Recently, the Indian Government presented its annual budget and proposed various amendments in the Indian Income-tax Act, 1961. Amongst these amendments, one that is of immense importance to Indian citizens residing abroad, is the amendment proposed in Section 6 of the Act, which deals with the “residential status of a person.”
The Finance Act, 2020 (FA 2020) has inserted sub-section (1A) into Section 6, which introduces a new form of residency for Indian citizens, i.e., “Deemed to be Resident.” It states that where an Indian citizen, having Indian income (i.e. income other than income from any foreign sources) is not liable for tax in any other country or territory by reasons of domicile, residence, or any other similar criteria, then he shall be deemed to be a ’resident but not ordinarily resident’ of India in that previous year.
Intent of the Amendment
The Memorandum to the Finance Bill, 2020 (Part ‘H’, Page 23) elucidates the rationale by stating that individuals (typically high net worth individuals), who are Indian citizens and have been arranging their affairs in such a manner so as to avoid paying taxes on income earned by them to any country, which is undesirable in light of current developments in the global tax environment where avenues for double non-taxation are being systematically closed.
Thus, the intent of the Indian government seems to be to plug this loophole to prevent Indian citizens from exploiting the residency rules of multiple jurisdictions to their advantage and to avoid tax in all countries.
The issue of “stateless income” was also raised during the discussions surrounding the formation of the Base Erosion and Profit Shifting (BEPS) Action Plan. The Organization for Economic Cooperation and Development (OECD), in its articles on the BEPS Action Plan (“Tackling BEPS in the digital economy” and “Addressing the Tax Challenges of the Digital Economy”) had observed that the comprehensiveness of the BEPS Action Plan would ensure implementation of different measures to put an end to the phenomenon of so-called “stateless income.”
‘New Residency’ Rule—Doing Away With Traditional Test of Residency
In the Indian Income Tax law, the test of residency has always been determined with reference to a person’s period of stay in India in a previous year. The status of residency in India—whether as an “ordinary resident,” a “resident but not ordinarily resident,” or a “non-resident”—used to be determined on based on a person’s stay in India. However, with the introduction of “deemed residency,” the traditional rule of residency has been tinkered with.
‘Liable to Tax’
The new rule would be applicable only to those Indian citizens who are “not liable to tax” in any other country. The phrase has not been defined in the Act but has been extensively used in double tax avoidance agreements (DTAA) in determination of the residential status of a person. The OECD, in Para 8.11 of Paragraph 1 of Commentary on Article 4 of the Model Convention on Tax and Capital (2017), explains that the term “liable to tax” should be determined by applying the domestic laws of the concerned state. It also states that in certain states, a person shall be “liable to tax” even if the person is exempted from payment of taxes. In contrast, in certain other states, a person exempted from paying the taxes is not considered as “liable to tax.” Therefore, the determination of “liable to tax” would depend upon the domestic tax laws of foreign jurisdictions.
The term “liable to tax” cannot be equated with ‘payment of tax’ for the reason that ‘liability to tax’ is a legal situation and ‘payment of tax’ is a fiscal fact [See, UoI v. Azadi Bachao Andolan  263 ITR 706 (SC)]. Therefore, the term “liable to tax” does not signify that the person should be paying tax in the resident state. It is enough to say that a person is “liable to tax” in a jurisdiction if such jurisdiction has a ”right to tax,” irrespective of whether such person essentially pays any tax or not.
Is Global Income Taxable?
Under the Indian Income Tax Act, incidence of tax is determined with reference to “residential status.” Before the amendments by the FA 2020, “Residential status” takes three forms: (i) resident and ordinary resident (ordinary resident”), based on period of stay in India in the relevant year or earlier years; (ii) resident but not ordinarily resident (RNOR), based on non-residency status or period of stay in India, in earlier years; and (iii) non-resident, if the period of stay in India in the relevant year is less than required to become a resident.
A person can be a “resident” in India, depending upon on his period of stay in India in a relevant previous year. With the introduction of proposed clause (1A) to Section 6, an Indian citizen who is not liable to tax in any jurisdiction, is deemed to be resident in India. Thereafter, the determination would be whether such person is an “ordinary resident” or an “RNOR.” The Indian Legislature has also provided that such deemed resident individuals would be treated as “resident but not ordinary resident” under Section 6(6) of the Indian Income-tax Act.
The ordinary resident is taxed on income earned in India as well as outside India. However, RNORs are taxed only to the extent of income earned in India, and as regards income earned outside India, RNORs are not liable for taxation under the Indian Income-tax.
Interestingly, the Central Board of Direct Taxes of India (CBDT) in its “Press Release dated 02nd February 2020” has clarified that in the case of an Indian citizen who is deemed to be resident of India under the proposed provision, income earned outside India would not be taxed in India unless it were derived from a business or profession in India, and a necessary amendment would be made. Accordingly, the Government moved certain amendments to the Finance Bill, 2020 before its passage, to treat these ‘deemed residents’ as RNORs. Thus, the foreign income of such deemed residents would not be taxable in India, unless such income is derived from a business or profession controlled from India. With the passage of this necessary amendment, which explicitly excludes the taxability of foreign income of such ‘deemed residents’, the issue of taxation of global income in India has been put to rest.
Before the amendments proposed to the Finance Bill, 2020, the proposed new residency rule had created various doubts as to whether these will give rise to taxability of global income of Indian citizens residing abroad. One plausible view was that yes, the global income can be taxed in India. However, with the introduction of proposed amendments which has become part of the statute, the controversy has been put to rest and now, Indian citizens who are residing abroad and affected by these new provisions, would be taxable under the Indian Income-tax Act only with regard to their Indian income and not income earned from foreign sources.
The introduction of clause (1A), leading to a new residency rule, is intended to target those Indian citizens who plan their stay in various countries in such a way so as to escape the tax net globally. But, with the introduction of clause (1A), such citizens would now be deemed to be RNOR in India and consequently, their income earned in India would be chargeable to income tax. However, income from sources outside India (but not derived from a business/profession managed from India) would not be taxed in India.
The Indian Government via its press release had stated that Indian citizens who would be deemed to be resident in India under proposed provisions, would be taxable only for income earned in India and not on income earned outside India, and a necessary amendment would be brought into the statute. The Government has acted on its promises and averted many inadvertent consequences which could have arisen from the originally proposed law.
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Ravi Sawana and Samyak Lohade are with Lakshmikumaran & Sridharan in Mumbai.