsequently withdrawn. The option, however, stands withdrawn if a specified person becomes a non-resident in India in a particular year after exercising the option.
Grey areas remain
What is the impact of such change in tax residency? Here’s an illustrative example: Mr X, who has exercised the option in FY 2021-22, becomes a non-resident in FY 2024-25. As a result, option exercised by him stands withdrawn from FY 2024-25; and income accrued to him from FY 2021-22 to FY 2023-24 becomes taxable in FY 2023-24, though tax on such income can be paid till the due date of filing tax return for FY 2024-25 (July 31, 2025).
Unless the change in tax residency during FY 2024-25 can be anticipated in FY 2023-24 itself, Mr X would be paying the said additional tax in the next FY (FY 2024-25). This may, in turn, make him liable for interest under sections 234B and 234C on such tax; and it is not clear if Mr X would get immunity from such interest . Further, Mr X would not be able to file a revised/belated return for FY 2023-24 beyond March 31, 2025, though he can still pay the additional tax by July 31, 2025. Moreover, as such income taxed in India in FY 2023-24 would be taxable in the notified country at the time of withdrawal/redemption, it seems that it will be taxed in both the countries (albeit in different years) without scope for elimination of double taxation.
Besides, it appears that section 89A and consequently rule 21AAA would not apply if a specified person is resident or non-resident in both India as well as a notified country at the time of opening a specified account. Further, different tax years followed by different countries would pose challenges in determining the point of tax residency and consequent applicability of these provisions. Positions like tie-breaker rule under the tax treaties and split residency may have to be explored (but may not necessarily be accepted by tax authorities). Thus, clarity on such issues will help in avoiding probable litigation on this front and taxpayers would, in the true sense, be able to avail the solace sought to be provided by these provisions.
The writers are Partner and Director, respectively, at Nangia Andersen LLP