1. Why Budget proposal on tax on Indians working abroad triggered confusion

Relevant for GS Prelims & Mains Paper III; Economics

An amendment to the Income Tax Act proposed in the Finance Bill 2020, has created confusion about Indians who primarily work and earn their living outside India.

The broad import of the amendment, as understood on February 1, was that all Indians who were working abroad and not paying any income tax in those countries — like the many Indians who work in jurisdictions like the UAE — would be liable to be taxed in India. Kerala Chief Minister Pinarayi Vijayan wrote to Prime Minister Narendra Modi recording his government’s “strong disagreement” with the provision, which he said “will hurt those who toil and bring foreign exchange to the country”.

On February 2, the Finance Ministry issued a clarification, and Finance Minister Nirmala Sitharaman sought to reassure non-resident Indians that they would not be unfairly targetted.

What is the existing law?

There are two parameters which determine whether India levies income tax on an individual. The first is “residency”. Unlike in the United States where citizenship also implies residency, in India, residency requires a person to actually live in the country for a specified number of days in a year.

The other parameter is the “source” of the income — the country where the income is being generated. The difference between the treatment of a resident and non-resident Indian citizen is that for a resident Indian citizen, the income tax law applies to that person’s worldwide income — that is, any income earned in any jurisdiction is used to calculate the taxable income, and such a resident Indian is required to pay tax on all of it.

But for a non-resident Indian, the income tax law applies only to the income earned from within India. As such, if an Indian national lives in New Delhi but earns rental income from a house she owns in London, then, along with all other income that she earns within India, this rental income too, will attract tax.

However, if an Indian citizen stays and works in London — making her a non-resident Indian — and additionally earns a rental income from a home in Delhi, then the Indian income tax would apply only to the rental income from that Delhi home.

What is the amendment proposed by the government?

The proposed amendment to the IT Act has three parts. The first cuts the number of days that an Indian citizen can stay in India without becoming a “resident”, to 120 from 182. The Memorandum to the Budget said this provision was being misused: “Individuals, who are actually carrying out substantial economic activities from India, manage their period of stay in India, so as to remain a non-resident in perpetuity and not be required to declare their global income in India.”

The second impacts the “Not Ordinarily Resident” category of taxpayers. The Memorandum has clarified that “this category of persons has been carved out essentially to ensure that a non-resident is not suddenly faced with the compliance requirement of a resident, merely because he spends more than specified number of days in India during a particular year.”

Imagine now an NRI who has stayed out of India for the past seven years and then spends 183 days at one stretch in the eighth year. The NOR status ensures that such an individual, who is “not ordinarily a resident” is not taxed as a resident. The amendment states that an NOR would be someone who has not been a resident of India for seven of the past 10 years. Under the existing law, it is nine out of the past 10 years.

The third proposed amendment is the one that created the confusion. This amendment said: “An Indian citizen who is not liable to tax in any other country or territory shall be deemed to be resident in India.”

What is the problem with this?

The amendment was seen as trying to tax non-residents as residents. As mentioned above, residents are charged income tax on their full global income while non-residents are charged only on their “Indian” income.

This led to panic because, in the absence of clarifications, all non-residents working in tax-free jurisdictions concluded that all their income in those jurisdictions will now attract the Indian income tax rate. Apart from the likely harrassment, this undermined the whole point of people leaving their homes in India to work in tax-free jurisdictions.

Why did the government propose this?

The government has clarified that its intention is not to target bona fide workers, rather to catch tax evaders who game the residency provisions to evade all taxes. “The issue of stateless persons has been bothering the tax world for quite some time. It is entirely possible for an individual to arrange his affairs in such a fashion that he is not liable to tax in any country or jurisdiction during a year.

This arrangement is typically employed by high net worth individuals (HNWI) to avoid paying taxes to any country/jurisdiction on income they earn. Tax laws should not encourage a situation where a person is not liable to tax in any country,” said the Memorandum to the Budget. Following the clarification, the government would be expected to now tweak the proposed amendment.

Source: The Indian Express

2. Criteria adopted by 15th Finance Commission resulting in reduction of States share in Centre’s revenues from 42% to 41%

Relevant for GS Prelims & Mains Paper III; Economics

The Fifteenth Finance Commission (FC) has considered the 2011 population along with forest cover, tax effort, area of the state, and “demographic performance” to arrive at the states’ share in the divisible pool of taxes. As had been widely anticipated, shares of the southern states, except Tamil Nadu, have fallen — with Karnataka losing the most.

About Finance Commission

The Finance Commission is a constitutionally mandated body that decides, among other things, the sharing of taxes between the Centre and the states. Article 280 (1) requires the President to constitute, “within two years from the commencement of this Constitution and thereafter at the expiration of every fifth year or at such earlier time as the President considers necessary”, an FC “which shall consist of a Chairman and four other members”.

Under Article 280(3)(a), the Commission must make recommendations to the President “as the distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under this Chapter and the allocation between the States of the respective shares of such proceeds”.

Accordingly, the Commission determines a formula for tax-sharing between the states, which is a weighted sum of the states’ population, area, forest cover, tax capacity, tax effort and demographic performance, with the weights expressed in percentages.

15th Finance Commission

The report of the Fifteenth FC, along with an Action Taken Report, was tabled in Parliament on Saturday. The Commission has reduced the vertical devolution — the share of tax revenues that the Centre shares with the states — from 42% to 41%.

Why share of States has been reduced?

The Commission has said that it intends to set up an expert group to initiate a non-lapsable fund for defence expenditure. The terms of reference of the Commission included considering the Centre’s demand for funds for defence and national security. It may do so by creating a separate fund from the gross tax revenue before computing the divisible pool — which means that states would get a smaller share of the taxes.

The population parameter

The population parameter used by the Commission has been criticised by the governments of the southern states. The previous FC used both the 1971 and the 2011 populations to calculate the states’ shares, giving greater weight to the 1971 population (17.5%) as compared to the 2011 population (10%). The Fifteenth FC has reasoned that the terms of reference leave it with no choice but to use the 2011 population; it has also argued that in the interest of fiscal equalisation, it is necessary to use the latest Census figures.

The use of 2011 population figures has resulted in states with larger populations like Uttar Pradesh and Bihar getting larger shares, while smaller states with lower fertility rates (the number of children born to a woman in her life) have lost out.

The combined population of the Hindi-speaking northern states (Bihar, Uttar Pradesh, Madhya Pradesh, Rajasthan and Jharkhand) is 47.8 crore. This is over 39.48% of India’s total population, and is spread over 32.4% of the country’s area, as per the 2011 Census. They also get a slightly more than the proportional share of the divisible pool of taxes (45.17%).

On the other hand, the southern states of Tamil Nadu, Kerala, Karnataka and undivided Andhra Pradesh are home to only 20.75% of the population living in 19.34% of the area, with a 13.89% share of the taxes. This means that the terms decided by the Commission are loaded against the more progressive (and prosperous) southern states.

The demographic effort

In order to reward population control efforts by states, the Commission developed a criterion for demographic effort — which is essentially the ratio of the state’s population in 1971 to its fertility rate in 2011 — with a weight of 12.5%. States such as Kerala, Tamil Nadu, Karnataka, Andhra Pradesh, and Telangana have fertility rates below the replacement rate, or the number of children that have to be born to a woman of reproductive age in order for the population to maintain itself at the current level without migration.

However, the effect of the demographic effort in increasing states’ devolution is not clear. Shares of states like Maharashtra, Himachal Pradesh and Punjab, along with Tamil Nadu, all of which have fertility rates below the replacement level, have increased slightly. On the other hand, Andhra Pradesh, Kerala, Karnataka, and West Bengal’s shares have fallen, even though their fertility rates are also low.

Incidentally, Karnataka, the biggest loser in this exercise, also had the highest tax-GSDP ratio in 2017-18, as per an RBI report on state finances. Tax effort was also used by the Commission to decide the states’ shares, with a weight of 2.5%.

Income distance criterion

The total area of states, area under forest cover, and “income distance” were also used by the FC to arrive at the tax-sharing formula.

Income distance is calculated as the difference between the per capita gross state domestic product (GSDP) of the state from that of the state with the highest per capita GSDP, with states with less income getting a higher share in order to allow them to provide services comparable to those provided by the richer ones.

The Commission used the per capita GSDP of Haryana as the reference for calculating the income distance, and gave it a weight of 45%, down from the 50% assigned by the 14th FC. The weight assigned to state area was unchanged at 15%, and that of forest cover was increased from 7.5% to 10%.

Source: The Indian Express

3. What Brexit means for the EU and its partners

Relevant for GS Prelims & Mains Paper II; IOBR

On January 31, 2020, the United Kingdom left the European Union. We lost a member of our family. It was a sad moment for us, for European citizens — and, indeed, for many British citizens.

Nevertheless, we have always respected the sovereign decision of 52% of the British electorate, and we now look forward to starting a new chapter in our relations.

A structured exit

Emotions aside, February 1 turned out to be historic but also undramatic. This is largely thanks to the Withdrawal Agreement that we negotiated with the U.K., which enabled us to secure “an orderly Brexit”. One that, at least for now, minimises disruption for our citizens, businesses, public administrations, as well as for our international partners.

Under this agreement, the EU and the U.K. agreed on a transition period, until the end of 2020 at least, during which the U.K. will continue to participate in the EU’s Customs Union and in the Single Market, and to apply EU law, even if it is no longer a Member State. During this period, the U.K. will also continue to abide by the international agreements of the EU, as we made clear in a note verbale to our international partners.

Element of continuity

So, with the transition period in place, there is a degree of continuity. This was not easy given the magnitude of the task. By leaving the Union, the U.K. automatically, mechanically, legally, leaves hundreds of international agreements concluded by or on behalf of the Union, to the benefit of its Member States, on topics as different as trade, aviation, fisheries or civil nuclear cooperation.

We now have to build a new partnership between the EU and the U.K. That work will start in a few weeks as soon as the EU 27 Member States have approved the negotiating mandate proposed by the European Commission, setting out our terms and ambitions for achieving the closest possible partnership with a country which will remain our ally, our partner and our friend.

Shared and deep links

The EU and the U.K. are bound by history, by geography, culture, shared values and principles and a strong belief in rules-based multilateralism. Our future partnership will reflect these links and shared beliefs. We want to go well beyond trade and keep working together on security and defence, areas where the U.K. has experiences and assets that are best used as part of a common effort. In a world of big challenges and change, of turmoil and transition, we must consult each other and cooperate, bilaterally and in key regional and global fora, such as the United Nations, the World Trade Organization, the North Atlantic Treaty Organization or the G20.

It is perhaps a cliché but the basic truth is that today’s global challenges — from climate change, to cybercrime, terrorism or inequality — require collective responses. The more the U.K. is able to work in lockstep with the EU and together with partners around the world, the greater our chances of addressing these challenges effectively.

At the very core of the EU project is the idea that we are stronger together; that pooling our resources and initiatives is the best way of achieving common goals. Brexit does not change this, and we will continue to take this project forward as 27.

Together, the 27 Member States will continue to form a single market of 450 million citizens and more than 20 million businesses. Together, we remain the largest trading bloc in the world. Together, at 27, we are still the world’s largest development aid donor.

Our partners can be sure that we will stay true to an ambitious, outward-looking agenda — be it on trade and investment, on climate action and digital, on connectivity, on security and counter-terrorism, on human rights and democracy, or on defence and foreign policy.

We will continue to live up to our commitments. We will continue to stand by the agreements that link us to our international partners and we will continue to develop multilateral cooperation frameworks around the world.

The European Union will continue to be a partner you can trust. A steadfast defender of rules-based multilateralism, working with our partners to make the world more secure and fair.

Josep Borrell Fontelles is High Representative of the European Union for Foreign Affairs and Security Policy/Vice-President of the European Commission. Michel Barnier is Head of Task Force for Relations with the United Kingdom

Source: The Hindu

Q. In what ways would the ongoing US-Iran Nuclear Pact Controversy affect the national interest of India? How should India respond to this situation? (2018, 15 marks, 250 words)

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