Understand New Concept of Tax Residency

 

 

Tax Residency is one of the main decisive factors for establishing the category of taxpayer and devising nexus with a country's tax laws. Globally, the residential status of a person is a key factor in determining his or her taxability in a particular country which is different from citizenship. In India, Tax residency is determined u/s 6 of the Income-tax Act which until the amendment brought in by Finance Act, 2020 did not consider citizenship to be a determining factor/ condition. Indian Government introduced certain major amendments in Sec. 6 as anti-avoidance provisions that largely base its premise on 'citizenship' rather than 'the number of days of stay in India'.

Against this backdrop, we elucidates on the amendments and their likely impact on the stakeholders particularly the NRI community as well as the ordinary residents in India. Here, we explains the concept of deemed residency introduced by the Finance Act, 2020 through the insertion of a new clause (1A) in Section 6. We  opines "In essence, there are many Indian citizens who become NRIs by taking the tax residency certificate of a tax haven. Such people not only avoid paying taxes in such tax heaven (i.e. stateless person) due to the NIL tax rate in such jurisdictions, but also continue to stay in India for 6 months and enjoy the NRI status, thus taking benefit of all concessional tax rates and exemptions available to an NRI as per Indian tax laws". Further, we  also analyses the amendments from a tax treaty perspective.

Tax Residency is one of the main decisive factors for establishing the category of taxpayer and devising nexus with a country's tax laws. Under Indian tax laws, the scope of total income as envisaged in section 5 is dependent on the residential status of a person. Residential status is different from citizenship. Until recently (Finance Act 2020), under Indian tax laws, citizenship wasn't a relevant factor/ condition for determining tax residency. Through the Finance Bill of 2020, the Indian government introduced certain amendments in section 6 of the Income Tax Act, as anti-avoidance provisions that largely base its premise on 'citizenship' rather than 'the number of days of stay in India'. In this article, we shall analyse and demystify what the aforesaid amendments are and their likely impact on the stakeholders, particularly the NRI community as well as the ordinary residents in India. For the sake of maintaining brevity in the article, the irrelevant portions of the law have not been discussed.

Section 6 classifies a person into 3 categories:

• Ordinary resident

• Not ordinary resident

• Non-resident

I. Scope of income of a person as defined under section 5, is dependent upon the residential status of a person as analyzed below:

• Taxability of Ordinary Residents - Section 5(1) defines the scope of total income for ordinary residents as follows: All incomes that are received or deemed to be received in India, accrues or arises or deemed to accrue or arise in India or any income that accrues or arises outside India, altogether is taxable in the hands of an ordinary resident. In a nutshell, the worldwide income of an ordinary resident is taxable in India. Hence, provisions of section 5(1) imply that an Indian resident is taxed on its global income. Accordingly, India follows the "principle of residence" for taxing the income of its ordinary residents.

• Taxability of Not-Ordinary Resident - There is a unique category of residency in India, named as Not Ordinary resident ('NOR') wherein the 'principle of residence' is replaced with the 'source rule' to tax income of the taxpayer. Hence, all income from whatever source that is received or deemed to be received in India, accrues or arises or deemed to accrue or arise in India shall be taxable in the hands of a NOR Proviso o section 5(1) of the Income Tax Act, 1962. Further, the overseas income of a NOR shall be taxable only to the extent of that part of the income as is arising from or accruing outside India or the part of income that is derived from a business controlled or professional set up in India. Accordingly, there should be a clear nexus and only the foreign income that is sourced from India shall be taxable in the hands of a NOR.

• Taxability of Non-Resident – In the case of a non-resident, Indian legislature follows a very strict approach of taxing only that income that either is received or deemed to be received in India or accrues or arises or deemed to accrue or arise in India in the hands of a Non-Resident Section 5(2) of Income Tax Act, 1962o clause (1). However, there are several deeming provisions in section 9 that demonstrate India's unilateral approach in taxing the incomes that "deemed to accrue or arise in India". Since section 9 is not discussed in this article and is a subject worth analyzing in detail separately, it can be seen that the foreign income of a non-resident is not taxable in their hands if such income is not received in India and such income does not attract the deeming provisions of accrual under the Indian income tax laws.

II. Test of residency for an individual u/s 6:

Test of residency under Indian Tax laws has been defined under section 6(1) as follows:

a) If he stays in India in that year for an aggregate period of 182 days or

b) ***

c) If he stays in India

i. Within 4 years preceding that year for an aggregate period of 365 days or more and

ii. In that year for an aggregate period of 60 days or more.

Pre-Amendment exceptions to Section 6(1)

Pre-Amendment Explanation 1(a) carves out an exception to clause (c) of Section 6(1) as follows:

1 Proviso o section 5(1) of the Income Tax Act, 1962 2 Section 5(2) of Income Tax Act, 1962o clause (1)n

Any citizen of India, who leaves India in the previous year:

a) As a member of the crew of an Indian ship; or

b) For employment outside India,

The period 60 days in sub-clause (c) shall be substituted by 182 days for the previous year in which he/ she leaves India.

Pre-Amendment Explanation 1(b) :

Any individual being a citizen of India, or a Person of Indian Origin (PIO), who is outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply concerning that year as if for the words "sixty days", occurring therein, the words "one hundred and either two days" had been substituted.

• Amendments to Explanation 1(b) – as proposed in Finance Bill, 2020

Any individual being a citizen of India, or PIO, who, being outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply concerning that year as if for the words "sixty days" occurring herein, the words "one hundred and twenty days" had been substituted.

• Amendments to Explanation 1(b) – as legislated in Finance Act, 2020

Any individual being a citizen of India, or a PIO, who, being outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply concerning that year as if for the words "sixty days" occurring herein, the words "one hundred and eighty days" had been substituted and in case of the citizen or PIO having a total income, other than the income from foreign sources, exceeding fifteen lakh rupees during the previous year, "for the words "sixty days" occurring therein, the words "one hundred and twenty days" had been substituted.

Impact Analysis

Finance Bill of 2020 proposed to amend Explanation 1(b) to introduce anti-avoidance provisions by enhancing the scope of NRIs to be taxed in India. The simplest way of doing that was to cut short the 'number of days' time window relaxation provided to the NRIs from 181 days to 119 days. Since this move would make it difficult for an NRI to remain an NRI and yet look after the Indian business, he must ensure that his stay in India is for less than 120 days. However, his pose a bigger problem for NRI workmen and blue-collar workers who would stay in India in an offseason and yet remain an NRI and hence not pay taxes in India. The NRIs living in the USA and other high tax jurisdictions areas is not very likely to dwell in India for long periods for growing their Indian business. The case is different for those who take citizenship of tax havens to avoid paying taxes on India sourced income.

Nevertheless, this proposed amendment affected NRIs and there was a worry and a ripple of protest against the cut down in the relaxation given to an NRI visiting India. Accordingly, the Indian government listened to the affected NRI community and while passing the Finance Act 2020, amended Explanation 1(b) to affect that the cut down from 180 days to 120 days shall be applicable on only those NRIs who have India sourced income exceeding fifteen lacs in a year and are a citizen or PIO, coming to India on a visit. By providing the threshold of 15 lace (which is also apparently the highest income tax threshold bracket in India), the government ensured that only those NRIs face the risk of becoming tax residents of India who already have a high income of 15 lacs being sourced from India in a particular tax year.

However, even this move was watered down by the insertion of clauses (c) and (d) to section 6 (6) as discussed in part V of the Article.

III. The New Residency Rule – Doctrine of Deemed Residency

The Finance Bill of 2020 further introduced the concept of Deemed Residency as a non-obstante provision to clause (1) to section 6, which is as follows:

• New clause (1A) to section 6 – As proposed in Finance Bill, 2020

Notwithstanding anything contained in clause (1), an individual, being a citizen of India, shall be deemed to be resident in India in any previous year, if he is not liable to tax in any other country or territory because of his domicile or residence or any other criteria of similar nature.

• New clause (1A) to section 6 – As legislated in Finance Act, 2020

"(1A) Notwithstanding anything contained in clause (1), an individual, being a citizen of India, having a total income, other than the income from foreign sources, exceeding fifteen lakh rupees during the previous year shall be deemed to be resident in India in that previous year if he is not liable to tax in any other country or territory because of his domicile or residence or any other criteria of similar nature.

Impact Analysis

The concept of deemed residency based on 'Indian citizenship' was not in existence before the amendment of 2020. Since in India, both the concepts of 'residency principle' and 'source rule' of taxation co-exist in section 5. Hence, the Indian Government did not place any additional burden of establishing tax residency through the use of 'test of citizenship' on the taxpayers. However, the use of single criteria of 'number of days of stay' in India gave rise to certain tax planning opportunities for NRI who could continue to source their income from India and stay in India for 6 months as well in the same financial year. Accordingly, the introduction of 'Deemed Residency' through the insertion of new clause (1A) in Section 6 was done through Finance Act, 2020 as an anti-avoidance measure.

In essence, many Indian citizens become NRIs by taking the tax residency certificate of a tax haven. Such people not only avoid paying taxes in such tax heaven (i.e. stateless person) due to the NIL tax rate in such jurisdictions, but also continue to stay in India for 6 months and enjoy the NRI status, thus taking benefit of all concessional tax rates and exemptions available to an NRI as per Indian tax laws.

Though the introduction of the draft clause (1A) created a stir in the NRI community since it implies that under mere citizenship of India, a person would become a tax resident in India in case such person is not liable to tax in any foreign country. Accordingly, 'stateless persons' aka individuals who were not liable to tax in any other tax jurisdiction on the world map, would become tax residents in India and hence shall be liable to pay tax on their global income in India. This posed as a particular issue with most NRIs settled in the USA and Europe who haven't taken foreign citizenship (and continue to hold Indian citizenship) and are not liable to tax in any other tax jurisdiction, even when they have not come on a visit to India for a single day. All such individuals would be liable to pay tax in India on their foreign-sourced income. This proposed law, hence, was posing as a perfect breeding ground for dislike and non-acceptance by the affected NRI community and it did receive strong opposition and criticism for the same. Hence, after considering all aspects and repercussions of the proposed clause (1A), the final legislation passed with an important add-on being "…an Indian citizen having a total income, other than the income from foreign sources, exceeding fifteen lakh rupees during the previous year…". This one extra line made a huge difference on the impact that the section 6 amendment shall have on the interested parties. Presently, any Indian citizen shall become a deemed resident if the following two conditions are satisfied, namely:

- The individual is a 'stateless person', meaning he does not have any income liable to tax in any foreign tax jurisdiction other than India; and

- The Indian citizen has a total India sourced income exceeding INR 15 lacs.

IV. Summary of amendments to section 6(6)

Residency on account of Stay – Section 6(6)(c )	Deemed Residency – Section 6(6)(d)
- Indian citizen or PIO - Visiting India - Stay in India between 120 to 181 days - Having total India sourced income of INR 15 lacs	- Indian citizen - Having total income sourced from India of INR 15 lacs - Not liable to tax in any foreign tax jurisdiction

 

V. Amendments to NOR provisions Section 6(6) of the Income Tax Act, 1962

The erstwhile provision as envisaged in section 6(6) is as follows: A person is said to be "not ordinary resident" in India in any previous year if such person is: - An individual who has been a non-resident in India in 9 out of 10 previous years preceding that year; or - Has during the 7 previous years preceding that year been in India for an aggregate period of 729 days or less.

NOR Amendment – as proposed in Finance Bill, 2020

A person is said to be "not ordinarily resident" in India in any previous if such person is:

(a) An individual who has been a non-resident in India in seven out of the ten previous years preceding that year;

Amendments to NOR provisions - as legislated in Finance Act, 2020

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 9 out of 10 previous years preceding that year or has during 7 years preceding that year been in India for an aggregate period of 729 days or less; or

b) *** or

c) A citizen of India, or a PIO, having a total income, other than the income from foreign sources, exceeding fifteen lakh rupees during the previous year, as referred to in clause (b) of Explanation 1 to clause (1), who has been in India for a period or periods amounting in all to 120 days or more but less than 182 days; or

d) A citizen of India who is deemed to be resident in India under clause (1A).

As per the above amendments to section 6(6), both the types of individuals who are become India tax residents, based on number or stay4 as well as deemed residents5 (as per the amended provisions) shall be subject to tax in India as a NOR. As per Indian tax laws, a taxable person having a status of a NOR shall not be liable to Indian tax on his foreign income (unless such foreign income is derived from a business controlled or professional set up in India) and will not be liable to disclose his foreign assets & incomes in India.

With this important change in the provisions of section 6(6), the Indian Government has not only nullified the effect of amendments in section 6(1) but has provided additional relaxation to those covered under the definition of Deemed Residents (a benefit which was not in existence before the introduction of the concept of 'Deemed Resident' based on citizenship). Under the amended provisions, while the Non-resident may be treated as an Indian Resident under S. 6(1A), he will also be treated as NOR and hence he will not be liable to Indian tax on his foreign income.

Under the un-amended Indian tax law provisions also, all non-residents were liable to pay Indian tax only on their Indian sourced incomes. So the Finance Act 2020 amendment achieves almost nothing. On the contrary, the entire Anti-avoidance premise on which the amendments in tax residency rules is made in the Finance Act of 2020, has been watered down in one go with the insertion of sub-clause (c ) and (d) in section 6(6). VI. Section 6 Amendments - Tax Treaty Perspective

Under Article 1 of a tax treaty, the applicability of the DTAA on a person is determined if the person is a resident of at least one of the Contracting States. Accordingly, tax treaty benefits are not available to a person who is not resident of 4 Explanation 1(b) to section 6(1) 5 Section 6(1A) of Income Tax Act, 1962 either of the Contracting States. Further, the DTAAs also provide the tests for determining the residential status of a person.

Under the provisions of Model Double Taxation Avoidance Agreement, a 'resident of a Contracting State' is a person who, under the laws of that state is liable to tax therein because of:

- Domicile (the place where a man has his true, fixed and permanent home and the principal establishment and to which whenever he is absent he has the intention of returning);  - Residence;

- Place of management

- Or any other criterion of similar nature;

- And (Under UN Model only) place of incorporation.

 As per Section 90(2) of the Act, DTAAs overrule domestic tax laws in India. Accordingly, NRIs can reduce their instance of paying double tax on the same income.

Most countries have the condition of stay for 182 days or more for determining residency. However, under the amended provisions, a person may become a resident in India in some cases even if he stays for less than 182 days in India. Such a situation could give rise to 'dual residency'. Most DTAAs have a tie-breaker Article which provides that in case of dual residency, such person will become resident of only one country as per the 'Tiebreaker rule' of such DTAA.

In cases of Dual-residency, the 'Tiebreaker test' is applied in the case of a person that is found to be a resident of both the Contracting States. To avoid double taxation of the same income twice under the taxing statutes of the two Contracting States, Article 4(2) of the DTAAs provide for Tie Breaking provisions. Article 4(2) provides several tests for determining the country of residence of a taxpayer. Each test is to be considered in the chronological order in which it is enlisted in Article 4(2).

Now the issue is that most of the DTAAs do not have citizenship as a test for determining residency. However, under the amended Indian section 6 provisions, an Indian citizen who stays outside India becomes 'deemed resident' in India if he has an India sourced income of INR 15 lacs and is not liable to tax in any other country. In such a situation, where even the' Tiebreaker rule' does not provide a solution to the problem of dual residency because most DTAAs do not contain 'citizenship' as a criterion for determining residency. Though, certain DTAAs with India provide for a resolution mechanism through Mutual Agreement Procedure.

Conclusion

Since new clause 1(a) specifically overrules clause (1) of section 6, accordingly, an Indian citizen having Indian income of 15 lakhs and if such individual is not liable to pay tax in any other country, then post FY 2020-21, such person shall be "deemed resident" under the provisions of section 6(1A) of the Act irrespective of his number of stay in India. Accordingly, under section 6(6)(d), such deemed residents will always be NOR, implying that the foreign sources income of such individual shall not be taxable in India unless it is sourced from India, i.e. only such part of foreign income that is derived from a business controlled or profession set up in India shall be subject to tax in India.

This is yet another example where the legislature had to give in to the demands of the mighty NRI lobby and diffuse its anti-avoidance laws to make room for the unhindered flow of investments from outside into the Indian economy. As an aftermath, the so-called anti-avoidance law has enhanced complexity and provided extra loop-holes for allowing tax planning, making the entire amendments the opposite of anti-tax-avoidance law in itself, without serving its purpose for which the amendments were initially brought into existence