This article is written by Ankita Tiwari, pursuing a Certificate course in Advanced Corporate Taxation from Lawsikho.com.
Table of Contents
Introduction
Our economy requires funds to suffice for which it collects a part of income from persons. This person can be a natural person or a juristic person and are called an ‘assessee’ or ‘taxpayer’. Further, the part of income so collected is known as tax. The origin of income and country of residence are the factors which determine, whether or not, a person’s tax liability arises in India. A person can be a citizen of India yet not liable to be taxed in India. On the other hand, a person who is not a citizen of India or even, a non- resident citizen of India can be taxed in India.
Understanding ‘residential’ and ‘non-residential’ status in India
The Income Tax Act, 1961 discusses the concept of ‘residence’ under section 6. As per sub-section 1 of section 6, the residential status of an individual is in India if, either his/her stay in India during the Relevant Previous Year (RPY) is for 182 days or more, or his/her stay in India during the four years prior to the RPY amounts to 365 days or more. For any Indian citizen working outside or as a crew member of Indian ship or a person of Indian origin coming for a visit to India, 60 days applies in case of 182 days. This implies that if a person’s stay in India is less than 182 days or 60 days (in case of exceptions) in RPY and also, less than 365 days in four years prior to RPY then the person is not a resident of India. At least one criteria under section 6 (1) should be fulfilled to be a resident which can be further categorized into an ‘ordinary resident’ or ‘not ordinary resident’.
Association of persons like Hindu Undivided Family, firm, etc are non-residents only if the control and management of affairs is entirely external from India. In case of juristic personality like companies, residency arises on the basis of either place of registration or Place of Effective Management (POEM) of the company. The concept of POEM was introduced by the Finance Act, 2015 on the basis of Article 4(3) of the OECD Model.[i] Article 4(3) denotes that in situations where a person is resident of two or more Contracting States in a given financial year, then such Contracting States shall mutually decide the residential status of such person for the purpose of taxation.
Before POEM, ‘control and management’ was the term governing companies as well. The requirement for POEM was felt because earlier, shell companies were established outside India, with major operations carried on from India itself, giving opportunity to companies to escape tax liability.[ii] POEM was made applicable from Assessment Year 2017-2018 onwards however, the POEM guidelines were issued on 24th January, 2017 by way of Circular No. 6 of 2017. The companies with turnover below 50 crore have been put outside the scrutiny of POEM by Circular 8/2017 of the CBDT.[iii] The definition of POEM in Explanation to sub-section 3 of section 6, has been dissected into various tests which has to be fulfilled during the RPY to constitute POEM. The tests are[iv]:
- Decision Test- It implies where the key management and commercial decision are taken.
- Necessity Test- It implies that the decisions taken under the decision test should be necessary for the conduct of business.
- Universality Test- It implies that the decision so taken for the conduct of the business is in entirety or pervasiveness i.e. from the perspective of the business as a whole.
- Substance Test- It implies that the decision should actually be undertaken or put to execution.
POEM is a strict and efficient tax rule which leads to drop in tax escape instances. With the application of POEM, foreign based companies having its head and brain in India will be liable to pay tax in India. As of now, if a company is registered in India it is an Indian company, moreover, if it is registered in some other company but its POEM is in India then its country of tax residency will be India. If the POEM is also outside India, then such company is a non-resident company with business connection in India.
Do foreigners pay tax in India
After LPG reform, the borders started opening up for the purpose of commerce and trade. People began to expand their business to other countries. This also gave rise to various tax hurdles. To curtail the tax hurdles countries came up with two basic rules for the purpose of taxation: Source Rule and Resident Rule. As per source rule, the country in which the income arises will charge income whereas as per resident rule the global income of the resident will be taxed in resident country. As per the above two rules, if a foreigner is a resident in India as per section 6 of the Act, then his income will be liable to be taxed in India. For example, a U.S. citizen working in India becomes resident of India, so he has to pay tax in India for his global income. However, as per the source even though a person’s residential status is not in India yet some income is arising to him in India, it will be taxed in India as it originates in India. For example: A foreigner invests in shares of an Indian company in India. If source rule is applied to such dividend income arising from such shares, then it will be taxed in India as it originates in India. Therefore, even though a person is a complete alien to India in the sense that he never even visited India, still his income arising in India can be taxed in India. If any conflict of double taxation arises by applying these two rules, then it is resolved by mutual agreement of the two states.
Is the country of tax residency other than India
The other criteria for an income to be taxable in India is the origin of income. As per section 5 (2) of the Act, all incomes from any source received or deemed to be received in India, accrues or arises or deemed to accrue or arise in India, of a non-resident, will be taxable in India. Meaning thereby, a resident’s global income will be taxable in India whereas a non-resident’s income is taxable in India only if its origin is India. On bare reading of section 5 and 6, we determine that the country of tax residency can be different from the country of residence. Therefore, if a foreign registered company’s income arises in India, then such incomes will be taxable in India even though it is registered in a foreign company. The income of a foreign company, to the extent it arises in India will be taxed in India irrespective of whether it has its POEM in India or not.
Another important provision under Act, in order to understand the accrual and origin of income is Section 9 which states that any income, whether arising directly or indirectly in India, through any source of income, whether in the form of a business connection or property income or capital gains income will be taxable in India. Income from Permanent Establishment or Business Connection in India shall be taxable in India as it accrues or arises in India. The business connection being a broader concept than Permanent Establishment also includes ‘significant economic presence’ inserted in the form of Explanation 2A to subsection 1 of section 9. For non-residents companies, having business connection or permanent establishment in India, the income which is received, accrues or arises in India will be taxed in India.
Is NRI remittance taxable in India
The remittances payable to NRI earned by way of salary, house property, business, capital gains or interest and other sources will be taxable in India if it originates in India. When a capital asset of an NRI in India is transferred in RPY, resulting in capital gains, then as per section 45 of the Act it will be taxable in India. As the capital asset is situated in India, it will be taxable in India even if it is transferred outside India or the income arises outside India.[v] Through judicial holding in the case of Vodafone International Holdings B.V. vs. Union of India[vi], the Hon’ble Apex Court held that, the transfer of an asset situated outside India can be brought under the ambit of Indian tax, if such capital asset derives its substantial value from the capital asset situated in India. For example: if a U.S. company ‘XYZ’ has shares in an ‘STU’ company in U.K. which is ultimately a subsidiary of an Indian company, then the‘STU’ company shall be deemed to be situated in India and the shares of ‘XYZ’ company derives its substantial value from the Indian company. Therefore, it might be taxed in India (if other conditions are fulfilled).
The taxable amount of capital gain will be calculated as per section 48 of the Act. Further, to easily trace the non-resident, tax is deducted at source, before the payment of capital gains which arise to such non-resident in India. This deduction of tax at source is done as per section 195 of the Act. There was confusion on whether the deduction of tax at source, has to be done on the total amount of income received in respect such transfer or just on the amount of capital gains. This confusion was removed by the Apex Court in GE Technology Cen. P. Ltd. vs. CIT,[vii] by holding, “The obligation to deduct tax at source is, however, limited to the appropriate proportion of income chargeable under the Act forming part of the gross sum of money payable to the non- resident.” This means that deduction has to be done on the income and not on the capital gain.
Since in the case of non-residents, laws of two or more countries apply, there might be a conflict relating to taxability. The conflict is resolved by applying sub section 2 of section 90 which determines the taxability of non-residents in case of conflict by applying the provisions of the Double Tax Avoidance Agreement (DTAA) or provision of domestic law, whichever is beneficial.
Conclusion
An individual’s citizenship has nothing to do with his tax liability. The major factors which lead to tax liability in India are the Resident Rule and the Source Rule. Section 6 of the Act talks about the residential status of an individual. Section 5 and 9 of the act collectively talk about the source rule. An individual, who is a foreigner, or has a different country of tax residency, or is a NRI may be taxed in India if any conditions of section 5, 6 and 9 of the Act are met with. Any instance of double taxation arising by application of the above two rules shall be mutually mitigated by the two countries.
References
[i] The Final Action Plan on BEPS Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances
[ii] Radha Rani Holdings vs ACIT, (2007) 110 TTJ Delhi 920
[iii] Circular No. 8 of 2017- IT (Dated 14th March, 2017)
[iv] CA Pinakin Desai, Place of Effective Management- Redefining Corporate Residency, 19th INTERNATIONAL TAX & FINANCE CONFERENCE, 2015 https://www.bcasonline.org/ContentType/ITF%20Material/ITF-Pinakin%20Desai.pdf
[v] Kanga & Palkhivala’s The Law and Practice of Income-tax, Seventh Edition, Page 205
[vi] (2012) 341 ITR 1 (SC)
[vii] [2010] 193 TAXMAN 234 (SC)
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