Taxing deferred foreign emoluments in India: a move to widen the tax base?

In today’s era of globalisation, many individuals move to a foreign jurisdiction for better employment opportunities. In many cases, individuals receive emoluments such as bonuses, shares in lieu of employee stock options (ESOPs), and other perquisites from their past employer abroad after they return to their home country (say, India). A conundrum arises with respect to the taxability of such emoluments in respect of employment that is exercised abroad but received in a later year, when the employee becomes a resident of India.

Recently, a similar issue came up before the Delhi bench of the Income Tax Appellate Tribunal (the Tribunal), wherein the Tribunal categorically held that a bonus received by an Indian resident with respect to past employment exercised abroad is taxable in India. Considering the far-reaching implications of the ruling, this article aims to analyse the decision and the income tax impact of deferred emoluments that are received in lieu of employment exercised abroad.

In the case of Souvik Mukherjee v Income Tax Officer, the assessee was a tax resident of India during the assessment year (AY) 2012–13. During that year, the assessee received a bonus from his previous employer in Singapore. The bonus was received in lieu of rendering employment services in Singapore during the previous AY (i.e., 2011–12), when he was a non-resident.

The assessee treated his bonus as part of his income in filing the income tax return in India. However, the assessee claimed a tax exemption on the income in India by contesting that since the bonus was received outside India in a Singapore bank account and in respect of services rendered by him when he was a non-resident, the income is not taxable in India. The contention was rejected by the lower tax authorities and the matter reached the Tribunal.

The Tribunal observed that the right to receive a bonus was not automatic; i.e., the bonus became payable to the assessee only after the company explicitly declared it in AY 2012–13. In its ruling on June 27 2023, it consequently held that the bonus was accrued and received in AY 2012–13, when the assessee was a resident in India. Therefore, the bonus falls within the scope of the total income of the assessee, in light of Section 5 of the Income-tax Act, 1961 (the IT Act). Furthermore, the tribunal held that in terms of Section 90 of the IT Act, the assessee is entitled to foreign tax credit to the extent of the tax paid in Singapore with respect to the bonus amount.

Similar to a deferred bonus, persons returning to India may be allotted certain ESOPs after termination of the employment that was exercised by them abroad. In India, it is a settled position of law that a perquisite in the form of ESOPs is taxable in the hands of the employee at the time of allotment of shares. Accordingly, a conundrum may arise when ESOPs are vested in an individual when they are a non-resident, but the option is exercised, and shares are allotted after termination of employment when the individual becomes a resident of India.

A similar issue arose before the Canadian Tax Court in the case of Tedmon v Her Majesty the Queen, 1991, wherein an individual taxpayer was employed with General Electric, US (GE) and was a tax resident of the US from June 1964 to February 1987. Subsequently, he became a tax resident of Canada and began working for a Canadian company. In 1988, the individual, while a Canadian tax resident, exercised his option to a US stock plan of GE. During the tax assessment, the individual relied on Article 15 of the US–Canada double tax convention to advance an argument that Canada cannot tax this income since it arose from employment exercised in the US. However, the court upheld the Canadian tax authority’s argument and taxed the same under local law by holding that the individual received the benefit when he was a Canadian resident.

The principles laid down by the Canadian ruling and the Tribunal ruling in the case of Souvik Mukherjee will allow the Indian tax authorities to tax income from shares allotted under ESOPs that were vested while exercising employment in a foreign jurisdiction (Soundarrajan Parthasarathy v DCIT, 2016).

The ruling in the Souvik Mukherjee case certainly provides clarity on the taxability of a deferred emolument received by residents in lieu of past employment exercised abroad. However, it will be interesting to see whether this will unequivocally apply in the following cases:

• Where a certain fixed or contractual bonus (performance/referral bonus, etc.) forming part of an employee’s cost to the company, and accruing from employment exercised abroad, is received in later years in India; and

• Where ESOPs are vested abroad and the corresponding income has already been taxed in the source state at the time of vesting, but the option is exercised in a later year after the person becomes a resident of India.

Despite the aforesaid ruling, in such cases, taxpayers will be free to contest that if the remuneration is casually connected to, and intends to compensate a person for, their past employment activities, the remuneration should be taxable in the state where the employment was exercised (paragraph 2.4 of the Commentary on Article 15: Concerning the Taxation of Income from Employment, Model Tax Convention on Income and on Capital, 2017).

Furthermore, an argument may be available to the taxpayer that if the income in question accrued in an earlier year when they were a resident of another country, then the same should not be taxable in India merely because they have become an Indian resident in the year of receipt.

The position and arguments in each case may vary depending on the underlying facts and circumstances. It will be interesting to see how courts deal with these cases.

Meanwhile, employees returning to India and anticipating the receipt of emoluments in India should factor in the additional tax cost. Commercially, this may become a bigger issue for employees returning from countries that do not impose personal income tax on individuals, such as the UAE and Saudi Arabia.

This may call for proper planning on the part of these individuals to avoid an unnecessary financial burden.