INTRODUCTION
1. As a general principle, law of a State has effect only within its own boundaries. This general principle, however, has a very important exception. If a sufficient territorial nexus can be established between the person sought to be taxed and the country seeking to tax him, the income-tax law can extend to that person in respect of his foreign income also. This income has to be real and the basis of this can be established based on certain well-settled principles.
This write-up attempts to analyze the provisions relating to scope of total income & Residence in respect of cross border transactions under the Income-tax Act, 1961 (‘the Act’).
The main provisions relevant to our discussion today are sections 5 & 6 of the Act. While section 4 is the charging section, section 5 outlines the scope of total income for various categories of taxpayers depending on their residential status, which is provided by section 6. Broadly speaking, the world income of a resident is taxed while for the non-resident only income accruing or arising in India or received or deemed to be received in India is taxed.
WHO IS A RESIDENT/NON-RESIDENT?
2. A non-resident is defined by section 2(30) of the Act as a person who is not a “resident and for the purposes of sections 92, 93 and 168, includes a person who is not ordinarily resident within the meaning of section 6(6)”. Similarly as per section 2(42) “resident” means a person who is resident in India within the meaning of section 6.
2.1 RESIDENTIAL STATUS OF AN INDIVIDUAL – An individual is considered as a resident in India if he fulfils any of the following conditions:
(i) if he is in India in the relevant year for a period aggregating to 182 days or more; or
(ii) if he is in India for a period aggregating to 60 days or more in the relevant year and has been in India for an aggregate period of 365 days or more in the preceding 4 years.
But there are two important exceptions to this rule :
(i) in case of an individual, who is a citizen of India and who leaves India in any previous year for the purpose of employment outside India, the period of 60 days in second condition shall be substituted by 182 days. The same rule will be applicable for the crew of the Indian ship. However this relaxation is not available:-
a. To person touring abroad wrt his/her employment in India
b. To a person, who after employment outside India, comes back to India for an employment in India
c. To a foreign citizen
Employment (although not defined in Act) may be interpreted as doing business/profession outside India, as one can employ himself/herself as well.
(ii) in case of an individual, who is a citizen of India, or is a person of Indian origin, period of 60 days in the second condition given above, will be substituted by 182 days. Therefore, he shall not be a resident unless his stay in India is at least of 182 days during the relevant previous year in which he visits India.
2.2 Additional conditions [Section 6(6)] - An individual will be treated as resident and ordinarily resident, if he is able to satisfy both of the following two additional conditions -
(i) Resident in India [in accordance with basic conditions] in at least 2 out of 10 previous years immediately preceding the relevant previous year; and
(ii) Presence in India for at least 730 days during 7 years immediately preceding the relevant previous year.
2.2.1 REASONS FOR CHANGE IN SECTION 6(6)
The Govt. to overcome the tax planning measures of assesses took this decision through amendment in Finance Act 2003 .What used to happen in pre 2003 period was that the Assessee used to go in Tax free Countries like Dubai on say 20th September 2000 and comeback in India on 5th October 2001 and declare that being non resident in previous year 1999-2000 and 2000-2001 their income earned outside India was not taxable in India. Also as per definition of sec 6(6) prevalent at that time they were entitled to being resident but not ordinary resident for the 9 years and hence income accruing or arising out of India as per section 5(1)(c) was exempt.
2.3 RESIDENTIAL STATUS OF COMPANIES - A company is said to be resident in India if:
(i) It is an Indian company; or
(ii) The control or management of its affairs is situated wholly in India.
A company is said to be a non-resident company if it is not resident in India as defined above. The term ‘Indian company’ refers to a company formed and registered under the Indian Companies Act, 1956.
(For changes in residential status of companies as per DIRECT tax code, kindly read last para)
3. The provisions of section 5 provide as under:-
(1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which—
(a) is received or is deemed to be received in India in such year by or on behalf of such person ; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year ; or
(c) accrues or arises to him outside India during such year
Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section (6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India.
(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which—
(a) is received or is deemed to be received in India in such year by or on behalf of such person ; or
(b) accrues or arises or is deemed to accrue or arise to him in India during such year.
Explanation 1. — Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India.
Explanation 2. — For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India.
The distinctive features of sections 5 as enumerated from various decided case laws are as follows:-
(a) The other provisions of the Act will have an overriding effect on the provisions of section 5. [CIT vs. Nippon 233 ITR 158]. That means provisions of sections 10-13A and sections 80 HH to 86 and section 90 [CIT vs Vishakhapatnam port Trust 144 ITR 146, CIT vs Davy Ashmore 19 ITR 626] may have the effect of exempting income which would otherwise be chargeable under this section.
(b) Source of Income is not relevant
The Supreme Court in Performing Right Society Ltd. v. CIT, pointed out that even if the source of income was the agreement entered into in England, the question as to the source of income was not relevant because section 5(2) provides that all income ‘from whatever source derived’ is to be included in the total income of the non-resident assessee, if the income accrued or arose in India during the relevant year
(c) Actual vs Constructive receipt-
· In Raghava Reddi v. CIT [1962] 44 ITR 720, the Apex Court held that income was received in India when it found that the Japanese company instructed its Indian party not to remit the commission due to it but to credit the same to its account for disposal according to its instructions from time to time. The Supreme Court while holding that such credit effectively constitutes receipt, set store, rightly, by the fact that the amount belonged to the Japanese company and was at its disposal. In other words, every credit entry in favour of a non-resident will not automatically expose him to tax liability in India on the ground that such credit tantamounts to receipt of income in India unless such credit is explicitly at the instance of the creditor and is at his disposal.
· It is possible that a person may be at once both a creditor and debtor and it is well possible that he may use his credit to wipe out the debit that may spring on account of supplies having been made to him. As per the ratio of the SC verdict in Raghava Reddi’s case (supra), in such circumstances the credit entry to square off the debit is effectively receipt of income in India.
· The Apex Court in CIT v. Toshoku Ltd. [1980] 125 ITR 525, correctly pointed out that unlike in Raghava Reddi’s case (supra), where the income was placed at the disposal of and was under the control of the non-resident, in the instant case there was only passing of credit entry unaccompanied by any act that vested the entry with the character of a deposit.
(d) First receipt: Income cannot be received twice Receipt of income refers to first occasion when the recipient gets the money under his control. Income after first receipt moves as remittance only. The position remains same even if at first instance the money is received by an agent (bank etc). Same income cannot be received twice {Keshav Mills Ltd v CIT [1953] 23 ITR 230 (SC)}.A non-resident is taxed on his foreign income only if it is ‘received in India’ ie received for the first time from the foreign source. If the NR has already received the income outside India ,he would not be chargeable when he remits or transmits it to India. Mere signing of receipt is not conclusive proof of receipt of income in India.
(e) When and where income is received
· In case of money paid to a banker, broker or other agent of the assessee the time and place of payment to the banker, broker or other agent are the time and place of receipt by the purpose of this Act.
· SC held in CIT vs SKF Ball Bearing Co.Ltd.40 ITR 444 that where a commission agent effects sales and services and receives the proceeds in India on behalf of the foreign principal, the latter’s profits are received and taxable in India.
· The fact that assesse is unable to operate on income immediately on account of some legal restriction ,shall have no bearing on the question of date of receipt.
(f) Is Income received at place where cheque posted?
· Yes, as per CIT vs Ogale Glass Works Ltd. 25 ITR 529(SC) if the mode of sending it by post is adopted at express or implied request of recipient, the post office acts as an agent of the addressee.
· In other cases the receipt would be at the place where the cheque is delivered to the addressee.
· However in later case of CIT vs Patney & Co. it was held that where there is an express agreement, that the payment should be made at a certain place, then there is no question of express or implied request of recipient to send the same by post.
(g) Income accruing or arising in India or deemed to accrue or arise in India
Income, which accrues or arises in India, is chargeable to tax for all categories of persons, whether ‘resident’ or ‘non- resident’. Like income accruing in India, income that is deemed to accrue or arise in India is also chargeable to tax for all categories of persons, whether resident or non-resident. Generally speaking, the following income is deemed to accrue or arise in India per sec 9(1) :—
- Income through, or from, any business connection in India;
- Income through, or from, any property in India;
- Income through, or from, any asset or source of income in India;
- Income through the transfer of a capital asset situated in India;
- Dividend paid by an Indian company outside India;
- Income payable by way of royalty or fees for technical services by an Indian company or from an Indian source; and
- Income by way of salary, if it is earned in India.
It should be noted that the income, which is deemed to accrue or arise in India, is wholly taxed in India. That being a separate topic as a whole which needs to be dealt with separately.
(h) Income accruing or arising outside India
- In the case of Performing Right Society Ltd. v. CIT, it was held that although the society was a non-resident company and it received the income out of the agreement which was executed in England and not in India, the income undoubtedly accrued or arose in India.
- The Court pointed out that determination of whether a certain income accrued or arose in India within the meaning of section 5(2), is a question of fact which should be examined and decided upon in the light of common sense and plain thinking.
- The Supreme Court approved the decisions of the lower authorities that it is a matter of fact that the income derived from broadcast of copyright music from the stations of AIR arose in India.
- The provisions of section 9 which deem income to accure or arise in India, though actually accruing elsewhere, would not be relevant since income in the instant case has in fact accrued in India.
- As per sec 220(7) in case of income arising in foreign country the laws of which prohibit or restrict the remittance money to India, proceedings cannot be taken against the assessee for recovery of tax assessed and due in respect of such foreign income till the income cannot be brought into India .
- Only income accruing or arising outside India and not income deemed to accrue or arise outside India is taxable.
TAXATION OF NON-RESIDENT COMPANIES
4. The principles of residential status and receipt and accrual of income as discussed above are fully applicable in case of foreign business entities also. For taxation purposes, the various types of legal entities will broadly fall in any of the following two categories depending on the residential status of the concerned company :
(i) A Foreign Company
(ii) An Indian Company
Foreign company - Foreign company is defined under the Indian Income-tax Act as a company, which is not a domestic company. A domestic company means an Indian company or any other company, which has made prescribed arrangements for the declaration and payment of dividend in India.
A non-resident company is one which is neither an Indian company nor does its control and management lie wholly in India. Thus, in effect, in almost all cases a foreign company will be a non-resident company.
Indian company - A foreign company may operate in India through an Indian company either as a 100 per cent subsidiary of the foreign company or as an Indian Joint-Venture Company. Such companies are liable to be taxed as Indian companies. Their income will be determined by applying various provisions of the Indian Income-tax Act. They will be liable to pay tax at the rates applicable to Indian companies.
CHANGES PROPOSED IN DTC
It was proposed in the original draft of DTC that a foreign company will be treated as resident in India if, at any time in the financial year, if the control and management of its affairs is situated “wholly or partly" in India (unlike wholly situated in India, as at present).
It was pointed out to the Tax Authorities that under the new test for determining residence in the DTC, a foreign company whose control and management is partly in India say by holding a single meeting of the Board of Directors in India, will be treated as a resident of India and thus liable for taxation in India on its global income.
Also, a foreign company owned by residents in India could be held to be resident in India as part of the control of such company may be in India.
In the new draft DTC released recently it has been proposed that a foreign company will be treated as resident in India if Place of effective management is situated in India. “Place of effective management of the company means-
(i) The place where the board of directors of the company or its executive directors, as the case may be, make their decisions; or
(ii) In a case where the board of directors routinely approve the commercial and strategic decisions made by the executive directors or officers of the company, the place where such executive directors or officers of the company perform their functions.”
The Concept of POEM ie Place of effective management is an internationally recognized concept for determination of residence of a company incorporated in a foreign jurisdiction. Most of Indian tax treaties recognize the concept of “place of effective management for determination of residence of a company as a tie-breaker rule for avoidance of double taxation.
Simply speaking POEM provides that it is the place where key management and commercial decisions that are necessary for the conduct of the entity's business as a whole, are, in substance, made.
This concept is lot more practical and accepted universally than the original originally mooted. There are still some clarifications needed in this cyber age regarding the holding of meetings through teleconferencing etc. Let’s all hope that clarifications required are included in the final draft.
Appendix-1
Residence in India.
6. For the purposes of this Act,—
(1) An individual is said to be resident in India in any previous year, if he —
(a) is in India in that year for a period or periods amounting in all to one hundred and eighty-two days or more ; or
(b) [* * *]
(c) having within the four years preceding that year been in India for a period or periods amounting in all to three hundred and sixty five days or more, is in India for a period or periods amounting in all to sixty days or more in that year.
[Explanation.—In the case of an individual,—
(a) being a citizen of India, who leaves India in any previous year [as a member of the crew of an Indian ship as defined in clause (18) of section 3 of the Merchant Shipping Act, 1958 (44of 1958), or] for the purposes of employment outside India, the provisions of sub-clause (c) shall apply in relation to that year as if for the words “sixty days”, occurring therein, the words “one hundred and eighty-two days” had been substituted ;
(b) being a citizen of India, or a person of Indian origin within the meaning of Explanation to clause (e) of section 115C, who, being outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply in relation to that year as if for the words “sixty days”, occurring therein, the words “one hundred and [eighty-two] days” had been substituted.]
(2) A Hindu undivided family, firm or other association of persons is said to be resident in India in any previous year in every case except where during that year the control and management of its affairs is situated wholly outside India.
(3) A company is said to be resident in India in any previous year, if—
(i) it is an Indian company ; or
(ii) during that year, the control and management of its affairs is situated wholly in India.
(4) Every other person is said to be resident in India in any previous year in every case, except where during that year the control and management of his affairs is situated wholly outside India.
(5) If a person is resident in India in a previous year relevant to an assessment year in respect of any source of income, he shall be deemed to be resident in India in the previous year relevant to the assessment year in respect of each of his other sources of
income.
[(6) A person is said to be “not ordinarily resident” in India in any previous year if such person is—
(a) an individual who has been a non-resident in India in nine out of the ten previous years preceding that year, or has during the seven previous years preceding that year been in India for a period of, or periods amounting in all to, seven hundred and twenty-nine days or less; or
(b) a Hindu undivided family whose manager has been a nonresident in India in nine out of the ten previous years preceding that year, or has during the seven previous years preceding that year been in India for a period of, or periods amounting in all to,seven hundred and twenty-nine days or less
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