Like any other country, India is governed by its own taxation laws i.e. Income Tax Act, 1961. A person who is a citizen of India and has his source of income located within India will be taxable in India as per the provisions of Income Tax Act. But what if the source of income of a person residing in India is located outside India? Will he be taxable in India or outside India (where the source of income is located)?

This is a very general yet important question which needs to be answered and the answer lies within the Income Tax Act itself.  It may seem tricky at once but if we focus on the provisions mentioned in the Act and correctly interpret it we will get our answer. Now moving to the answer of the question I raised above, let’s take a situation:

A person who lives in India owns shares in a company which is located and incorporated outside India (Foreign company). Now the questions are: Will he be liable to pay tax on the earning received from those shares? Will he be taxable in India or outside India (where the foreign company is situated)? How the tax to be paid is calculated on such income?

Income from shares owned in a Foreign Company

Owning shares in a foreign company is an investment made by a person in order to earn from those shares. It is kind of a source of income whose earning will be taxed. Two types of income can be generated from owning shares:

• Dividend received on shares

According to Section 4 of the Income Tax Act, income tax is chargeable on the “Total income” of a person and section 5 states that tax will be charged on the total income regardless of the source of the income. Section 10 of the Act provides us with a list of income which is not included in the total income to be taxed. Further, Section 10(34) states that income received by way of Tax dividend from an Indian company is not taxable under the Act. However, income received by way of dividend on shares of a foreign company is taxable. Hence, in the current situation, the person earning the dividend on the shares owned by him in a foreign company will be liable to be taxed under the head “Income from other sources” of Income Tax Act, 1961.

• Income received from such shares by their transfer

Income received from shares by way of their transfer is covered under the head “Capital Gains” of Income Tax Act. According to Section 45 of the Act, any profits or gains arising from the transfer of the capital asset effected in the previous year shall be chargeable to income-tax under the head. Capital gain can be:

• Short term capital gain – When a capital asset is sold within 36 months of its purchase (within 12 months in the case of shares or securities), income earned is short-term capital gain.
• Long term capital gain – When a capital asset is held for more than 36 months (12 months in the case of shares and securities), income earned on the sale of that asset is long term capital gain.

Hence, income earned from the transfer of shares held by a resident of India in a foreign company will be charged under head “capital gains” and the amount of tax charged will depend upon the period within which it is sold after its purchase i.e. whether the gain short term or long term.

Liability to be taxed in India or outside India

Section 5^[1] of the Income Tax Act states that: The total income of any previous year of a person who is a resident includes all income from whatever source derived which is-

• is received or is deemed to be received in India in such year by or on behalf of such person; or
• accrues or arises or is deemed to accrue or arise to him in India during such year; or
• 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.

Section 5(1)(c) makes it clear that a person who is a resident of India and is earning from a source located outside India will be liable to be taxed in India. In the present case, the source of income is the shares owned in a foreign company by the person who is a resident in India. Hence, the person will be liable to be taxed in India. As per the Section, his earning from shares will be included in his total income of the previous year regardless of its source.

Further, a person is said to be Resident of India^[2] in any previous year if he:

• is in India in that year for a period of 182 days or more; or
• having within 4 years preceding that year been in India for a period of 365 days or more and is in India for a period of 60 days or more in that year.

Computation of Tax under the head ‘Capita Gains’

Section 48 of the Income Tax Act provides for the mode of computation of tax under the head “capital gains”. It states that:

The income chargeable under the head “Capital gains” shall be computed, by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely:

1. Expenditure incurred wholly and exclusively in connection with such transfer;
2. The cost of acquisition of the asset and the cost of any improvement thereto.

Tax charged → Full value of the consideration received from the transfer of capital asset (subtracted by) expenditure incurred on such transfer (subtracted by) the cost of acquiring such asset and cost incurred on its improvement if any.

Double Taxation Avoidance Agreement (DTAA)

Besides focusing on the provisions of Income Tax Act, 1961 while calculating tax to be payable by an Indian resident whose source of income is Shares owned by him in a foreign company, one should also keep in mind the provisions of DTAA so that the person is not put in jeopardy by being taxed twice for the same income.

DTAA is a treaty signed between two or more countries with an objective to protect the taxpayers from being taxed twice for the same income. It applies to those situations where the taxpayer resides in one country but earn income in another country. It can cover either all source of income or can only be limited to certain sources. Currently, more than 80 countries are members to DTAA.^[3]

India is also a member of DTAA and as per its provisions, a resident of India whose source of income is from outside India will get deduction on the payment of tax in the other country if he has paid the tax on the same income in India. In the present situation, the person is a resident of India and is earning income from the country other than India. If he pays tax on that income in the country from where he is earning that income, he will be exempted from paying tax on the same income or the tax paid in that country will be deducted while calculating total tax to be paid on that particular income in India. This will give him relief from being taxed twice on the same income. But this is applicable in the countries to which India is a member under DTAA.

Conclusion

A person who is a resident of India under Section 14 of the Income Tax Act will be taxable in India of his earnings whether received in India or outside India. While charging tax on an Indian resident, it is charged on the total income of that person regardless of whatever source it is derived from. So if a person is living in India who is earning from the shares owned by him in a foreign country will pay tax in India. One important point needs to be taken care of while taxing a person is that he should not be taxed twice for the same income (double taxed).

LawSikho has created a telegram group for exchanging legal knowledge, referrals and various opportunities. You can click on this link and join: 

https://t.me/joinchat/J_0YrBa4IBSHdpuTfQO_sA

References

^[1] Section 5(1) of Income Tax Act, 1961

^[2] Section 6(1) of Income Tax Act, 1961

^[3]http://www.thehindubusinessline.com/opinion/columns/all-you-wanted-to-know-aboutdtaa/article8607732.ece [11      July, 2017; 05:30 PM]