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EY ITS Course Session 2

Article-4 - Residence

25th April 2012

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Article 4 - Residence2

Article 4 - Objective

In terms of Article 1, in order to claim treaty benefit, a person should be resident of one of the

contracting states.

"The concept of 'resident of a Contracting State' has various functions and is of importance in

three cases:

in determining a conventions personal scope of application

in solving cases where double taxation arises in consequence of double residence

in solving cases where double taxation arises as a consequence of taxation in the State of

residence and in the State of source or situs.

The following articles of a treaty can be brought into operations even if a person is not a

resident of either of the contracting states.

Article 24 : Non Discrimination : The application of this article is based on nationality

rather than residence.

Article 26 : Exchange of Information : The contracting states can exchange information in

respect of persons who are not resident of either of the contracting states.

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Article 4 of OECD /UN Model Tax Convention on Incomeand on Capital

For the purposes of this Convention, the term resident of a Contracting State means any

person who, under the laws of that State, is liable to tax therein by reason of his domicile,residence, place of management or any other criterion of a similar nature, and also includes that

State and any political subdivision or local authority thereof. This term, however, does not

include any person who is liable to tax in that State in respect only of income from sources in that

State or capital situated therein.

Definition of the term resident under the OECD and UN Model Tax Conventions is primarilyidentical

UN Model Tax Convention additionally mentions that a person liable to tax by reason of his

place of incorporation shall also be regarded as resident.

The US Model has two additional criteria in paragraph 1 i.e. citizenship & place of incorporation.

Income derived and paid by partnership, estates or trusts has also been specifically dealt with.

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Tax Treaty - Residency Rules

A person is a resident of a country if it is 'liable to tax in the country by virtue of:

Domicile

Residence

Place of management

Any other criterion of a similar nature

In case a person is resident of both countries

In the case of an individual -- tie breaker rule determines residency

In any other case -- the place of effective management determines residency

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Residency - Individuals

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The Tie Breaker Clause

Where the individual qualifies as a resident of both Contracting states then his status is

determined as follows:

1) he shall be deemed to be a resident of the State in which he has a permanent home

available to him;

2) f he has a permanent home available to him in both States, he shall be deemed to be a

resident of the State with which his personal and economic relations are closer (centre

of vital interests);

3) if the State in which he has his centre of vital interests cannot be determined, or if he

does not have a permanent home available to him in either State, he shall be deemed

to be a resident of the State in which he has an habitual abode;

4) if he has an habitual abode in both States or in neither of them, he shall be deemed to

be a resident of the State of which he is a national;

5) if he is a national of both States or of neither of them, the competent authorities of the

Contracting States shall settle the question by mutual agreement.

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Tie Breaker Clause contd

Centre of VitalinterestPermanent Home

Both

R

Closer withOne state

Not available in either state

R

In one state

NationalityHabitual abode

R

In one state

Both / Neither

R

In one state

Both or none

To be decided by mutual agreement

or by Competent Authority

Not determinable

Start

DisputeResolution

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The Tie Breaker Tests - Permanent Home Test:

The individual will be resident of the state in which he has permanent home available to him.

The concept of home, means any form of dwelling place, or apartment belonging to or rented

by the individual, rented furnished room.

Permanence of the home is the most essential.

Dwelling place should be available at all times, and not occasionally for the purpose of a stay

or for short duration (say for example travel for pleasure, business travel, educational travel,attending a course at a school, etc).

Size, quality, value of premises does not matter.

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The Tie Breaker Tests - Centre of Vital Interest Test:

The term Centre of Vital Interest means the place where personal and economical

interests of an individual are concentrated.

Personal interest generally means family, social relations, political & cultural activities.

Economical interest generally means occupation business or profession i.e. source of

livelihood.

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The Tie Breaker Tests - Habitual Abode Test

This test is applicable in two distinct type of situations:

If the individual has permanent home in neither of the states; or

While the individual has permanent home in both states and centre of vital interest cannot

be determined.

Habitual abode implies the continuous, repeated and persistent stay. While the permanent

home is available to a person in both the states, the frequency of his stay in a particular state

will become the deciding factor.

While considering his stay in a particular state, the period for which he stays at the permanent

home as well as the period for which he stays in some other place in the same state will also

be considered.

Comparison must cover a sufficient length of time for it to be possible to determine whetherthe residence in each of the two States is habitual and to determine also the intervals at which

the stays take place - Neither the Model Conventions nor the commentaries specify the length

of time.

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The Tie Breaker Tests Nationality and MAP

If the habitual abode test also does not resolve the tie, the individual is considered to be a

resident of the state of which he is a national. The term National will have the same meaning

as given by Article 3 (Definitions).

Ordinarily the term national means any individual possessing the nationality or citizenship of

a Contracting State

Mutual Agreement Procedure:

In case where an individual is national of both states, or national of a third state the

competent authorities will have to resolve the situation.

In most of the cases, the nationality tests will break the tie of dual residence. However,

recently many advanced countries have started accepting the concept of Dual Citizenship.

Thus in such cases a Mutual Agreement Procedure under Article 25 will have to be

initialed to resolve the difficulty.

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Residence of individuals

Residency in India -

As per domestic tax

laws

Residency in other

country - As per

domestic tax laws

Residency as per Tax Treaty

Resident Non resident Resident of India

Non resident Resident Resident of other country

Resident ResidentTie breaks to India resident of

India

Resident Resident

Tie breaks to other country

resident of other country

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Lets understand : Case Study 1

Mr P, an individual, is resident, but not ordinarily resident (RNOR) in India under Indian

income tax laws

Mr P is living in State S and is also employed in State S

His wife and 3 children stayed in State S for 6 years and then returned to India for better

education

He has permanent home available in State S and India

Family members go to State S for vacations every year

Mr P owns two flats and a motor car in India

Shares and debentures in Indian companies where investment made out of NRI account on

which tax duly withheld.

Determine the treaty residence. Would the tie break in India or S?

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Lets understand: Case Study 2

Singh , NRI has temporarily settled in US for last 4 years and carries on business in US

He qualifies as RNOR in India under Indian income tax laws

He is staying in US in a house owned by him

His wife and other family members are in India and they are staying in a house belonging to

the family

Before Singh left for US, he made substantial investments in India and has continued to make

investments in India thereafter also out of his income in US

Singh substantial income annually from such investments and the same is also reinvested in

India

Mr Singh is a tax resident in US and regularly visits India

Would R but NOR be considered as treaty resident under IndiaUS treaty ? Would itmake any difference if Singh would have gone to UK instead of US ?

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Lets understand: Case Study 2Relevant Provisions

As per the India US treaty the term "resident of a Contracting State" means any person

who, under the laws of that State, is liable to tax therein by reason of his domicile, residence,

citizenship, place of management, place of incorporation, or any other criterion of a similar

nature, provided, however, that

(a) this term does not include any person who is liable to tax in that State in respect only of

income from sources in that State..

As per the India UK treaty the term "resident of a Contracting State" means any person

who, under the law of that State, is liable to taxation therein by reason of his domicile,

residence, place of management or any other criterion of a similar nature.

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Mr. Bhatt, employed as doctor in Government hospital in Japan from where drawing salary of

25 million p.a.;

Other source of income in Japan are interest on FDs. The asset value in Japan of about 15

million p.a.;

He is ordinarily residing in Japan in apartment allotted by the employer;

His wife and children are residing in India; Mr. Bhatt had no desire of taking family to Japan;

He has made substantial investment in shares, debentures and Mutual Fund in India;

Dividend and interest equivalent earned in India amounts to 50 million p.a. in India

Income and property value in India more in comparison to Japan.

Mr Bhatt is a resident under the Japan domestic laws and also treaty resident in India since

his income liable to tax in India.

Determine the treaty residence. Would the tie break in India or Japan? Would theanswer be different in terms of the provisions of UK treaty ?

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Lets understand : Case Study 3Relevant provisions of IndiaJapan tax treaty

(1) For the purposes of this Convention, the term "resident of a Contracting State" means any

person who, under the laws of that State, is liable to tax therein by reason of his domicile,residence, place of head or main office or any other criterion of a similar nature of income

from sources in that State.

(2) Where by reason of the provisions of paragraph 1 a person is a resident of both the

contracting states, then the competent authorities of the Contracting States shall determine by

mutual agreement the Contracting State of which that person shall be deemed to be a

resident for the purposes of this Convention.

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Residency Corporates

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Test of Residency - Corporates

Ordinarily corporates are resident in the country where they are liable to tax by virtue of their

place of incorporation, or place of effective management.

In case of a tie break situation Place of effective management relevant

The key factors in determining the place of effective management are as follows:

where the head and the brain is situated.

where de facto control is exercised and not where ultimate power of control exists.

where top level management is situated.

where business operations are carried out.

where directors reside.

where the entity is incorporated.

where shareholders make key management & commercial decisions.

According to Klaus Vogel, place of management is where management directives are given

and not where they take effect.

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Peculiar provisions of India UAE treaty as amended byProtocol dated 28-11-2007

Article 4 Impact

(a) In the case of India: any person who,under the laws of India, is liable to taxtherein by reason of his domicile,residence, place of management or anyother criterion of a similar nature. Thisterm, however, does not include anyperson who is liable to tax in India inrespect only of income from sources inIndia; and

(b) in the case of the United Arab Emirates:an individual who is present in the UAEfor a period or periods totaling in theaggregate at least 183 days in the

calendar year concerned, and acompany which is incorporated in theUAE and which is managed andcontrolled wholly in UAE.

Amended provision permits UAE registeredcompany to access India-UAE DTAA only ifUAE Co incorporated and wholly managedand controlled in UAE .

UAE Co not having bonafide business activityor created with the main purpose of obtaining

benefits of the treaty not eligible for treatybenefit even assuming above conditionsatisfied.

Where a UAE based company is unable tosatisfy the residence test, under the treaty itmay be vulnerable to India domestic lawprovisions - potential challenge of applying

any other treaty ?

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Place of Effective Management

Extracts from the Treatise of Kanga, Palkhivala and Vyas

As a rule, the direction, management and control, the head and seat and directingpowerof

a companys affairs is situated at the place where the directors meetings are held and

consequently a company would be resident in this country if the meetings of directors who

manage and control the business are heldhere.

It is not what the directors have power to do, but what they actually do, that is of importance

in determining the question of the place where the control isexercised

Supreme Court in the case of Subbayya Chettaiar V/S CIT :

Controland management signifies the controlling and directive power, the head and brain;

and situatedimplies the functioning of such power at a particular place with some degree of

permanence

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Place of Effective Management - OECD Article 4(3) -Test of place of effective management as tie breaker rule: The place of effective management is the place where key management and commercial

decisions that are necessary for the conduct of the entitys business as a whole are insubstance made. All relevant facts and circumstances must be examined to determine the

place of effective management.

India position on the above.

It is of the view that the place where the main and substantial activity of the entity is carried

on is also to be taken into account when determining the place of effective management.

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F Co, a company incorporated in Mauritius with the purpose of carrying on business of dealing

and making investment in shares and securities etc;

F Co has two individual as shareholders who were US residents;

F Co has a valid Tax Residency Certificate (TRC) issued by Mauritius tax authorities

F Co has obtained RBI permissions for investment in Indian capital market under Portfolio

Investment Scheme

F Co, derived income in the form of short/long term capital gains

Power of Attorney issued to Indian residents as authorized representatives to carry on

activities on behalf of F Co

Pre condition for India-Mauritius tax treaty benefit : place of effective management in Mauritius

Is F Co entitled to treaty benefit ofIndia-Mauritius tax treaty ?

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A Co, a shipping company, wishes to claim the benefit of India Mauritius tax treaty

Pre condition for tax treaty benefit : place of effective management in Mauritius.

TRC from Mauritius is available

Directors meetings and other statutory corporate compliances undertaken in Mauritius.

However, actual operations/management of A Co is at the jurisdiction of the ultimate holding

company in Singapore

Entire correspondence of Indian agents with Singapore.

All staff, officers, captain in Singapore

No significant policy/ operational decisions taken at the directors meeting in Mauritius.

Is A Co entitled to treaty benefit of India-Mauritiustreaty ?

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Shipping Company incorporated in Panama wishes to claim the benefit of India-Greece tax

treaty on the basis that the company is wholly managed in Greece.

The company has appointed a Greece company as its agent / general manager

There is no staff or facility at Panama; General manager (Greece) has power to appoint staff;

dismiss staff; collect and disburse money on behalf of the company; can contract and

negotiate on behalf of the company; The general manager has power to negotiate all legalcontracts and maintain accounts

Where is the effective place of management ?

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Test of Residency- Trusts, Partnership Firms etc.

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Test of Residency- Trusts, Partnership Firms etc

A tax transparent entity refers to that entity which is regarded as a tax exempt entity under a tax law and

instead the members / partners/ beneficiaries of the said entity are taxed vis--vis the income earned bysuch tax transparent entity

Some examples of tax transparent entities - Partnership firms, Trusts, Real Estate Investment Trusts,

Collective Investment Vehicles, etc

For instance A UK partnership is tax exempt in UK. Its partners are subject to tax vis--vis the income

earned by such partnership firm

Most tax treaties do not treat tax transparent entities as tax resident - Need to carefully consider the

specific tax treaty provisions and the domestic laws, wherein such tax transparent entity is being

governed

OECD committee on fiscal affairs has considered the difficulty which arises in regard to the treaty

entitlement of fiscally transparent entities in its detailed report of August 1999 titled Application of the

provisions of the OECD Model Tax Convention to Partnerships

Indias reservations to the OECD A fiscally transparent partnership shall be entitled to thebenefits of a tax convention, only if the provisions to that effect are included in the conventionentered into with the State where the partnership is situated

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Peculiarities in Indian Tax Treaties

India-USA India-UK

Any person who, under the laws of that State, is liable to tax

therein by reason of his domicile, residence, citizenship, place of

management, place of incorporation, or any other criterion of a

similar nature, provided, however, that

(a)

(b)in the case of income derived or paid by a partnership,

estate, or trust, this term applies only to the extent that

the income derived by such partnership, estate, or trust is

subject to tax in that State as the income of a resident,

either in its hands or in the hands of its partners or

beneficiaries.

Any person who, under the law of

that State, is liable to taxation

therein by reason of his domicile,

residence, place of management

or any other criterion of a similar

nature

The India-US treaty treats a tax transparent entity as a resident to the extent income derived by such

tax transparent entity has been taxed in the US either in the hands of the entity or its partners/

beneficiaries. Most of the treaties that India has signed would be UK patterned and hence it will be a

challenge to determine residential status of transparent entities

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Peculiarities in Indian Tax TreatiesIndia US Tax Treaty

Under the Convention income received by a partnership, estate or trust will be treated as

income received by a U.S. resident only to the extent such income is subject to tax in theUnited States as the Income of a U.S. resident.

This rule regarding residence of partnerships, estates or trusts is applied to determine the

extent to which that person is entitled to treaty benefits with respect to income which it receives

from the other Contracting State and the extent to which a resident of the other Contracting

State is entitled to treaty benefits with respect to income paid by such person.

Under US tax law, a partnership is never, and an estate or trust is often not, taxed as such

(treated as fiscally/ tax transparent entities).

To the extent the partners of the partnership firm are subject to US tax, as residents of the

United States, the income received by the partnership will be treated as income received by a

US resident.

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Linklaters LLP On eligibility of partnership firms toavail the benefits of the treaty

Linklaters, is a UK based LLP engaged in law practice rendered legal service to clients whoseoperations extended to India. Legal services were services rendered from UK office, with occasional

visits of partners/ staff in India.

Linklaters filed Nil tax return in India on the basis that it did not have a permanent establishment inIndia; Tax Authorities contended a service PE of Linklaters in India

Issues as regards eligibility of Linlklaters to avail India-UK tax treaty benefit was raised for the first timebefore the Tribunal and it was held that Linklaters should be eligible to avail India-UK tax treaty benefits:

In the contextual senses, liable to tax by reason of domiciles refers to a situation in which a personis liable to tax in a jurisdiction by virtue of a locality related attachment which leads to residence typetaxation;

Tax treaty cannot be strictly interpreted isolating it from the object and purposes for which theprovision is made;

The event of taxability in the residence country rather than the mode of taxability there, which should

be a decisive factor for determining whether the person should be eligible for tax benefit or not;

Where, the entire income of partnership is taxed, whether in its own hands or in the hands of thepartners, tax treaty benefit should be available;

As long as the resident country has the right to tax the entire income of the person, whether or notsuch a right is exercised, the test of fiscal domicile should be satisfied.

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Liable to tax connotation thereof and controversies

Does the term refers to being actually subject to tax, or whether it refers to a legal liability to pay

tax, but which may be inoperative due to a specific exemption, or whether it refers to the right of

the State to levy tax on an entity, which may be exercised by such State in future?

The term liable to tax matter of various controversies particularly in the context of India-UAE Tax

Treaty prior to its amendment since UAE does not levy any taxes, other than on companies engaged

in the oil and banking sector.

The legal liability to tax is considered as distinct (and more relevant for the purposes of beingconsidered as a resident under a Tax Treaty) compared to the fiscal fact of actual payments of tax

[Supreme Court in Azadi Bachao Andolan]

Said term refers to the fact of actually being taxed as distinct from merely being governed or

subject to the tax laws [GE Pension Trust (AAR)].

O

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General Electric Pension Trust (GE) On eligibility oftrusts to avail the benefits of the treaty

GE Trust a tax resident of USA , registered with the SEBI as a FII as a sub account of GEAM

made regular investments in Indian securities and derived gain from sale of such securities GE

did not have any employee, branch, office or place of business in India. In reference to

department raising a doubt on the eligibility of GE to claim the benefit under India-US treaty in

terms of clause (b) of Para 1 of article 4 of the treaty, AAR held as under:

It is worth pointing out that the phrase liable to tax in Para 1 and the phrase subject to tax inproviso (b) are not synonymous. If both were to be read as synonymous, proviso (b) wouldbecome otiose;

Para 1 speaks of being in the tax net, proviso is concerned with actual taxation;

In the case of a trust, the term resident of USA would apply only to the extent that the incomederived by such trust is subject to tax either in the hands of the trust or the beneficiaries;

It is an admitted fact that both GE enjoys exemption from payment of USA tax under therelevant code of US and nothing was brought on record to show that the income of securities ofIndian companies is being taxed in USA in the hands of the Trust or the beneficiaries;

GE is liable to tax by reason of its place of management and place of incorporation and as suchis a tax resident yet having regard to the wording in proviso (b), GE being tax exempt in theUSA cannot be treated as resident for the purpose of treaty;

T R id C ifi

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Tax Residency Certificate

T R id C ifi (TRC)

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Tax Residency Certificate (TRC)

Generally, from a practical perspective, obtaining a tax residency certificate from the tax

office of the particular country is an accepted test of demonstrating ones residential status.

An interesting issue which arises is whether once a foreign entity produces a tax residency

certificate of the other contracting state, whether the tax authorities of the source country is

bound to accept them, without making any further inquiries.

The Supreme Court in the case of Azadi Bachao Andolan (supra) had held that

reproduction of tax residency certificate by the FIIs registered in Mauritius should be

considered as evidence of such FIIs being tax residents of Mauritius under the India-

Mauritius Tax Treaty.

Budget 2012-13 has introduced a requirement of obtaining TRC providing the prescribed

particulars

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