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Role of Total Income and Residential Status in Determining the Basic Change

Income

8.2. Taxation Law

Submitted by

Mrinal Kishore Jha

SM0115025

4th Year & 8th Semester

National Law University and Judicial Academy, Assam


INTRODUCTION

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 juridical 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.

PROBLEMATIZATION

The researcher has tried to draw focus upon significance of Residential Status in relation to
determining the total Income taxable in India of a person. Brief elaboration as to the various
types of Residential Status followed by the rules for determining residential Status for different
categories of persons, have also been done. Various others rules be it for determining the Status
of Resident Ordinary and Not Ordinary in case of Individual and HUF or ability to solve
problems relating to residential Status have been equally focused upon. Lately, rules for
determining the Scope of total Income that will be taxable in India Vis a Vis the Residential
Status of a person have been dealt shortly.

CONCEPTULISATION

Governments need to collect taxes in order to function. Federal, state and local governments
impose tax assessments against real property, personal property and income. The word tax
assessment is used in different ways but often refers to a tax liability owed by a taxpayer.
Residential status and total income of the person is one of the important element in assessing
the total liability of the person which has been critically analysed in the following project. Basic
objectives of the project are be it to determine the Status of Resident Ordinary and Not Ordinary
in case of Individual and HUF or ability to solve problems relating to residential Status etc.,
have been focused upon.

The scope of the project is limited to the study of “Role of Total Income and Residential Status
in Determining the Basic Change Income”.

For fulfilling the objectives of the project, the researcher has adopted the doctrinal type of
research methodology; various books and online available data sources helped in completion
of this paper.

CONTENT PRESENTATION

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.

Residential Status

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 Act1 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.2

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:3

• 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.

o 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.
o 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.

o Dividend paid by an Indian company outside India.

o Interest

o Royalty

o Fees for technical services

The Test For Person Nor Ordinarily Resident In India

In Pradip J. Mehta v. Commissioner of Income Tax, Ahmedabad4, the case 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.5

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. CIT6, 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. CIT7 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 Tax8, 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.

5. Evaluation and Conclusion

The tax liability of a person is determined on the basis of his residence in India in the previous
year. On the basis of residence, the persons are divided into three categories 'namely' (a)
Resident (b) Not ordinarily resident (c) Non-resident. Further the categories of persons for tax
liability have been classified into four groups 'namely' (a) Individual (b) Non-company plural
entities (c) Company (d) Any other person.

The rules for determining the residential status are not the same for all the groups. Different
conditions are to be satisfied by the concerned assessee to be a resident in India.

An Individual and a Hindu Undivided Family can be resident, not ordinarily resident and non-
resident. A firm and other association of persons, a company and any other person can never
be a not ordinarily resident. They can only be either resident or, non-resident.

Four types of incomes have been mentioned for the purpose of tax liability.

a) Incomes received in India.

b) Incomes deemed to be received in India.

c) Incomes accruing or arising in India.

d) Incomes deemed to accrue or arise in India.

The incidence of tax depends on the residential status of an assessee. In case of a resident except
income earned and received outside India hut later on remitted to India, every other income
attracts tax, and the tax incidence is the highest. On the other hand, tax incidence is the lowest
in the case of non-resident, as only income which i's accrued or received or deemed to accrue
or deemed to be received in India, is liable to tax.

Not ordinarily resident in India attracts tax on every income except on 'Income ' received and
accrued outside India from a business controlled from outside India or a profession set up
outside India' and on 'Income earned and received outside India but later on remitted to India',
The incidence of tax is relatively higher when compared with 'non-resident'.

Bibliography

• DR. VINOD K. SINGHANIA, DR. KAPIL SINGHANIA; DIRECT TAXES – LAWS


AND PRACTICE, Taxmann Publications, 41st ed., 2009-10, New Delhi.

• SANJIV MALHOTRA, N D BERRY; ALLIED LAWS AND OFFICE PROCEDURE


(INCOME TAX & SERVICE RULES), Jain Book Depot, 1st ed., 2009, New Delhi.

• DR. GIRISH AHUJA, DR. RAVI GUPTA, DIRECT TAXES LAW AND PRACTICE
INCLUDING TAX PLANNING, Bharat Law House Pvt Ltd, 8 th ed., 2016, New Delhi.

• A R LAKSHMANAN, TAXATION LAW, Universal Law Publishing, 1st ed., 2015,

New Delhi.

• S R MYNENI, LAW OF TAXATION, Allahabad Law Agency, 3 rd ed., 2016,


Allahabad.

• TAXMANN, DIRECT TAXES MANUAL, Taxmann Publication, 45 ed., 2015, New th

Delhi.

• ARVIND P DATAR, KANGA& PALKHIVALA’S THE LAW AND PRACTICE OF


INCOME TAX, Lexis Nexis, 10 th ed., 2014, Haryana.

1
Section 6 of the Income Tax Act, 1961
2
DR. VINOD K. SINGHANIA, DR. KAPIL SINGHANIA; DIRECT TAXES – LAWS AND PRACTICE,
taxmann Publications, 102-104, 41st edition, 2009-10, New Delhi.
3
Craig, C.K., Silhan, P.A., "Developing expert decision support systems for tax applications", (1991) 22 Tax
Adviser (No 1) 50-53.
4
Pradip J. Mehta v. Commissioner of Income Tax, Ahmedabad (2002) 175 CTR Guj 394.
5
SANJIV MALHOTRA, N D BERRY; ALLIED LAWS AND OFFICE PROCEDURE (INCOME TAX &
SERVICE RULES), 201-206, Jain Book Depot, 1st Edition, 2009, New Delhi.
6
C.N. Townsend v. CIT 1974 97 ITR 185 Patna.
7
P.B.I. Bava v. CIT (1955) 27 ITR 463 (Trav. & Coch).
8
Manibhai S. Patel v. CIT (1953) 23 ITR 27 (Bom).

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