Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of Parallelewelten.
Justice Oliver Wendell Holmes, Jr. once said that taxes are the price that we pay to live in a civilized society. Though as individuals, we don’t like the concept of parting with a share of our hard earned money, as a member of a civil society, paying taxes is not just fulfilling our duties, but a very important aspect of the growth of the nation, which directly or indirectly affects our very own growth.
Not indulging himself too much into the philosophical aspects of taxation, the researcher would now focus at the task at hand – to analyze the importance of “Residential Status” under the Income Tax Act, 1961.
The Income Tax Act, 1961 (hereinafter referred to as the Act) is an Act to consolidate and amend the law relating to income-tax and super-tax. However, not everyone is liable to pay taxes on income under the Act. The Act makes certain exceptions and exempts certain kind and extent of income from taxation. Those who are liable to pay tax and whose incomes are assessed under the Act are known as “Assessees”. They can be either natural persons or artificial judicial persons, including but not limited to corporations, firms, trusts, local authorities etc. The website of the Income Tax Department lists the following kinds of assessees: –
- An individual,
- A Hindu Undivided Family,
- A corporation,
- A firm,
- An ‘association or persons’ or ‘body of individuals’,
- A local authority,
- Any other artificial juridicial person not falling in any of the above categories.
The Department notes that there are different sets of rules that exist for the taxation of different kinds of the abovementioned individuals. The next basis of categorization of assessees is their residential status. Under the Act, assesses are either resident in India or non-resident in India. It might sound weird at first instance that an income accrued to an individual outside India would be taxable in India or an income accrued to a foreign national in India could not be taxable in India. However, the determination of tax liability under the Act is not on the basis of citizenship but on the basis of the residential status of the person.
The Concepts Of Residential Status And Income
Under the Act, assesses are either resident in India or non-resident in India. The same with respect to an individual or an HUF can be further divided into resident and ordinarily resident or resident but not ordinarily resident.
What do we exactly mean by these terms – resident, non-resident, resident and ordinarily resident, resident but not ordinarily resident. Any further discussion on this issue will first require clarification and explanation of these terms.
The first thing that needs to be kept in mind is that the residential status is determined with respect to the previous financial year – hence, an assessee may be a resident in one year and a non-resident in the next year. Attention needs to be brought to Section 6 of the Act which mandates that a person is said to be resident in India in any previous year if he was in India in that year for a period of 182 days or more or in the four years preceding that year, had been in India for 365 days or more. However, the basis for determination is not the same for all kinds of assessees. While it is the number of days spent in India for an individual, for an HUF, firm or other association of persons, the determination is made on the basis of its control and management. If the control and management of such assesses was outside India in a financial year, then it was not resident in India for that year, otherwise it was.
With respect to Companies, the very fact that a company is an Indian company is enough to establish residency in India. Even in case of foreign companies not incorporated in India, if the control and management of its affairs is wholly situated in India, the said Company is deemed to be resident in India.
Another concept that needs clarification before we proceed to discuss the implications of the residential status under the Act is “not ordinarily resident in India”. As per the Act, if an individual has been a non-resident in India in 9 out of the 10 previous years preceding that year, or has during the 7 previous years preceding that year been in India for a period of, or periods amounting in all to, 729 days or less or an HUF whose manager has been a non-resident in India in 9 out of the 10 previous years preceding that year, or has during the 7 previous years preceding that year been in India for a period of, or periods amounting in all to, 729 or less, then such a person or HUF is deemed to be “not ordinarily resident in India”. However, the Finance Act 2003 had the effect of restricting the benefit of status of “not ordinarily resident” in the case of a non-resident Indian coming back to India or foreign citizens working in India to only a period of two years as against the earlier benefit of nine years. Hence, non-residents coming back to India will have to pay tax on their global income after a period of two years. Similarly, foreign citizens working in India will be required to pay tax on their global income if they continue to be resident in India beyond a period of 2 years. The intention of the amendment may be principally to prevent tax avoidance by persons who arrange their affairs in such a manner as to artificially become eligible for NOR status. However, they also note that this move could cause a lot of hardship to a large number of people coming to India for permanent settlement and will have a negative impact on the inflow of funds through the medium of non-residents.
Indian And Foreign Income
Indian and Foreign Income are two concepts that need to be understood before one can assess the relationship of residential status with tax liability. The Act mandates that all incomes, whether directly or indirectly accruing or arising in India shall be deemed to accrue or arise in India.
Certain types of income are deemed to accrue or arise in India even though they may actually accrue or arise outside India. The categories of income which are deemed to accrue or arise in India are:
- Any income accruing or arising to an assessee in any place outside India whether directly or indirectly
- through or from any business connection in India,
- through or from any property in India,
- through or from any asset or source of income in India or
- through the transfer of a capital asset situated in India.
- Income, which falls under the head “Salaries”, if it is earned in India. Any income under the head “Salaries” payable for rest period or leave period which is preceded and succeeded by services rendered in India, and forms part of the service contract of employment, shall be regarded as income earned in India.
- Income from “Salaries” which is payable by the Government to a citizen of India for services rendered outside India. However, allowances and perquisites paid outside India by the Government are exempt.
- Dividend paid by an Indian company outside India.
- Fees for technical services
The Test For Person Nor Ordinarily Resident In India
In Pradip J. Mehta v. Commissioner of Income Tax, Ahmedabad, assessee was appointed as Marine Engineer by Wallem Shipping Management Ltd., Hong Kong and, during the course of his employment, he was posted to work on high seas and paid abroad for many years. The assessee while filing his return for the assessment year 1982-83 claimed the status of “not ordinarily resident in India” as defined in Section 6(6)(a) of the 1961 Act and to exclude income accruing outside India under Section 5(1)(c) of the 1961 Act, which provides 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 in his total income.
The Assessing Officer refused to grant the assessee the status of “not ordinarily resident” for the relevant year, on the ground that the assessee was a non-resident in India for only 3 years during the last 10 years and during the past 7 years he had stayed in India for more than 730 days. He came to the conclusion that during the last 9 previous years, the assessee was non-resident for only three years and during the last seven previous years, he had stayed in India for a period of 1,402 days. It was held that the status claimed by the assessee of ‘not ordinarily resident’ was not acceptable.
The case eventually reached the Supreme Court and the issue to be decided was whether the status of the assessee for the year in question was not that of ‘resident but not ordinarily resident’ as claimed by him?
The Court noted that the definition of “resident” and “not ordinarily resident” was enacted by the British Rulers, i.e., the officers of the Indian Civil Services and those in armed forces serving in India, who were absent from India on furlough for a year out of every four years so that they could be treated as “not ordinarily resident” and avoid tax on income in their home country, notwithstanding continuous stay and service in India.
The Court further noted that Law Commission of India had recommended that the provisions of Section 4B of 1922 Act defining “ordinary residence” of the taxable entities be deleted but the suggestion was not accepted by the Legislature. Rather, on the legislative anvil, it was felt necessary to keep Section 4B of 1922 Act intact and, accordingly, Section 6(6), which corresponds to and is pari materia with Section 4B of 1922 Act, was enacted in 1961 Act.
The Court presumed that the legislature was in the know of the various judgments given by the different High Courts interpreting Section 4B but still the legislature chose to enact Section 6(6) in the 1961 Act, in its wisdom, the legislature felt necessary to keep the provisions of 4B of 1922 Act intact.
It was held that a person will become an ordinarily resident only if (a) he has been residing in nine out of ten preceding years; and (b) he has been in India for at least 730 days in the previous seven years.
In C.N. Townsend v. CIT, the Patna High Court has held that if any of the conditions mentioned in Clauses (a), (b) or (c) of Section 6(1) of the 1961 Act is fulfilled, the assessee will be a ‘resident’ within the meaning of the 1961 Act and if he comes within the mischief of either of the two conditions mentioned in Section 6(6)(a), he will be treated as ‘not ordinarily resident’. In that case, the assessee came to India in April, 1964, and continued to stay in India till the end of March, 1965, and therefore, it was held that he clearly fulfilled the condition laid down in Sub-section (6)(1)(a) of the 1961 Act and as such, was a ‘resident in India’ during the previous year in question. It was held that the assessee, however, could not be treated as ‘ordinarily resident’ in India as he fell within the first condition in Section 6(6)(a) namely, that he was not resident in India in nine out of ten previous years preceding the year 1964-65 even though he did not come within the mischief of the second condition.
Similarly, the Travancore-Cochin High Court, in P.B.I. Bava v. CIT held that a person was not ordinarily resident in any year unless he satisfies both of the conditions of the said provision which make a person ordinarily resident, namely, (i) the condition that he must have been resident, in nine out of ten years preceding that year, and (ii) the condition that he must have been, here for periods of more than two years during the seven years preceding that year. It was held that a person is ‘not ordinarily resident’ in India in the previous year if he has not been ‘resident’ in nine out of the ten years preceding that year; he need not establish that he was ‘not resident’ in nine out of the ten years. It was observed that ‘not resident’ and ‘not ordinarily resident’ are not positive concepts but only the converse of ‘resident’ and ‘ordinarily resident’ and a category of persons ‘not resident and not ordinarily resident’ is impossible to imagine and unknown to the Act.
The Bombay High Court, in Manibhai S. Patel v. Commissioner of Income Tax, held that an individual is `not ordinarily resident’ in the taxable territories, he should satisfy one of the two conditions laid down in Section 4B(a) of the Indian Income Tax Act, 1922 (which corresponded to Section 6(6)(a) of the 1961 Act). It was held that, under Section 4B(a), what was required to be considered was the assessee’s residence in the ‘taxable territories’ and not his residence outside the ‘taxable territories’. If the assessee had been in the ‘taxable territories’ for more than two years in the preceding seven years, then he does not satisfy the second condition laid down in Section 4B(a) and would, therefore, not be ‘not ordinarily resident’ in the taxable territories. In that case, the assessee was living in Africa for four years out of the preceding seven years and he was in the ‘taxable territories’ for about three years and the question was whether he was ‘not ordinarily resident’ in ‘taxable territories’ under the second part of Section 4B(a). It was held that, he did not satisfy the second condition. The Court also noted that the Legislature is primarily concerned with the residence of the assessee in the taxable territories, and in order that an assessee should be “not ordinarily resident” in the taxable territories what has got to be considered is his residence in the taxable territories.
In order to enjoy tax benefits through non-resident status, individuals visiting India on a business trip should not stay for more than 181 days during one previous business year and their total stay in the previous four years should not exceed more than 364 days.
If individuals, having been in India for more than 365 days during four years preceding the relevant previous year, which to stay for more than 60 days, they should plan their visit to India in such a manner that their total stay in India falls under two previous years. Such persons can come to India any time in the first week of February and stay till May 29.
An Indian citizen or a person of Indian origin can stay for a maximum period of 181 days on a visit to India without losing his non-resident status.
An Indian citizen leaving India will not be treated as a resident unless he has been in India in that year for more than 181 days.
- Dr. Vinod K. Singhania, Dr. Kapil Singhania; Direct Taxes – Laws and Practice, Taxmann Publications, 41st edition, 2009-10, New Delhi
- Sanjiv Malhotra, N D Berry; Allied Laws and Office Procedure (Income Tax & Service Rules), Jain Book Depot, 1st Edition, 2009, New Delhi
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