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India needs to design legislative pills to euthanise tax-induced expatriation!

THE POLICY LAB (TPL) - 43
APRIL 20, 2024

By J B Mohapatra

IN answer to Lok Sabha starred question no 29, on matters related to renunciation of Indian citizenship, EAM's statement dated 21-7-23 reads as follows:

"As per the information available with the Ministry, the number of Indians who renounced their Indian citizenship was 85,256 (in 2020); 1,63,370 (in 2021); 2,25,620 (in 2022) and 87,026 (till June, 2023). For reference purposes, data was 1,22,819 (in 2011); 1,20,923 (in 2012); 1,31,405 (in 2013); 1,29,328 (in 2014); 1,31,489 (in 2015); 1,41,603 (in 2016); 1,33,049 (in 2017); 1,34,561 (in 2018); 1,44,017 (in 2019).

The number of Indian nationals exploring the global workplace has been significant in the last two decades. Many of them have chosen to take up foreign citizenship for reasons of personal convenience. The Government is cognizant of this development and has undertaken a range of initiatives centring around 'Make in India' that would harness their talents at home. At the same time, to take full advantage of the contemporary knowledge economy, we have also promoted skills and start-ups. Recognizing that the Indian community abroad is an asset to the nation, Government has brought about a transformational change in its engagement with the diaspora. A successful, prosperous, and influential diaspora is an advantage for India, and our approach is to tap diaspora networks and utilize its reputation for national gain. The Government's efforts are particularly aimed at encouraging the exchanges of knowledge and expertise in a manner that would contribute to India's national development."

Reading the above reply alongside another reply to unstarred question no 2466 dated 10-08-23 in the Rajya Sabha by the MOS (MEA), 3 aspects become clear: (a) USA, UK, Australia, Canada remain the most desired destination countries for immigration (b) there are no official data on the number of businessmen or HNIs who have opted for renunciation of Indian citizenship (c) Individuals renounce their citizenship for reasons personal to them.

2. Renouncing Indian citizenship on a voluntary basis is statutorily provided under section 8 of the Citizenship Act, 1955 read with Rule 23 of Citizenship Rule, 2009. Renouncement or surrender of Indian citizenship entails no liability on the declarant except the liability to surrender of certain official documents which the declarant had acquired on the basis of his Indian citizenship. Especially, since India (generally) taxes residents rather than citizens, permanent and voluntary expatriation by an Indian citizen from India creates no special Indian tax liability.

3. Criterion of residence and not citizenship being seminal to enforcing taxation in most tax jurisdictions, there are at least two distinct practices across tax jurisdictions in firming up an architecture for taxation of erstwhile citizens by the original tax jurisdiction:

A - Imposing tax on erstwhile citizens for a length of time subsequent to their renunciation of citizenship:

Under this practice, a citizen even though has renounced his citizenship is liable to tax in the jurisdiction where he was originally resident for 3 to 10 subsequent years, unless he is able to establish that he has severed all 'essential ties' or 'substantial economic ties' with the jurisdiction he was originally resident of. 'Essential ties' or 'substantial economic ties' mostly connote (a) the erstwhile citizen's spouse or family continues to reside in the country whose citizenship has been renounced (b) owning real estate in the jurisdiction whose citizenship has been renounced (c) pursuing business activities in the jurisdiction whose citizenship has been renounced.

Examples are Germany's 'extended limited tax liability' under section 2 of the Foreign Tax Act, whereby an individual who has been resident in Germany for at least five years prior to emigrating is subject to a limited tax liability for a period of ten years after the year in which the unlimited tax liability ended if (a) the burden of income tax levied in the foreign territory is more than one-third below the burden of German income tax for individuals under otherwise identical conditions and (b) individual living abroad continues to have substantial economic ties with Germany.

In Finland, an immigrating citizen is liable to income tax on his global income for 3 succeeding years, unless he is able to establish that he has severed all 'essential ties' with Finland.

Tax jurisdictions in France, Norway, Spain and Sweden more or less with slight inter se variations follow the above model of taxing former residents based on almost similar criteria.

B - Departure tax on unrealized capital gains at the time of expatriation:

Departure or exit tax adopted among certain tax jurisdictions is principally an effort to impose tax on such benefits the expatriate derived during the period when he was both a citizen and a tax resident and obliquely it could be working to dis-incentivise the act of renunciation of citizenship. Australia's exit tax applies to assets in ownership of a former resident whose disposal creates liability to a capital gains tax and for a former resident, it covers all such assets other than 'taxable Australian property' (TAP). A former resident is liable to determine gain for each qualifying asset owned prior to the individual becoming a non-resident on the basis of fair market value of assets and also liable to pay taxes thereon by deeming the very act of expatriation as an event of deemed disposal of those assets. USA, Canada, Denmark and Singapore have similar form of exit tax for an emigrating individual.

26 US Code 877A narrating 'tax responsibilities of expatriation' reads as follows:

"(a) General rules- For purposes of this subtitle -

(1) Mark to market

All property of a covered expatriate shall be treated as sold on the day before the expatriation date for its fair market value."

A 'covered expatriate' is defined in 26 US Code 877 as an individual who fulfils any one of the 3 parameters: (a) net worth test: net worth of USD 2 Million or more on the date of expatriation (b) net income tax liability test: average annual net income tax of USD 1,90,000 or more (for the year 2023) (c) non-compliance with taxes: individual has failed to certify on Form 8854 - compliance reporting on US federal tax obligations for the 5 year period preceding the date of expatriation.

4. While India broadly ignores citizenship in creating a taxing jurisdiction, renunciation of Indian citizenship has real world consequences for its own tax revenues, principally because the income earning capacities of erstwhile citizens and current expatriates would be ostensibly utilised elsewhere other than in India which will generate income and consequent rendering taxes for an altogether different taxing jurisdiction on a permanent basis. These seminal revenue significant events for some other purpose and in some other set of circumstances are required in terms of the Indian Income Tax Act to be specifically reported. For example, when a person terminates or discontinues his business, under section 176(3) of the Act (quoted below), this has to be reported within a 15 day period:

"(3) Any person discontinuing any business or profession shall give to the Assessing Officer notice of such discontinuance within fifteen days thereof."

Conversely, renunciation/ surrender of Indian citizenship is not a compliance requirement for specific reporting to the ITD.

On substantive basis, India's Income Tax Act presently does not provide for any tax on individuals who have renounced their citizenship but continue to maintain significant economic ties with India. It also does not have a departure or exit tax for individuals seeking to permanently renounce their Indian citizenship. Evolution of both ideas in most jurisdictions where legislative framework exists for the said purposes arose on account of significant number of termination of residency by the well-heeled and wealthy individuals. It is well within the legislative competence of India's policy makers to weigh in the absolute and incremental expatriation numbers on a year on year basis, and then decide on the exact instrumentality to prevent the adverse tax consequences of expatriation including the timing of such policy move.

The end goals of a tax regime seeking to impose tax on citizens intending to renounce their citizenship either before the date of their actual renunciation in respect of certain unrealised capital gains or after the completion of renunciation/ surrender of citizenship for a length of time on the basis of certain indicators are many. One, it may deter tax-induced expatriation and act as a disincentive for those whose principal motivation in seeking citizenship of a new country is only to escape rigours of continuing judicial or fiscal proceeding in the original tax jurisdiction. Two, it expresses the rightful claim of the original jurisdiction to impose tax on the appreciation in asset value of an individual intending to renounce his citizenship. Three, it ensures that no tax benefits accrue to expatriating individual if the individual continues to maintain significant ties with the original tax jurisdiction. These are not unreasonable grounds for establishing a fairer tax regime and as a counter to substantial scale permanent relocation of high net worth permanent resident individuals.


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