Unsettled waters ahead for non-resident Indian sailors?

Indians working in the merchant navy (commonly known as ‘Sailors’) form a large part of the expatriate community of India. These sailors work aboard ships owned by foreign companies, which sail in international waters and earn their salaries for the services rendered on such ships.

In the earlier times, the salaries were also paid to these sailors in cash aboard the ship itself. However, with the advance of times, the salaries are paid directly into the designated bank accounts of such sailors. Historically, these sailors have taken positions in their tax returns that their salaries are not taxable in India as the salaries are not accruing or arising in India and are also received by them aboard the ship outside India. The credit in the Indian bank account was considered only as a subsequent deposit of the salary i.e. application of money accrued and received outside India.

However, this settled position is now being challenged in cases where the salary of these sailors is transferred from the foreign employer’s bank account outside India directly in the sailor’s Non-resident External (NRE) account in India. The issue on hand in such cases is whether it can still be said that such salary is received outside India and only subsequently transferred to a bank account in India or is it a case of first receipt of salary in bank account in India itself.

Provisions of the Income-tax Act, 1961 (‘the Act’)

These sailors are generally Non-resident (NR) under the provisions of the Act because their stay in India does not exceed 182 days in a financial year. As per the provisions of the Act, the following incomes are taxable in India in case of NR taxpayers:

a) Income received or deemed to be received in India; or/ and

b) Income accruing or arising or deemed to be accruing or arising in India

It has been observed that while taking a position on non-taxability of their salaries, the sailors generally tend to concentrate more on the fact that the income is accruing or arising outside India. However, they lose sight of the manner in which the salary is received by them. The manner of receipt of income is equally important too because income which is not accruing or arising in India under point (b) can still be taxable under the Act if the same is ‘received’ or ‘deemed to be received’ in India under point (a).

While this issue is not relevant in cases where salary earned outside India is deposited in the Indian Sailor’s bank account outside India, there is a practical challenge in cases of Indian sailors who are not in a position to receive the salaries in a bank account outside India and are hence forced to receive the same directly in their NRE accounts in India.

The taxability of such receipt was discussed in the recent decision of the Kolkata Tribunal in the case of Tapas Kumar Bandopadhyay Vs. DDIT[1] where it was held that remuneration received by the taxpayer from the foreign company directly in his NRE account was taxable in India as the same was ‘received’ in India and was not a case of ‘transfer’ of earned salary to India.

Facts

• The taxpayer was a NRI Marine Engineer rendering services aboard ships of foreign employers outside India.
• The taxpayer received his salary in US$ which was deposited in his NRE Account in India.
• The taxpayer’s position in the tax return was that the amounts credited in NRE account in foreign currency were earned and received by him outside India and hence were not taxable in India.
• The taxpayer’s argument on the ‘receipt’ issue was mainly that he had gained control over the salary in international waters and only for the sake of convenience he had instructed the foreign employer to send the monies to his NRE account in India. In other words, the argument was that amount brought into India was the salary ‘amount’ and not the salary ‘income’. Hence, it was a case of application of income.
• The Assessing Officer (‘AO’) however did not agree with the position taken by the taxpayer and held that the salary received directly in NRE account in India was taxable in India on ‘receipt’ basis.
• The first appellate authority upheld the order of the AO. Aggrieved by the same, the taxpayer filed an appeal with the second-appellate authority (Tribunal).

Decision of the Tribunal

While ruling on the matter against the taxpayer, the Tribunal held as under:

• The only possibility of receiving salary on board of a ship outside India is to receive in hot currency. In the taxpayer’s case, it was not that hot currency received aboard ship got subsequently deposited in the NRE account. The salary money was directly transferred from the employer’s account outside India to the taxpayer’s NRE account in India. Accordingly, it was difficult to accept the contention that salary was not ‘received’ in India in absence of documentation.
• The Third Member decision of the Mumbai Tribunal in the case of Captain A. L. Fernandes Vs. ITO[2] would squarely apply in the taxpayer’s case as in that case it was held that since the salary was received in Indian bank account by the NR taxpayer, the said income was taxable in India on ‘receipt’ basis.
• The Tribunal specifically observed “Moreover, we find that if this argument of the assessee is to be accepted, then the assessee goes scot free from not paying tax anywhere in the world on this salary income. The provisions of section 5(2)(a) of the Act are probably enacted keeping in mind that income has to suffer tax in some tax jurisdiction. We believe that such provisions would exist in tax legislation of all countries. We hold that if the argument of the assessee is accepted, then it would make the provisions of section 5(2)(a) redundant. It is only elementary that a statutory provision is to be interpreted ut res magis valeat quam pereat, i.e. to make it workable rather than redundant. From the provisions of section 5(1) of the Act, in the case of a resident, then global income is taxable in India. In case of non residents, the scope of total income has four modes, one of which is receipt in India, ’from whatever source derived’. If this is construed to mean that income from whatever source, should first accrue or arise in India and then it should be received in India to be included under section 5(2)(a), then section 5(2)(a) will lose its independence and will become a subset of section 5(2)(b) and there would not be any need for having section 5(2)(a) on the statute.”
• In this regard, let’s also analyse some more decisions rendered in this regard :
  • In the case of Avatar Singh Wadhwan[3], the taxpayer, a marine engineer was working on an Indian ship. The ship did not touch Indian coast except for 8 days during the previous year. The Assessing Officer concluded that the income of the taxpayer was taxable in India on the ground that the same accrued in India. This conclusion was based on the premise that the taxpayer was an employee of an Indian ship and the salary was earned as per contract which was executed in India. The Hon’ble High Court of Mumbai reversed the decision and held that the income of the taxpayer accrued outside India and hence the same was not taxable in India. In arriving at the conclusion, the Court relied on Circular No. 586 of 1990, which provides clarification regarding liability to income-tax in India and deduction of tax at source of members of the crew of foreign going Indian ship. The Hon’ble Court, keeping in mind the provisions of section 5,6 & 9 and the fact that the taxpayer was a non-resident held that in order to decide whether the income accrues in India what was important was the place where the services are rendered and not the source of income. Thus, although this decision is quite commonly used for the purpose of deciding the taxability of sailors, unfortunately, this does not deal with the receipt part and hence would not be applicable to the above mentioned Kolkata Tribunal decision.
  • Similarly, in the case of Prahlad Vijendra Rao[4], the taxpayer worked as a chief engineer on the board a ship. He stayed outside India for 225 days. He earned salary on account of the work discharged by him on board outside the shores of India. The Assessing Officer held that the amount received by way of salary was income deemed to have been received in India as per section 5(2)(b) and brought the same to tax in India. Relying on the decision of Avtar Singh Wadhwan, the Hon’ble High Court of Karnataka held that the income was not taxable in India. It further held that as per section 5(2)(b), the income which is earned in India for services rendered in India only is taxable in India. It further went on to hold that under section 15, even on accrual basis salary is taxable only when services are rendered in India. If services are rendered outside India such income would not be taxable in India. Thus, this decision also did not dwell on the aspect of receipt of salary in India.

It is interesting to note that while the Kolkata Tribunal has relied on the Third Member bench of the Mumbai Tribunal in case of Captain Fernandes by treating the same at par with a Special bench decision, the Kolkata Tribunal has not discussed an earlier ruling of Kolkata Tribunal itself in the case of Ranjit Kumar Bose v. ITO[5].

In the case of Ranjit Kumar Bose, it was held that where salary earned from services provided outside India was received in India during the same year, the said salary would not be taxable in India. The rationale was that ‘salary’ is to be taxed in India on accrual basis whether received or not. The same can be taxed on receipt basis only if the same is received in advance. Since the taxpayer had provided services outside India and the said income was accruing outside India, the same was not taxable in India even if ‘received’ in India during the same year.  In our view, the later decision of the Kolkata tribunal appears to be a better view as, if one adopts the earlier view , it would make section 5(1)(a) otiose. Further, in earlier decision Kolkata tribunal relied on the provisions of section 15 to come to conclusion that since salary is taxable on accrual basis, the place of receipt has no relevance.  However, in our view, section 5 and section 15 operate in different field and one can not bring in provisions of section 15 into play to defeat the provisions of section 5.

After-math of the decision

The decision of the Kolkata Tribunal has come as a jolt to many Indian sailors who have been taking the positions of non-taxability of salary incomes in their tax returns. In fact, recent newspaper reports suggest that the income-tax department has begun issuing notices to such sailors asking them to pay taxes. With the option available to the income-tax authorities to reassess incomes of up to past 6 years, this action is expected to impact approximately 100,000 such sailors in India.  The key here is to understand how the sailors have arranged their affairs and at what point of time they get control of the money. If they can demonstrate that the money was received outside India and what has been received in Indian bank account is merely “transfer” of money, then perhaps they can still take a position of non-taxability in India.

 In this regard, attention is drawn to the judgment of the Karnataka High Court in the case of Director of Income tax Vs. Dylan George Smith[6] where it was held that salary earned from services provided in international waters and received in NRE account in India was not taxable in India as the said amounts were received on board the ship and were only ‘allocated’ by the taxpayer in his NRE account in India. Accordingly, in this case, documentation seems to have helped the taxpayer defend his position of non-taxability of such salary income in India.

Considering the variation in views arising on this issue across Tribunals and the impact that the decision of the Kolkata Tribunal in case of Tapas Kumar Bandopadhyay would have on the Indian sailors and also possibly on the industry (if the sailors insist on higher salaries to negate such tax impacts), it is likely that this issue may be litigated further before the Courts to attain absolute clarity on the taxation of such incomes.

In the meanwhile, it is advisable that the sailors properly analyse the facts of their case before taking a position of non-taxability under the Act. If need be, the modality of receipt of salaries from foreign employers needs to re-evaluated to ensure that the sailors are not venturing into a voyage of uncharted tax territory!

[1] ITA No. 70/Kol/2016

[2] [2002] 81 ITD 203 (Mum.) (TM)

[3] (2001)247 ITR 260 (Mum)

[4] (2011)239CTR107(Kar)

[5] [1986] 18 ITD 230 (CAL.)

[6] [2011] 11 taxmann.com 348 (Kar.)