Hypothetical Tax Paid Abroad Not Income

In what would come as a relief to expat employees coming to India on a posting or Indian employees going abroad, a tax tribunal has ruled that they could exclude the amount deducted as ‘hypothetical tax’ by their employers from their taxable income in the country. The tribunal turned down income-tax authorities contention that this amount was part of the total salary and hence taxable.

Hypothetical tax is an approximate amount of tax liability of the employee which would have been there in his home country, had he not been sent out. The employer deducts the amount from the employee’s salary and takesover the obligation of paying the actual taxes incurred by the employee at the assignment obligation and at home.

The idea behind the hypothetical tax is to ensure that employees salaries remain tax neutral when they are posted to another country. The Mumbai bench of the Income Tax Appellate Tribunal has ruled that the tax should be allowed to be claimed as a deduction from the gross salary and not treated as a part of it. It held that the amount of hypo-tax withheld from the salary of the taxpayers was not income accruing to him in India.

“In respect of international assignments, generally tax equalisation policies are followed wherein employer assures the employee net of tax salary in respect of the actual tax liability in the country of assignment. These policies are very effective in international assignments as employee gets the comfort of receiving a specified amount of take home salary irrespective of tax rate in host country,” said Vikas Vasal, executive director (tax and regulatory services), KPMG.

The judgement was given out in the case of an employee of British Airways, who was a foreign national and not a resident in India in the assessment year 2001-02 for which the income-tax return was filed. For tax purposes, a resident is anyone who has stayed in the country for more than 180 days. The taxpayer had reduced the amount of hypo tax withheld by the employer from the gross salary income.