India should liberalize its taxation regime for expats

India has undoubtedly emerged as an attractive destination for international investment, with foreign direct investment (FDI) inflows in 2021-22 at an all-time high of $83.5 billion. However, as of October 2022, none of the top 50 Fortune 500 companies have chosen to locate their Asia-Pacific headquarters in the country. No Indian city has found its way into the 15 most significant global financial centres expected by 2024, or even the top 10 list of Asia-Pacific cities of the future. Singapore and China (though less so in recent times) remain preferred destinations for global conglomerates. As India sets its sights on becoming a global financial hub, it can benefit from emulating the investor-friendly business environment of its Asian competitors. In particular, India stands to gain from liberalizing its stringent income tax laws for foreign nationals.

Singapore and China have set an international benchmark with their liberal income tax regimes for expats. In 2003, Singapore announced a tax exemption for residents on their foreign-sourced income. Since 2019, expats in China only pay taxes on global income if they have held tax resident status for six consecutive years. This period restarts from zero if the individual leaves China for a consecutive period of 30 days or 90 days cumulatively within a year. By contrast, foreign-domiciled individuals in India are subject to taxes on their global income if they live in India for over 182 days, as they are assigned Overseas Citizen of India (OCI) status after this period. This period can be extended by amending Section 6 of the Income Tax Act, 1961, in line with applicable parallel provisions in Singapore and China.

Such a tax policy change effected by India would be beneficial for three reasons. Firstly, it would attract greater FDI. In both Singapore and China, the introduction of a liberal tax policy regime for expats was associated with a significant increase in FDI inflows across sectors.

A decisive factor that drives a company headquarters’ location decision is the ease of living and doing business in the host country. If investors setting up new enterprises are able to stay for extended periods without being subject to taxes on their global income, they are better able to manage their overall investments effectively. Additionally, the key managerial personnel of these companies are likely to include expats who also seek relief from dual taxation (in two jurisdictions).

The positive spillovers of FDI are well documented. Besides bringing in capital, FDI is a non-debt financial resource that promotes economic growth, generates new jobs, enables access to international markets and promotes competition in domestic markets. It facilitates the transfer of technology, skills and organizational and managerial practices, as local employees are trained and domestic firms are integrated into production processes.

India’s FDI stands at 2.7% of gross domestic product (GDP) and has largely stagnated around this proportion of national output in recent years. By comparison, China received 6.2% of GDP at its peak.

Secondly, a significant loss of tax revenue due to the policy change we recommend is unlikely, as the beneficiaries of this exemption are not domiciled in India. Since locally-sourced income would continue to be subject to the usual Indian tax regime, domestic income generated by FDI would augment government revenue through the taxation of wages and profits generated by foreign-owned companies in India. There are concerns over tax revenue losses on account of high net-worth Indian citizens taking up foreign citizenship to avail of such a tax exemption. To prevent such misuse, the exemption may be provided to foreign-domiciled individuals who have not been citizens of India for a significant period of time, such as 3 to 5 years.

Thirdly, while expats can already avail of double taxation avoidance treaties to serve the same purpose, several practical challenges make this process cumbersome. If the tax rate of their home country or the country where their income is generated is lower, they would end up paying higher taxes when their global income is taxed in India. They may be unable to avail of tax credit benefits due to mismatched financial years, as India follows an April-to-March annual schedule while most other countries follow the calendar year. They are likely to face greater subjectivity in tax assessments by Indian tax authorities, given the incorporation of the new ‘principal purpose’ test since India’s signing of the Multilateral Instrument, adopted by over 100 countries and jurisdictions about half a decade ago. Additionally, they would be exposed to risks arising from reporting requirements, as the smallest error in reporting foreign assets would incur heavy penalties.

It is no wonder that India remained in the bottom 40% of global economies in the 2020 edition of Paying Taxes Ranking, which ranks the administrative burden of paying mandatory contributions and complying with post-filing procedures in different countries. Given India’s bid to become a $5 trillion economy within this decade, substantial and lasting foreign investment is more vital than ever. The need of the hour is a favourable tax policy regime and robust business environment for foreigners who plan to stay and work in India.

These are the authors’ personal views.

Palakh Jain & Shreya Ganguly are, respectively, an associate professor at Bennett University and senior visiting fellow at Pahle India Foundation; and a research assistant at Pahle India Foundation