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

 Residence & Tax 1
Incidence Page No.:

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.

ITAT / Rashmin
 Residence & Tax 2
Incidence Page No.:

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.

ITAT / Rashmin
 Residence & Tax 3
Incidence Page No.:

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.

ITAT / Rashmin
 Residence & Tax 4
Incidence Page No.:

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.

ITAT / Rashmin
 Residence & Tax 5
Incidence Page No.:

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
ITAT / Rashmin
 Residence & Tax 6
Incidence Page No.:

legislate Income-tax Act? For this paper, I am not discussing

provisions of the Constitution.

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.
ITAT / Rashmin
 Residence & Tax 7
Incidence Page No.:

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.

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
ITAT / Rashmin
 Residence & Tax 8
Incidence Page No.:

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.

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.

ITAT / Rashmin
 Residence & Tax 9
Incidence Page No.:

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.

ITAT / Rashmin
 Residence & Tax 10
Incidence Page No.:

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 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.

ITAT / Rashmin
 Residence & Tax 11
Incidence Page No.:

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

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:

ITAT / Rashmin
 Residence & Tax 12
Incidence Page No.:

(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 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.

ITAT / Rashmin
 Residence & Tax 13
Incidence Page No.:

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.
ITAT / Rashmin
 Residence & Tax 14
Incidence Page No.:

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).

ITAT / Rashmin
 Residence & Tax 15
Incidence Page No.:

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 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
ITAT / Rashmin
 Residence & Tax 16
Incidence Page No.:

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 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,
ITAT / Rashmin
 Residence & Tax 17
Incidence Page No.:

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 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)
ITAT / Rashmin
 Residence & Tax 18
Incidence Page No.:

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 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
ITAT / Rashmin
 Residence & Tax 19
Incidence Page No.:

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 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.

ITAT / Rashmin
 Residence & Tax 20
Incidence Page No.:

Next Annexures I to III

ITAT / Rashmin
 Residence & Tax 21
Incidence Page No.:

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.

ITAT / Rashmin
 Residence & Tax 22
Incidence Page No.:

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

Shares quoted Marketing &

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

Production. Software development & website

maintenance facilities; and mirror servers
located at :

Malaysi India Japan U.K. U.S.A.

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:

ITAT / Rashmin
 Residence & Tax 23
Incidence Page No.:

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.
ITAT / Rashmin

1 5
Assessee Assessee
Mr. I 2 4 Mr. U
6
 Residence & Tax 24
Incidence Page No.:

In the above diagram, there are several Interactions

Between Struggle

1. Mr. I and Indian tax Mr. I tries to reduce his Indian

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

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

Government each others tax base.
4. Mr. U & Indian Mr. U tries to minimise Indian
Government tax.

5. Mr. U & U.K. Mr. U tries to minimise U.K. Tax

Government & 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

ITAT / Rashmin