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Home >> TII EDIT
Further change in residency rules: Three attempts (and counting)?
By D P Sengupta
Sep 24, 2020

The residency rule for individuals has evolved in India in a patchwork fashion, giving priority to one aspect or another in such a way that at the beginning of 2020, it was possible to arrange one's affairs in a way that citizens of India who made their fortunes in India could avoid paying taxes on their out of India income just by adjusting their period of stay in India. There has never been a holistic examination of this vital aspect of taxation that determines the very nexus of taxation of income with a country.

In the budget 2020, an attempt was made to correct a few obvious aspect of the distortions caused in the residency rules over time. However, the government has faltered over the actual language used in the Act.

In the original Finance Bill, 2020, the focus was apparently on the stateless persons and double non-taxation. Two aspects are worth mentioning.

In terms of the residency rules prevailing at that time, Indian citizens residing abroad could be in India for almost half a year every year without becoming resident of India and thereby sheltering their foreign income. The Memorandum to the Finance Bill, 2020 explained that instances were noticed where the period of 182 days specified in respect of an Indian citizen or person of Indian origin visiting India during the year, was being misused and that individuals, who were 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. Therefore, the Finance Bill proposed to reduce the number of days for which such free stay could be availed of to 120 days.

More importantly, it seems that the government was also concerned by the phenomenon of Indian High Net worth Individuals (HNI) organising their stay in such a way that they were able to be residents of no particular country, thereby avoiding any tax obligation anywhere. The Memorandum explained the same as follows:

"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. The current rules governing tax residence make it possible for HNWIs and other individuals, who may be Indian citizen to not to be liable for tax anywhere in the world. Such a circumstance is certainly not desirable; particularly in the light of current development in the global tax environment where avenues for double non-taxation are being systematically closed."

The solution proposed in the original Finance Bill, 2020 was therefore addition of a deeming provision by adding the following sub-section 1A to section 6, after section 6(1) that determines the ordinary residency rules for individuals.

"(1A) 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 by reason of his domicile or residence or any other criteria of similar nature."

The way the provision was drafted meant that the ordinary rules of residence of individuals based on period of stay as per s.6(1) stood superseded where the taxpayer is a citizen of India and is not taxed anywhere else because of his domicile etc. Most of the Gulf Indians are citizens of India and most of these countries do not levy income tax. They would have been deemed to be residents of India despite being away from India, partly or wholly during the financial year and thereby subjecting their income outside India to full taxation in India under the domestic law. It is a different matter that treaty rules might override the domestic law provision. Naturally, there were protests from the affected sections and the government after braving out for a few days, ultimately caved in and the provision was to be replaced so that only those Indian citizens having income of more than INR 15 lakh income in India would be affected by the provision and it was also clarified that only their Indian income would be subject to tax in India. This was sought to be achieved by placing this category of persons as not ordinarily resident.

The redrafted provision now read as follows:

"(1A) Notwithstanding anything contained in clause (1), an individual being a citizen of India, having total income, other than 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 by reason of his domicile or residence or any other criteria of similar nature;"

Again, the way the provision was drafted meant that the pendulum had swung to the other extreme. To understand the dilemma, one should look at the language used. The clause begins with a non-obstant 'notwithstanding anything contained in clause (1)'. The Supreme Court had clarified in many decisions the import of the use of notwithstanding anything contained in a particular provision.

It was held that a clause beginning with the expression "notwithstanding anything contained in this Act or in some particular provision in the Act or in some particular Act or in any law for the time being in force, or in any contract" is more often than not appended to a section in the beginning with a view to give the enacting part of the section in case of conflict an overriding effect over the provision of the Act or the contract mentioned in the non obstante clause. It is equivalent to saying that in spite of the provision of the Act or any other Act mentioned in the non obstante clause or any contract or document mentioned the enactment following it will have its full operation or that the provisions embraced in the non obstante clause would not be an impediment for an operation of the enactment.

Applying the said interpretation, an individual would normally be resident or non-resident in a particular year by the application of section 6(1). However, the government wanted to treat Indian citizens having income of more than 15 lakhs in a different way. That would mean that section 6(1A) would override the provisions of section 6(1). Now imagine a situation where an individual is a citizen of India and is also resident of India by virtue of the application of section 6(1) because of his period of stay in India. If he has income from India above INR 15 lakhs and also has foreign income but is not resident in any foreign jurisdiction by virtue of his domicile, his case is taken out of section 6(1) and will be governed by the provisions of section 6(1A). In other words, any middle class or rich Indian who is resident of India and has foreign income will now be governed by the newly introduced section 6(1A).

And what are the consequences of being governed by Section 6(1A)? The taxpayer will be deemed to be resident of India. That by itself is not detrimental to the revenue although it may be detrimental to the taxpayer. But, because of the hue and cry following the initial amendment, as mentioned earlier, it was clarified by the government that only the Indian income of such persons would be chargeable to tax in India, while the normal consequence of anyone being resident of India is that he is taxable in India on his worldwide income. The intention of the government was made clear through an amendment in clause 6(6) that determines the status of a person not ordinarily resident.

(6) A person is said to be "not ordinarily resident" in India in any previous year if such person is - (…)

(c) a citizen of India, or a person of Indian origin, having 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 one hundred and twenty days or more but less than one hundred and eighty-two days; or

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

For the purpose of the present discussion, it is clause (d) that is more important. A conjoint application of section 6(1A) with section 6(6)(d) will be that any Indian resident having income above INR15 lakhs who is not a resident of any foreign jurisdiction would now be taxed only on his Indian income thereby taking his foreign income out of the ambit of taxation in India, a result that is exactly the opposite of what the government had set out to achieve!

As we are aware, in March, 2020 the government had introduced an Ordinance- Taxation and Other Laws (Relaxation of Certain Provisions) Ordinance, 2020 principally to extend the various compliance deadlines under the Act in the wake of the COVID-19 pandemic. The said Ordinance had to be regularised through legislation. Accordingly, the government brought in 'The Taxation and Other Laws (Relaxation and Amendment of Certain Provisions) Bill, 2020'.

According to the Statement of Objects and reasons, the purpose of the Bill is to provide for extension of various time limits for completion or compliance of actions under the specified Acts and reduction in interest, waiver of penalty and prosecution for delay in payment of certain taxes or levies during the specified period.

The other purpose mentioned is to propose amendments to the Income-tax Act which, include providing of tax incentive for Category-III Alternative Investment Funds located in the International Financial Services Centre (IFSC) to encourage relocation of foreign funds to the IFSC, deferment of new procedure of registration and approval of certain entities introduced through the Finance Act, 2020, providing for deduction for donation made to the Prime Minister's Citizen Assistance and Relief in Emergency Situations Fund (PM CARES FUND) and exemption to its income, incorporation of Faceless Assessment Scheme, 2019 therein, empowering the Central Government to notify schemes for faceless processes under certain provisions by eliminating physical interface to the extent technologically feasible and to provide deduction or collection at source in respect of certain transactions at three- fourth's rate for the period from 14th May, 2020 to 31st March, 2021.

The Bill also proposes to amend the Direct Tax Vivad se Viswas Act, 2020 to extend the date for payment without additional amount to 31st December, 2020 and to empower the Central Government to notify certain dates relating to filing of declaration and making of payment.

The Finance Act, 2020 is also proposed to be amended to clarify regarding capping of surcharge at 15 per cent. on dividend income of the Foreign Portfolio Investor.

Although not specifically stated in the objects and reasons, an examination of the Bill shows that amendments have now been proposed to section 6 possibly to correct the obvious anomalies discussed above. This is proposed to be done by adding the following Explanation to the newly introduced section 6(1A):

"Explanation.- For the removal of doubts, it is hereby declared that this clause shall not apply in case of an individual who is said to be resident in India in the previous year under clause (1)."

In other words, those individuals who become resident of India by virtue of the operation of section 6(1) continue to be residents of India irrespective of any income limit. Those Indian citizens who are not otherwise resident of India under section 6(1) and have income from India exceeding INR 15 lakhs in the year concerned would now be deemed to be resident of India under section 6(1A). However, in terms of section 6(6)(d), they will be treated as not ordinarily residents and their income from foreign sources would not be taxed in India.

The expression 'income from foreign sources' is new and could be subject of interpretation. The expression was defined through an Explanation by the Finance Bill 2020 that stated:

For the purposes of this section, the expression "income from foreign sources" means income which accrues or arises outside India (except income derived from a business controlled in or a profession set up in India).

Since the status of those deemed to be resident under the newly included 6(1A) is that of not-ordinarily resident, one has to examine the scope of total income in respect of these category of taxpayers. In terms of section 5, the scope of total income of a not ordinarily resident is the same as that of a resident of India with the exception that the income which accrues or arises to such a taxpayer outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India. Therefore, prima-facie, the definition of income from foreign sources newly introduced is in line with the above definition.

But, there is a catch. The scope of total income even in case of a non-resident is 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.

There are many situations where income is deemed to accrue or arise in India even to a non-resident in terms of section 9 of the Act. The definition of 'income from foreign sources' as introduced by the Finance Bill, 2020 however excluded all income which accrue or arise outside India, placing the deemed residents at an advantage since there could be debate about whether the deemed accruals of section 9 could be considered to be the cases of actual accrual. Apparently, this loophole is now plugged by modifying the definition as follows:

Explanation- For the purposes of this section, the expression "income from foreign sources" means income which accrues or arises outside India (except income derived from a business controlled in or a profession set up in India) and which is not deemed to accrue or arise in India.

Although it is not specifically mentioned, these seem to be the purpose of the further amendments to section 6 carried out through this Bill. Hopefully, with this, all the loopholes have been taken care of. However, 'accrue or arise' is a very tricky concept. One is not sure how the fertile minds of the tax planners will work and whether we will need some more amendments in this regard.

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