Paper No.

1
The Income Tax Appellate Tribunal

Residential Training Programme

Maharashtra Judicial Academy, Mumbai

Presentation on
Residence & Tax Incidence

Sunday, 12th August, 2012.

This is a conceptual paper. More importance is given to understanding the

concepts and less to case law and litigation.

CA. Rashmin C. Sanghvi

www.rashminsanghvi.com

Contents

Sr. No. Particulars Page No.

1. Summary of Legal Provisions 13

2. Indian Tax Base: Graph 4

3. Jurisdiction. 58

4. Scope of Total Income. 9 12

5. Residence 13 19

Ann. I Evolution of Tax Rates in India 20

Ann. II Global Corporation 21

Ann. III Additional Thoughts 22-23

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Residence & Tax Incidence

1. Summary of Legal Provisions:

In this presentation we are considering some fundamental

principles of Indian Income-tax Act. The word Incidence is not used in
any section of the Indian Income-tax Act. It is a word covering the
implications of several sections. First we may have a broad look at the
coverage of the term and then we can consider individual sections.

1.1 Tax Incidence means the tax to be borne by a person. (Note 1) The
amount of tax that a person will bear under Indian Income-tax Act is
affected by several legal provisions.

Section 1 (2) provides that the scope of Indian Income-tax Act is:
India. In other words, the jurisdiction for taxing authorities is within
India. Government has no jurisdiction to tax outside India. Despite clear
wordings of section 1 (2), jurisdiction remains a hugely controversial issue.

(Note: Some of the statements made in this paper may seem

unacceptable. However, as we proceed further, different implications of
these sentences will become clear.)

Section 3 defines Previous Year as financial year. The tax

incidence is decided separately for each year.

Section 4 levies the Charge of income-tax. The rates of tax are

provided in the schedule 2 of the Finance Act.

Section 5 provides for the Scope of total income.

Section 6 provides the definition of Residence.

Section 9 extends the primary scope of total income by making

deeming provisions.

Section 10 reduces the tax incidence by granting exemptions.

Chapter VIA reduces the tax incidence by granting deductions.

All these provisions impact the tax incidence tax burden on the
assessee.

Tax incidence from the point of view of the assessee is the tax cost
which he has to bear. From the Governments point of view it is the charge
by Government on a persons income.

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Note 1: In Economics, Tax Incidence is the analysis of the effect of a

particular tax on the distribution of economic welfare. (Wikipedia). In
case of indirect tax, one considers the ultimate person who bears the tax
consumer/ trader/ manufacturer. How much tax each person bears is the
tax incidence on that person. It depends on the elasticity of supply and
demand.

In International taxation, one can consider the issues who will

suffer the tax the payer or the receiver? This note also highlights the fact
that each word or term can acquire different meaning depending upon the
reference and context in which it is used.

1.2 Tax Base: When the total income on which Government of India can
levy income-tax is to be considered it is called Tax Base. In simple
terms, as the first step, Indias tax base is Indias GDP. All the incomes
earned within India are liable to Indian Income-tax. The chart on the next
page shows how tax base between India and the rest of the world is
distributed.

1.3 Double Taxation:

Under the classical system of taxation, a Government does not

restrict its rights to tax only the income within its geographical
boundaries. It would like to tax the global income of its residents. When
all the countries accept the classical system, there is bound to be double
taxation. When Indian GDP includes income earned by non-residents, the
right to tax that portion of the GDP is shared by India & some other
countries. Same income would be the tax base for two or more countries.

Double Tax Avoidance Agreements (DTA) provide-

(i) Relief to Non-Residents from Indian tax on Indian sourced income;

and
(ii) Credit for foreign tax paid by Indian residents on their foreign
income. There is no provision in the law or DTA that an Indian residents
foreign income will NOT be taxable in India.

Sections 90 & 91 provide for these reliefs.

Classical system of taxation attempts to extend Indias tax base beyond its
geographical boundaries; and DTAs try to manage the conflict between two
jurisdictions.

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1.4 Base Erosion & Base Protection:

To avoid the Indian Income-tax, a Non-Resident assessee may try

several games (1) Try to show that the income has been earned outside
India and hence India has no jurisdiction or (2) he may try to claim a
categorisation of income which attracts NIL or lower tax rate.

(1) To catch such incomes escaping Indian tax, there are deeming
provisions. Income which under normal accounting practices would be
considered as foreign income is deemed to be Indian Income under section
9. (2) Categorisation of income and few specific concepts are matters of
huge litigation.

Transfer Pricing provisions try to bring within Indian scope

incomes which the assessee has tried to shift to another jurisdiction.
Finance Act, 2013 may further provide for CFC & GAAR.

One can see that the word Tax Incidence is affected by so many
legal provisions. The assessee tries to reduce his tax incidence.
Government tries to expand its tax base and recover maximum tax. In this
Tug of War section 9, TP provisions, CFC, & GAAR and several provisions
will keep coming on the statute books.

1.5 The incidence of taxation is borne in different manners. Normally,

the assessee pays the tax as advance tax or self assessment tax. Or the
payer deducts income-tax at source and makes net payment to the
assessee.

Note: Some additional thoughts are given in Annexure III. They are
related to the concept of Tax Incidence. However, they will be discussed
only if time permits.

1. Summary of Legal Provisions completed.

Next: 2. A graph depicting Tax Base.

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2. Indian Tax Base. Graph

Our tax base is Our GDP - Section 5(1).

Add: Foreign GDP earned by Indian Residents - Section 5(1).
Add: Foreign GDP deemed to be taxable in India Section 9.
When non-residents earn Indian income, it remains Indian tax base.
Government of India shares tax on such incomes with foreign
Government.
Foreign GDP earned by Non-Residents is not taxable in India.

1 Global GDP

7
?
6
8
2 Indian
GDP

5
4

3 Rest of the World GDP

1 - Global GDP.
2 - Indian GDP
3 - Rest of the world GDP
4 - Indian income earned by Non-residents.
5 - Foreign income earned by Indian residents
6 - Foreign income received in India by Indian residents.
7 - Foreign income received in India by Non-residents.
8 - Foreign income deemed to be earned/received in India.

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3. Jurisdiction:

How does Government of India (GOI) get jurisdiction outside

India? How does a Foreign Government get jurisdiction to tax Indian
Income? ITA Section 1 provides that the Act extends to whole of India.
Can Government of India tax a foreign income?

It is now a settled principle that if there is a connection with India,

the Government of India gets jurisdiction. This issue has been discussed at
length in several cases latest is the decision in Vodafones case. We will
not go into that controversy in this paper. Let us see what that
Connection means.

A Governments tax jurisdiction is determined by Connecting

factors.

3.1 Scope & Residence:

There are two essential pillars of taxation. (i) Assessee and (ii)
Income. An assessees income is taxable in India. If there is no income,
there will be no tax. Assessee & income both must exist for charging
income-tax. And at least one of them should be connected with India.

For assessee, his residential status is the connecting factor giving

jurisdiction to the Government for taxation. For income its source country
gets the jurisdiction to tax the income.

Hence the two connecting factors are: Source & Residence.

Source is defined under section 5 and residence is defined under section 6.

If an income is sourced in India, it is taxable irrespective of whether

the assessee is an Indian resident or a non-resident. If the assessee is an
Indian resident then his income is taxable irrespective of whether it was
sourced in India or sourced outside India.

When the assessee is non-resident, his income is taxable only if

sourced in India.

If a non-resident gets income sourced outside India then GOI has

no jurisdiction to tax the same.

Note: This paragraph narrates interaction of Sections 5 and 6. One can

go further and ask which provisions of the Constitution of India grants
jurisdiction to the Parliament to legislate Income-tax Act? For this paper, I
am not discussing provisions of the Constitution.

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3.2 Business Income:

In case of business or profession generally it is an accepted

principle that the business profits are taxable in the country in which the
business is controlled & managed. (One can ask the question: Why? We
will attempt an answer in the paper on Treaty Models.)

For example, TISCO sells steel. Its profits from the business of
manufacture & sale of steel are primarily accruing / arising in India and
hence taxable in India. Let us say TISCO exports steel to United States
worth $ 100. Where is the net profit on this export of $ 100 arising? It is
generally assumed that the businessmans profits arise where the business
is controlled & managed. Just because $ 100 are received from USA, it does
not mean that the net profit on $ 100 is taxable in USA.

Similarly, India imports goods worth $ 300 billions every year.

Primarily, it is assumed that the foreign exporter of goods has not earned
any income from India. His income is not taxable in India.

Different economic logics are given for this assumption. Income-tax

is on the seller or supplier of goods & services. Income accrues where the
seller / exercises functions, utilises assets and takes risk.

Income-tax is not linked with consumer. Economic activities of

course depend upon consumption. But for that, consumption taxes like
customs duty, sales tax & VAT are levied.

3.3 With India / Within India:

There is a difference between doing business with India and

doing business within India. When the Saudi Arabian oil company
exports crude oil to India, it is doing business with India. However, if a
foreign exporter establishes a factory / branch / office in India and then
conducts business through such establishment in India, he is considered to
be doing business within India.

When a businessman earns profits by doing business With India,

his income is NOT taxable in India. When he does business Within India,
the portion of profits made in India, is taxable in India.

3.4 Permanent Establishment (PE):

Business establishments in India, belonging to non-residents are

considered as permanent establishments. In case of a permanent
establishment the profit attributable to the PE is taxable in the host
country. It is Indian GDP and forms part of Indian Tax Base.

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Consider an assessee carrying on business in several countries. For

example, State Bank of India (SBI) has many branches in India and many
branches outside India. Every branch outside India is considered as SBIs
permanent establishment outside India. The PEs income is primarily
taxable in the country in which the PE is situated (host country). At the
same time, it is also taxable in the Country of Residence of the Assessee.
DTA then tries to avoid Double Taxation.

HSBC bank has many branches in India. HSBC itself is a non-

resident of India. Hence each Indian branch of HSBC is considered a PE
situated in India. Profits earned by such branches are taxable in India.

3.5 Goods & Services:

Historically economists have distinguished goods & services.

Draftsmen have followed the economists and made separate laws for
goods & services. For example, Sale of Goods Act covered only goods. It
did not cover sale of services. When these laws were drafted, goods
constituted an important part of the GDP. The market for services was
insignificant. Hence there was no law called Sale of Services Act. This
trend continued in tax laws. Primarily, the tax provisions are defined for
goods. For computing profits from business in goods, detailed provisions
have been made.

However, as time passed simple items like interest, dividend,

royalty & technical services grew in importance. Hence these services
were also made taxable. However, no detailed provisions for computation
of income from services have been made.

For goods, the fundamental presumption is that the profits accrue

in the place where the business is controlled & managed. In case of
services, the U.N. & OECD Models have accepted that services are taxable
in the country from which payment has been made. There is no logical
reason for different treatment for goods and services. It is a weakness
built into International Taxation because of historical developments. Also
in essence payment does not determine the place of accrual of income.
This is a compromise in the UN & OECD Models. These compromises
have been incorporated in the Income-tax Act through Section 9.

3.6 Tax Jurisdiction determines the Tax Base. It extends beyond GDP. We
have looked at Tax Incidence in three different manners in paragraphs
I, II, & III.

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Note: Tax Base, Tax Incidence, Base Erosion etc. are terms given to certain
concepts of taxation. They are provided to understand fundamental
principles of taxation. Having understood the principles, they go in the
back ground. For real life taxation, one has to go to Income-tax Act &
DTA.

3. Note on Jurisdiction completed.

Next 4. Scope of Total Income.

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4. Scope of Total Income is determined with reference to Residential Status.

Hence Residence is summarised below. Details are covered in Part V.

Summary of Residential Status:

Section 6 provides for the definition of residence in India.

Section 6 sub-section (6) provides for the definition of Not Ordinarily
Resident (NOR).

A person may be resident in India or non-resident in India.

An Indian resident may be Ordinarily Resident in India or Not

Ordinarily Resident in India.

4.1 Section 5 - Scope of total income in simple terms:

Ideal terminology of section 5 should be that all incomes Sourced

in India are within the scope of total income. However, Parliament has not
used the term Source to define the scope of total income. Instead, two
different criteria are provided.

If any income is received in India, it is liable to taxation in India.

If any income accrues or arises (earned) in India it is liable to

taxation in India. For the word Earn, the law uses the terms Accrues or
Arises. Each term used makes a significant difference in the tax incidence.

4.2 Resident:

Section 5(1) is applicable to Indian Residents. For them income

accruing or arising anywhere in the world is liable to tax in India. This
phrase is extended to cover foreign income also. However, the concept of
receipt of income is not extended abroad. In other words, income received
in India is liable to tax in India. However, income received abroad does
not become taxable in India by itself. This may be better appreciated when
compared & contrasted with Earned. If an Indian resident earns income
whether in India or abroad, he is liable to tax. However, when it comes
to receipt, he is liable to tax only if he receives in India. A receipt abroad
does not make the income taxable. It is another issue that normally a
person would receive income only if he has earned it. Hence sooner or
later the income will be taxable.

Some times the accrual of income and the receipt of income may be
in the same previous year. In such cases there is no difficulty. However,
there are many instances when income is received in one year and it
accrues in another year. In such cases, for business income and income
from other sources, the taxability will depend upon the accounting system

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regularly adopted by the businessman. In case of salary income, it is

taxable on receipt or accrual whichever is earlier.

In short, for an Indian Resident, his Global Income is taxable in

India. (Income deemed to have accrued / arisen or received is also
taxable.)

4.3 Not Ordinarily Resident (NOR):

When a person is an NOR his foreign income is not taxable in India.

This simple sentence in legal language would be as under: The income
accruing or arising outside India is not taxable for an NOR. However, if
there is a business controlled in India or profession set up in India then
for such business or profession the income accruing or arising outside
India will be taxable in India.

4.4 Non-Resident: Section 5(2): In case of a non-resident, only the

income received or accruing or arising in India is taxable in India. Foreign
income is not taxable in India.

4.5 Explanation 1: An assessee may have business outside India. There may
be incomes accruing outside India. The assessee in his accounts may
provide for such accrued income even before receiving the same.
However, for the purposes of section 5 it shall not be understood that the
income was received in India just because it has been included in the
Indian balance sheet.

4.6 Explanation 2: An assessee may include in his own books of accounts

income on the basis of accrual. Such income would be taxable on accrual.
He may receive the income in a subsequent year. Once the income has
been taxed on accrual basis, it cannot again be taxed on receipt basis.

4.7 It is a settled principle of law that income can accrue at each &
every stage of a business. For example, if an assessee makes efficient
purchases, he earns income on purchase. If the production is more
efficient, then there is a profit in the manufacturing process also. When he
sells goods, he again makes profits. Profit does not arise only when goods
are sold. Only realisation of profits happens on sales.

In a business some functions may be performed in India and some

functions may be performed outside India. The income accruing or
arising on the functions performed in India forms part of Indian Scope of
Total Income. (This is a simple sentence & not to be taken as a principle.)

Illustration: PE to HO

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ABC Ltd. of USA has set up a PE in India. The Indian PE develops

software and exports to USA. Assume cost of development is Rs. 50,000.
Profit @ 20% margin is Rs. 10,000. Indian PE transfers the software to the
Head Office in USA for Rs. 60,000. (We assume that all transfers have been
made at arms length price.) Now HO sells the software for Rs. 1,00,000.

What is taxable in India, is only Indian PEs profits. ABCs profits

in USA are not taxable in India. Indian tax base is Rs. 10,000 earned by the
Indian PE.

(What is taxable as profits attributable to a PE is a full fledged

controversy. In this paper we are not discussing that controversy.)

4.8 A significant percentage of disputes in International Taxation is

on the issue whether the income is covered by Section 5 or not. For
taxation of Indian residents, this issue is irrelevant as his global income is
taxable in India.

Vodafones case involved two issues:

(i) Whether Hutchisons income was covered within the Scope of

Total Income Section 5 as extended by deeming provisions of Section 9.

(ii) And whether under section 1, India has jurisdiction to ask a

Non-Resident Vodafone to deduct tax at source. Understanding Section
5 is a $ two billion issue. In this elementary note, we have not even
scratched the surface.

(My personal, humble submission is: Hutchison was taxable in

India under section 5 itself. There was no need to focus on Section 9. And
existing ITA is robust enough to tax such transactions. One does not need
a legal provision specifically to say that a sham arrangement has to be
ignored.)

4.9 Some fundamental issues:

(i) The place of receipt of income is the place where the receiver gets
complete control over the funds. Thus when an Indian resident remits
funds to his non-resident supplier, India is only the place of payment. If
the non-resident receives the money outside India in his bank account and
he can exercise control over the funds outside India, then the place of
receipt is outside India. Hence Section 5 (2) (a) does not cover such
payments.

(ii) When a technocrat provides consultancy services, he earns Fees for

Technical Services (FTS). If the services are provided outside India, then
the place of accrual of business income is outside India. When Indian

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customer remits the fees abroad, the technocrat receives them outside
India. Hence primarily under section 5 this income would be beyond the
scope of total income. Hence such income would not be taxable in India.
Section 9 makes a deeming provision. If the FTS is paid by an Indian
resident etc., it is deemed to be taxable in India.

4. Note on Scope of Total Income completed.

Next - 5. Note on Residence.

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5. Section 6 Residential Status:

Indian Income-tax Act provides for physical stay as a test for

individuals, place of incorporation as a test for companies and control &
management as a test for other entities.

5.1 Section 6(1) If an individual is resident in India for more than

181 days during a financial year, he is considered as resident of India.
These 181 days may be in a continuous stretch or over several different
periods of stay in India.

If a person is travelling abroad frequently, how do we compute his

number of days in India? Indian Income-tax Act & Rules do not provide
for any specific guidance. There has been a tribunal ruling that out of the
two days of arrival & departure, consider one day as in India and the
other as outside India. There is no legal base for this decision. However, it
is a fair decision.

In UK, the Government considers mid night (12.00 hours) as the

relevant time to count the assessees presence. If he is in U.K. at mid night,
that day will be included as the day in U.K. If he arrives in U.K. after 12.00
in the night, he would be considered as outside U.K.

Different countries can have different ways of computing the

number of days. It would be best for India to provide for the method of
computing the number of days.

5.2 Earlier the income-tax Act provided a condition where if a person

had a home in India then he was considered as Indian resident even if he
spent just 30 days in India. Now this provision has been deleted. There are
many NRIs who purchase homes in India. Indian Government would
encourage investment within India. And if they come to India for vacation
etc., they cannot be deemed as Indian residents. Deeming a person as
Indian resident has significant consequences. His global income becomes
taxable in India.

5.3 Section 6(1)(c). This section provides that if a person had been
present in India for 365 days during preceding four years (on an average if
the person is present in India for 91 days or three months); and during the
relevant previous year he is present in India for 60 days or more, then he is
considered as an Indian resident.

This is an important provision to be considered. Sometimes people

just consider the 181 days rule and forget about the 60 days rule. A
frequent traveler to India may become Indian resident by just a 60 days
presence in India.

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5.4 60 days become extremely restrictive. What happens if a person

gets a job abroad and goes abroad in the month of July? He was present in
India for only 60 days. However, his next 10 months salary would be
taxable in India. These people made representations and Government
conceded. Hence explanation (a) has been provided. When a person goes
abroad for employment, he is granted the relief. He would be treated as
Indian resident only if he spent 182 days or more in India. Similarly,
Indian citizens going abroad on Indian ships for employment are also
granted the relief of 182 days or more.

5.5 In the year 1991 liberalisation started. Government of India was

inviting NRIs to invest in India. The NRIs complained that if they invest in
India, they have to visit India. And if their visits exceed 60 days, they
would be treated as Indian residents and even their foreign incomes
would become taxable in India. Government accepted their
representations. They have been granted 182 days or more.
Explanation (b).

5.6 Section 6(2): HUF, firm or AOP.

For a non-individual entity, number of days presence in India

cannot be counted. Hence the provision is based on control &
management of its affairs. When an HUF, a firm or an AOP has the
whole of its control & management outside India, it is considered a non-
resident of India. If even a part of its control & management is situated in
India, it becomes an Indian resident and its global income becomes taxable
in India.

Consider an American partnership firm having 1,000 partners

spread over several different countries. The firm has two partners looking
after the Indian business. Since two partners are managing a portion of the
firms affairs in India, the firm will be treated as an Indian resident. Hence
the global income earned by all the 1,000 partners will be taxable in India.

This is an archaic and a harsh provision. Even DTC has not

reviewed the provision. Simple advice to all involved in international
business: Dont do business through an unincorporated body. Make a
company to transact international business.

5.7 Section 6(3) Company Incorporation:

Section 6 (3) (i) provides that a Company is Indian Resident if it is

an Indian company. This takes us to Section 2 (26). Essentially, all
companies formed and/ or registered under the Indian Companies Act are
Indian companies.
In the case of a company Indian Income-tax Act has adopted a
simple and liberal approach. If a company is registered in India, it is

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considered to be Indian resident. If a company is registered abroad, it is

considered to be a non-resident.

5.8 Control & Management/ Place of Effective Management:

It is easy for one or more Indian residents to incorporate companies

in Mauritius, Dubai or other tax havens. These companies would be totally
controlled & managed from India. 100% of shares may be owned by
Indian residents. All the directors may be Indian residents. Still, the
company would be considered a non-resident and its foreign income
would be free from Indian tax. Section 6 (3) (ii) provides that if during a
previous year, the whole of the control & management of its affairs is
situated in India, that company will be Indian Resident. It is fairly easy to
ensure that at least a part of the control & management is situated outside
India.

Initially FERA was harsh. Indian residents could not invest abroad.
After 1993 FERA has been liberalised. Slowly the liberalisation has become
more substantial. Today Indian residents can easily invest abroad. Hence
people have started incorporating companies abroad. Income-tax
department has taken notice of this development. Hence it is proposed
under DTC to change the definition. The new proposal is to substitute
Place of Incorporation by Place of Effective Management. When the
new definition comes in place, any company would be considered as an
Indian resident if the place of its effective management is situated in India.

5.9 Section 6(4) Residuary Category:

Any other person (other than individual, HUF, firm, AOP, &
company) will be treated as an Indian resident unless the whole of the
control & management of his affairs is situated outside India. This is
similar to section 6(2).

5.10 Section 6(5):

Earlier section 3 permitted assessees to select any previous year. It

was not compulsory to take financial year as the previous year. And an
assessee could select a different previous year for each & every source of
income. It was possible that an assessee could be resident in India for one
previous year and non-resident in India for another previous year. To
cover such cases, section 6(5) provided that once an assessee is deemed to
be an Indian resident for one previous year and one source of income, he
shall be treated as resident for all the sources and all the previous years.

Original Section 3 has been replaced by the Direct Tax Laws

(Amendment) Act, 1987. Now all Indian assessees have to submit their
income-tax returns considering financial year as their previous year for all

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sources of income. Hence instances of being resident in India for one

previous year and non-resident of India for other previous years is not
possible.

Now let us see whether it is possible that an assessee can have

different previous years for different sources.

Section 6 (1) Once an individual is physically present in India for

more than 181 days, he is an Indian resident. This is irrespective of any
source.

Section 6 (2) provides that if even a part of the control and

management of the affairs of a firm etc. is situated in India, that firm
becomes an Indian resident. The firm may have several sources of income.
Some source may be wholly controlled and managed outside India. Some
source may be wholly or partly controlled and managed from India. Once
even a fraction of its control and managed is situated in India, the whole
firm, for all its incomes is treated as Indian Resident.

Section 6 (3) (i) Residence is based on incorporation and

registration. There is no question of a Company being resident for some
incomes and non-resident for other incomes.

Section 6 (3) (ii) & S. 6 (4) same as Section 6 (2).

Hence an assessee is either Resident or NOR or Non-Resident.

There cannot be a situation where an assessee may be resident for some
sources and non-resident for other sources.

5.11 Section 6(6) NOR:

5.11.1 Individuals & HUFs get an additional relief under the status NOR.
This status is not available to partnership firms or companies and other
kinds of assessees.

Section 6(6)(a) provides two alternative conditions. If an

individuals fulfills any one of the two conditions, he gets the NOR status.
Hence his foreign income is not taxable in India.

5.11.2 Section 6 (6) (a) (i) Earlier, the section was so worded that if a
person was non-resident of India for two years, he was considered as not
ordinarily resident for next nine years. Many assessees abused this relief.
They became non-residents of India by going to Dubai for 13 months in
two consecutive previous years. (Note: People preferred Dubai for many
reasons. It has no tax and no foreign exchange controls. It allowed people
to be residents. And No questions asked.) They claimed to have become
non-residents of India for two years. Within these two years they would

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have setup business abroad under a limited liability company. The

company would go on earning substantial income abroad even after the
assessee returned to India. The assessees would claim the income to be
free from tax in India.

The income earned abroad would be first received in their foreign

bank accounts. Hence receipt of income would be outside India. Having
received the income abroad, it would be remitted to India. On such
inward remittance, there would be no income-tax in India.

Finance Act, 2003 amended section 6(6). Now a person gets NOR
status for two years if he is a non-resident for nine out of preceding ten
years. The Dubai Tax Planning via section 6(6) is over. But Dubai has
started new series of tax planning. It has become a tax haven and opened
several free zones. And India Dubai Double Tax Avoidance Agreement
has opened new doors for tax avoidance.

5.11.3 Section 6 (6) (a) (ii), if the individual stayed in India for 729 days or
less during the preceding seven years, he will be considered an NOR.

For an individual, there are two alternative conditions to be an

NOR. If he fulfills any one of the two, he becomes an NOR.

If an individual is (i) either non-resident for nine out of preceding

ten years, or (ii) has stayed in India for less than 730 days in the preceding
seven years he becomes an NOR.

5.12 HUF:
The NOR status is granted to HUF also. HUF may have many
members. Different members may have different residences. Hence the
HUFs NOR status is made dependent upon its managers residence.

Hindu Law uses the term Karta of HUF.

Income-tax Act uses the term Manager of HUF.

Section 6 (6) (b) provides for NOR status for an HUF. The HUF gets
NOR status if its manager can fulfill any one of the above referred two
conditions. (Paragraph V.11.3)

It may be noted here that under section 6(2) an HUFs residential

status depends upon control & management of its affairs. Under section
6(6)(b) the NOR status depends upon the physical presence of the
manager. There can be mix up of the two conditions.

Consider the illustration of an HUF. The manager is Indian

resident. He spends almost 300 days every year in India. Hence the HUF
will not get NOR status. The HUF has set up a business outside India. The

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manager would travel abroad every month for a few days. During those
foreign visits he would give all necessary instructions and the business
would be run by employees. He can claim that the control and
management of HUF affairs have always been exercised outside India.
Hence the HUF is a non-resident of India. Hence irrespective of NOR
status, its foreign income would be exempt from Indian income-tax.

5.13 Internationally the definitions for residential status are not so

simple. For example, in Britain, there is no precise definition of residence.
Normally the physical stay in the country would be an important test.
However, there can be cases where the person may be out of U.K. for ten
months in the year. However, he may have maintained connections
with U.K. For example, his family continues to stay in U.K., he maintains
bank accounts and credit cards in U.K., he is member of a club or
association in U.K. These connections would be adequate to consider the
person as a resident of U.K. Compared to such definitions Indian
definition is fairly simple.

In USA the connecting factor is not just residence. Citizenship &

green card are also important. If a person is U.S. citizen then he is fully
liable to US tax on his global income irrespective of the fact that he may be
staying outside USA for several years.

Since each country has its own definition of Residence, it is

possible that same individual may simultaneously become Resident of two
countries.

Double Tax Avoidance Agreements provide for Tie Breaking

provisions in such cases.

5.14 There are some people who will live in India for less than 182 days
and will not maintain connections with any country. They will have
right to stay in several countries like Dubai, Mauritius etc. But they will
be non-resident of all countries. These are Perpetual Travelers or
Nomads. They do not pay tax in any country on Global basis. But they
have to pay tax on Source basis in the country where they earn income.
They will not get DTA relief in any country as they are non-residents
everywhere.

The residential status has to be considered separately for each

previous year. Thus, an assessee may be resident in year 1, non-resident in
year 2 and again resident in year 3.

Consider an illustration. Mr. A has made investments abroad

under liberalised remittance scheme (LRS) under FEMA. If he sells these
investments, he is likely to earn capital gains. Assume a case where Mr. A
is likely to earn substantial capital gains abroad. Under normal

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circumstances, his foreign capital gains would be taxable in India.

However, he may decide to go abroad for more than 182 days in a
particular previous year. He whould go abroad on employment. Once he
has gone abroad, he would sell his investment and earn the capital gains.
These would be free from Indian tax. After completing 185 days abroad,
Mr. A can return to India. He would not be liable to Indian Income-tax on
the foreign capital gains.

India has not amended this loop hole even in the DTC. Other
countries have taken care of it several decades back. However, GAAR
if properly drafted, may partially cover this loop hole.

Sections 1 to 10 constitute the base for the Income-tax Act. They

determine the tax base or tax incidence. We have discussed only a few
provisions here.

Some Annexures are given. These can be covered if time permits.

My submissions on Tax Incidence & Residence completed.

Many Thanks

Rashmin C. Sanghvi.

Next Annexures I to III

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 Residence & Tax Incidence Page No.: 20

Annexure I.

Evolution of tax rate in India.

In the decade of 1970s the tax rates were as under.

If an individual earned business income in a partnership firm, the

partner and the firm both were liable to tax. The total income-tax went
upto 97.5% for incomes above ` 1 lakh. The wealth-tax was @ 8%

Consider a person who had assets worth ` 10 lakhs providing

income of ` 2 lakhs per year. His tax incidence was as under:

Sr. Particulars Amount

No. (Rs.)
1 Income. 2,00,000
2 Income-tax @ 97.5%. 1,95,000
3 Wealth-tax @ 8%. 80,000
4 Net of tax amount available. (75,000)

This actually meant that the assessee had to sell his assets just to
pay the taxes. On top of it the Government could believe that any Indian
assessee could accumulate substantial estate. Hence an Estate Duty @ 85%
was imposed for estate above ` 20 lakhs.

If some one tried to reduce his own tax burden by gifting away his
wealth, there was a Gift tax @ 30%.

No wonder, under this kind of tax regime Government did not get
adequate tax revenue. Black money was an inherent part of the system.
Transfer of Indian wealth outside India by hawala was on a large scale.
FERA was a draconian law trying to prevent outward flow of Indian
wealth. It was an utter failure.

Government realised its own mistakes. In a series of significant

steps estate duty & gift tax are abolished. Income-tax is brought down to
31% and wealth-tax is almost negligible. Governments tax revenue has
increased significantly. In some years Government got more tax revenue
than its budgets.

Government of India has been Pragmatic.

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Annexure II

Residence of a Global Corporation:

A Global corporation having own websites & providing services

on the web.
Global Corporation.
Chairman, Resident (R)
of India.
Managing Director, resident of Brazil.

Board meetings
2 directors 2 directors held by Video
Board of
from U.S.A. from Europe conferences. No
Directors.
central place for
control and
1 director management.
from Japan

Shares quoted at Marketing &

Mumbai NSE, Distribution.
Chicago, Tokyo Company Facilities at 50
and Frankfurt registered in BVI. different countries;
stock exchanges. Tax Haven. and also through
Share holders Internet, T.V.,
from 50 different radio & cable T.V.
countries.

Production. Software development & website maintenance

facilities; and mirror servers located at :

Malaysia India Japan U.K. U.S.A.

Where is the Company Truly Resident?

Where should it pay its main tax on the Global Income?

Additional Thoughts
Annexure III

1. Tax Burden:
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Tax Incidence and Tax Burden are related concepts. Tax Burden
includes the cost of tax plus the cost of compliance with tax provisions,
professional fees, cost of litigation and in some countries, unavoidable
bribes. For the assessee all together constitute a burden imposed by the
tax law.

Simple tax laws; honest and efficient tax administration can cut
down the tax burden significantly and yet increase Governments revenue.

Where assessees are honest and tax advisors are intellectually

honest, laws can be simple.

It is a cycle of cause-effect-cause.

2. There is a Tug of War Between the assessee and the department.

Assessee Attempts to Reduce Tax incidence by:

Tax Planning, Tax Avoidance, Tax Havens, Treaty Shopping, Abuse of

DTA;
Twisting Interpretation of law;
Tax Evasion, Black money, Money Laundering; and
Lobbying with Political Bosses.

Tax Department Attempts to protect + increase Tax Incidence by:

SAAR: Section 56, Sections 68, 69, 93 etc.

GAAR, Transfer Pricing, CFC, etc.
Section 9
Attribution of Profits; Treaty Override

However, department is helpless when it comes to political lobbies.

Small assessees are helpless before the tyranny of tax law.

Judiciary is expected to be the saviour in both cases.

3. Tug of War: Several Dimensions

In International Taxation, there are several struggles for reducing/

protecting tax incidence: Consider the case of an Indian assessee Mr. I who
has income from U.K. and makes certain payments to a U.K. assessee Mr.
U.

India 3 U.K.

1 5
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Assessee 2 4 Assessee
Mr. I Mr. U
6
 Residence & Tax Incidence Page No.: 23

In the above diagram, there are several Interactions

Between Struggle

1. Mr. I and Indian tax Mr. I tries to reduce his Indian tax
department and wants maximum relief from
India for taxes suffered in U.K.
2. Mr. I and U.K. Government Mr. I wants to minimise his UK tax.

3. Indian & U.K. Government Both Governments try to snatch

each others tax base.

4. Mr. U & Indian Government Mr. U tries to minimise Indian tax.

5. Mr. U & U.K. Government Mr. U tries to minimise U.K. Tax &
get maximum relief from U.K.
Government for taxes borne in
India.

6. Mr. I & Mr. U. Mr. I wants to recover full TDS from

Mr. U who resists Indian Taxes.

Notes:
1. Real fight is between Government of India and Government of U.K.
for their revenue. Assessee has to pay to one or the other Government. In
practice Governments do not fight. They simply levy taxes on all assessees
& all the costs of litigation have to be borne by the assessees.

2. Generally Indians adopt a submissive approach and do not bargain

adequately to shift entire TDS burden to the foreign recipient.

Annexures to the Presentation on Residence & Tax Incidence completed.

Next Paper 2 on Model conventions

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