U.I.L.S., PANJAB UNIVErsity

Concept of Residence

Tax Law

Submitted To – Prof. SupreetSubmitted By – Karnika Bansal

Roll No. – 217/109th Semester

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TABLE OF CONTENTS

LIST OF CASES ........................................................................................................................ iii

CHAPTER I : INTRODUCTION............................................................................................1- 2

Overview

CHAPTER II : RESIDENCE, DOMICILE AND CITIZENSHIP.......................................3-4

Residence

Domicile

Citizenship

CHAPTER III : PROVISIONS RELATED TO RESIDENCE.............................................5-9

Variation in Chargeability on the basis of Residence

Tests of Residence for an Individual

Tests of residence for HUF, Undivided Family, Firm or Association of Persons

Tests of residence for a Company

CHAPTER IV : JUDICIAL INTERPRETATION.............................................................10-12

Union of India v. Azadi Bachao Andolan

Vodafone International Holdings B.V. v. Union of India & Anr

CHAPTER V : CONCLUSION............................................................................................13-14

BIBLIOGRAPHY.........................................................................................................................iv

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LIST OF CASES

Brown v Burt 5 TC 667

Choudhury v UOI 186 ITR 329

CIT v Avtar Singh 247 ITR 260

CIT v Nandlal 40 ITR 1 (SC)

Erin v CIT 34 ITR 1 (SC)

IRC v. Duke of Westminster [1935] All ER 259 (H.L.)

Khambhaty v CIT 61 ITR 30

Levene v IR 13 TC 486

Lysaght v IR 13 TC 511 (HL)

Mohammed v CIT 10 ITR 484

Narasimha v CIT 18 ITR 181

Narottam v CIT 23 ITR 1, 7 (SC)

Ram Kumar v UOI 252 ITR 205

Re Kamdar 14 ITR 158

Re Sarupchand 13 ITR 245

San Paulo (Brazilian) Rly Co Ltd v Carter 2 TC 407 (HL)

Sanofi Pasteur Holding v. The Department Of Revenue (2013) 354 ITR 316

Shrigopal v CIT 119 ITR 980

Subbayya Chettiar v CIT [1951] 19 ITR 168 (SC)

Union Of India v Azadi Bachao Andolan, (2004) 10 SCC 1

Vodafone International Holdings B.V. v Union of India, (2012) 6 SCC 613

Wallace v CIT 16 ITR 240 (PC)

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CHAPTER I

INTRODUCTION

Overview

Tax incidence on an assessee depends on his residential status. For example, whether income

accrued to an individual outside India is taxable in India, depends on the residential status of the

individual. Likewise, whether income earned by a foreign national is taxable in India depends on

the residential status. The determination of residential status is therefore significant to determine

one’s tax liability.

The Income Tax Act 1961 envisages three types of residential status: resident and ordinarily

resident, resident but not ordinarily resident, and non-resident. This categorization becomes

important, as tax rates vary according to the residential status of the assessee. For the purpose of

determining residential status, the taxable entities are grouped into- (a) individuals [s 6(1)]; (b)

Hindu undivided families, firms or other association of persons [s 6(2)]; (c) companies[s 6(3)];

and (d) every other person [s 6(4)]. An assessee can enjoy different residential status for

different assessment years. It is also possible for a person to be a resident of two different

countries in the same year. the burden of proving resident status is on the assessee. There are

various tests laid down to determine an assessee’s resident status.

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CHAPTER II

RESIDENCE, DOMICILE AND CITIZENSHIP

Residence

Black’s Law Dictionary1 defines residence as “the place where one actually lives, as

distinguished from a domicile”. It additionally states that residence merely requires bodily

presence in a particular place, and nothing further. This is what distinguishes it from domicile,

and the reason why a person can have more than one residence at any given point of time, but

only one domicile.2

Accordingly, a resident is one who lives in a particular place. A resident can also be a citizen

and/or domiciliary, though not necessarily. This distinction is important, as each term has its own

distinct requirements. Who exactly qualifies as a resident depends on the statutory definition,

which differs from country to country.

Domicile

Domicile is best defined as the place where a person is physically present, and regards as home. 3

It requires the bodily presence of a person, along with the intention to make the place one’s

home. It is the place where the person intends to return to, and remain there, even if currently

residing elsewhere. Therefore, at the end of the day, there is always just one country that can be

called one’s domicile.4 Residence, as mentioned above, is more of a transient term, and merely

requires physical presence.

1 Black’s Law Dictionary, 9th edn., 2009, p 1423.2 ibid.3 ibid at 558.4 ibid at 1423.

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Citizenship

The status given to a citizen is known as citizenship. A citizen is one who either by birth or

naturalisation is a member of a civil state. This status entitles one to the rights and privileges

offered by the state.5 Generally, these rights include the right to vote, right to work, right to own

property, etc.

Tax is usually calculated and levied on the basis of residence, which is why it is important to

understand what exactly constitutes residence, and how it is distinct from both domicile and

citizenship.

CHAPTER III

PROVISIONS RELATED TO RESIDENCE

Section 4 of the Act states that every person will be charged on the basis of her total income. The

Act defines ‘total income’ as the ‘total amount of income referred to in section 5, computed in

the manner laid down in this Act’.6

Section 5 lays down the scope of ‘total income’ and what that means for different categories of

assessees. There are three categories of assessees:

i. Resident and ordinarily resident;

ii. Resident but not ordinarily resident; and

iii. Not resident

By and large, the burden of tax is largest for one who is a resident and ordinarily resident,

smaller for one who is a resident but not ordinarily resident, and the smallest for non- residents.

Residence is always calculated on the basis of the previous accounting year; residence during the

assessment year is irrelevant.7

5 Black’s Law Dictionary, 9th edn., 2009, p 278.6 Section 2(45), Income Tax Act, 1961.7 Wallace v CIT 16 ITR 240, 244 (PC).

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Variation in Chargeability on the basis of Residence:

For persons who are Residents and Ordinarily Resident, tax is charged on:

- Income which is received or deemed to be received in India in the accounting year. The

place and date of accrual of such income plays no role for the purpose of calculating tax.8

- Income which accrues or arises or is deemed to accrue or arise in India during the

accounting year. The place or date of receipt of such income is immaterial for calculating

tax.9

- Income which arises or accrues outside India during the accounting year, even if it is not

received or even brought into India. 10

For persons who are resident in India in the accounting year, but not ordinarily a resident, the

rules remain the same as those for a resident. There is just one special exception granted to this

type of assessee – income accruing outside India is exempt from tax, unless it is derived from a

business controlled in, a profession or vocation set up in India or, is deemed to accrue in India, or

is received or deemed to be received in India. 11

For non-residents, tax is charged on the income received or deemed to be received in India in the

accounting year. For this purpose, date or place of accrual of income is immaterial. Tax is also

charged on the income which accrues or arises, or is deemed to do so in India in the accounting

year, the date or place of its receipt being immaterial.

All assessees, resident or not, are charged on the income that accrues, arises or received, or

deemed to do so, in India. Only residents are taxed for income that accrues or arises and is

received outside India, even if it the transaction is never brought into India. 12 However, the law

stated in these provisions is subject to the remaining provisions of this Act. This would mean that

provisions not in harmony with this section act as an exemption, even if it would have normally

been chargeable under section 5.13

8 Section 5(1)(a), Income Tax Act, 1961.9 Section 5(1)(b), Income Tax Act, 1961.10 Section 5(1)(c), Income Tax Act, 1961.11 Section 5(1)(c) proviso, Income Tax Act, 1961.12 CIT v Avtar Singh 247 ITR 260.13 Re Kamdar 14 ITR 158.

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Tests of Residence for an Individual:

Section 6 of the Act deals with the technical requirements for one to be considered a resident,

resident but not ordinarily resident and a non- resident. This section looks at the physical

presence of the person in India as a determination of the same. 14 A person’s residential status is

determined every year, and cannot be calculated only on the basis of the previous years. This is

because the physical presence of the person can change every year, and tax must be charged

accordingly. 15

For an individual, the tests are alternative. An individual is considered a resident if he is in India

for a total of 182 days or more in the previous year,16 or if he has lived in India for a total of 365

days or more in four years preceding the accounting year and for 60 days or more in the

accounting year.17 Therefore, it is clear that a person who is treated as a resident one year can be

treated as a non-resident the next, if he stays outside the country for the entire year.

If the assessee is put up in various hotels for the duration of his stay in India, he will still be

considered a resident, as long as he satisfies the aforementioned conditions.18 Similarly, a person

is constantly wandering about within the country can’t be used as a factor for him to not be a

resident.19 Therefore, permanence in settlement is not a requirement at all. The statute merely

requires the person to be within the country for the required period of time, as stated above.

When the section says that the person must be in India for a certain period, it means that the

person must be within the geographical territory that is considered India, and therefore, includes

Indian territorial water. Hence, a boat or yacht on Indian waters is considered Indian Territory. 20

Similarly, a person aboard an Indian ship in international waters, or foreign waters, cannot be

considered to be staying in Indian Territory.21

14 CIT v Avtar Singh 247 ITR 260.15 Wallace v CIT 13 ITR 39, 44; Narasimha v CIT 18 ITR 181.16 Section 6(1)(a), Income Tax Act, 1961.17 Section 6(1)(c), Income Tax Act, 1961.18 Lysaght v IR 13 TC 511 (HL).19 Levene v IR 13 TC 486, 492.20 Brown v Burt 5 TC 667.21 CIT v Avtar Singh 247 ITR 260. Further, the explanation to s 6(1), amended by the Finance Act, 1990, which

states that Indian seamen working on an Indian ship would be treated as a resident only if they stay in India for 182

days or more in that year.

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The determination of residence is not subject to the person’s will to reside in the country. Even if

the person is made to stay against his will, e.g. if he is imprisoned, he will still be considered a

resident, if he satisfies the conditions mentioned in the section. The differences between the

resident and domicile being highlighted in the previous chapter, it is significant to point out that

a person may be a resident in of two different countries in a year, but can have only one

domicile. 22 The burden of proof to prove that a person is a non- resident is on the person himself,

and must be done on the basis of material on record;23 it cannot simply be presumed that because

an Indian national is staying in Nepal, for e.g., he automatically is a non-resident Indian.24

Tests of residence for HUF, Undivided Family, Firm or Association of Persons:

A Hindu Undivided Family , firm or other association of persons is considered a resident in

every case except where the management and control of its affairs is situated outside India in the

relevant year.25 Therefore, in order to be considered a resident, the whole or part of the

management and control of the association must lie within India. 26 Partial control is sufficient to

determine residential status, therefore, (much like an individual), a firm can also have two places

of residence. 27 Residence of individual members of a HUF or partners of a firm is immaterial,

unless it affects the management and control of the association. 28

Control and management refers to where ‘the head and brain of the trading adventure’29 is

situated’. Place of control of business isn’t necessarily where the operations are actually carried

out.30 In Subbayya Chettiar v CIT 31 it was held that a HUF is presumed to reside in India. The

burden of proving otherwise rests on the assessee, and is to be done by showing that the

22 Levene v IR 13 TC 486, 505 (HL).23 Choudhury v UOI 186 ITR 329, 337.24 Ram Kumar v UOI 252 ITR 205.25 Section 6(2), Income Tax Act, 1961.26 Khambhaty v CIT 61 ITR 30.27 Erin v CIT 34 ITR 1 (SC); Re Sarupchand 13 ITR 245.28 Shrigopal v CIT 119 ITR 980, 983.29 San Paulo (Brazilian) Rly Co Ltd v Carter 2 TC 407, 410 (HL); CIT v Nandlal 40 ITR 1, 7 (SC).30 Erin v CIT 34 ITR 1 (SC); Narottam v CIT 23 ITR 1, 7 (SC).31 19 ITR 168.

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management and control is wholly outside India. Acts of actual control by a partner or karta

residing in India is proof of the firm or HUF being a resident of India. 32

Tests of residence for A Company:

Section 6 provides a test in the alternative to determine the residence of a company. A company

is a resident in the previous year if: (i) it is an Indian company, or (ii) the control and

management of its affairs is situated wholly in India in the accounting year. 33

Therefore, every Indian company is deemed to be a resident of India, even if its management and

control is situated outside, as per cl (i). A non-Indian company is considered resident only if it’s

control and management is situated wholly in India. A non-Indian company that is partially or

wholly situated outside India is to be considered a non-resident. 34

The test of control and management is similar to that for firms and HUFs. The place where

directors’ meetings are held is often considered an indication of the place of residence of the

company.35 The de facto exercise of power is what is relevant for the determination of residential

status. Since the place of control and management can change, so can the residence of a

company. A company that is considered a resident one year, can be considered a non-resident

the next. 36

Tests of residence for Ordinary Resident:

For an individual to be considered a ‘not ordinarily resident’ she must be a non-resident for 9 out

of 10 previous years preceding that year, or must have lived in India for 729 days or less in the 7

years preceding that year.37 Therefore, to be an ordinary resident, the assessee must fulfill both

conditions, i.e. be a resident in India for 9 out of 10 years preceding the year, and has lived in

32 Erin v CIT 34 ITR 1 (SC); Mohammed v CIT 10 ITR 484.33 Section 6(3), Income Tax Act, 1961.34 Narottam v CIT 23 ITR 1, 7 (SC).35 Narottam v CIT 23 ITR 1, 7 (SC); San Paulo (Brazilian) Rly Co Ltd v Carter 2 TC 407, 410 (HL).36 Kanga, Palkhivala and Vyas, THE LAW AND PRACTICE OF INCOME TAX, 9th ed, p 357.37 Section 6(6)(a), Income Tax Act, 1961.

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India for at least 730 days in the 7 years preceding that year.38 If either condition is not fulfilled,

the person is a ‘not ordinarily resident’.

CHAPTER IV

JUDICIAL INTERPRETATION

Union of India v. Azadi Bachao Andolan: 39

It was this confusion that arose in Azadi Bachao Andolan as well, as it was believed that the

McDowell case rejected tax planning. Accordingly, the court held that tax planning is legitimate,

and that McDowell was an exception to the law. The two cases were seen as conflicting

judgments on the same area, a position that was clarified in Vodafone.

These two cases are important from a ‘residence’ point of view, as in an attempt to reduce tax

liability, assessees may take shelter of the provisions of the law by diverting the transaction in a

manner that it falls outside the tax jurisdiction of India. Corporations are similarly set up to avoid

taxes. However, just because a nonresident sets up an intermediary entity to take advantage of

the law, the transactions entered into by the intermediary cannot be held to be invalid. Even if the

motive was to avoid taxes, the motive plays no role in determining the legality of transactions.40

The only situation where tax avoidance is problematic is when it falls outside the framework of

the law, by using colourable devices.

Vodafone International Holdings B.V. v. Union of India & Anr:41

The concept of residence played an important role in this landmark judgment. The dispute was

over whether a transaction between two non residents for sale of shares of an Indian company

would be taxable in India.

38 Kanga, Palkhivala and Vyas, The Law and Practice of Income Tax, 9th ed, p 359.39 (2004) 10 SCC 1.40 Mathews George and Pankhuri Agarwal, ‘Use of the Corporate Vehicle for Tax Planning: The Vodafone Case and

Direct Taxes Code’ 3 NUJS L. REV. 201 (2010) 201, 41 (2012) 6 SCC 613.

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Here, Vodafone International Holdings BV (non-resident entity) entered into an agreement with

Hutchison Telecommunications International Limited (non-resident entity) for the purchase of

CGP Holdings, a subsidiary of Hutch (situated in Cayman Islands). CGP owned approximately

66.9% in Huchison Essar, now Vodafone Essar, (Indian entity). The IT Department claimed that

as there was transfer of a controlling business situated in India, tax was payable in India.

Therefore, the question was whether the transaction can be deemed to arise in India, under

section 9.

Section 9 of the IT Act provides that all income that arises from the transfer of a capital asset

situated in India, is deemed to arise in India.42 Here, there was no direct transfer of shares in

India, and the court held that the transaction could not be taxed in India.

Since CGP was situated outside India, the asset in the given case was held to not have significant

nexus with India. The source of the income is the place where the transaction takes place, all of

which was outside India.

The Supreme Court clarified that there is no conflict between McDowell and Azadi Bacaho

Andolan cases. Tax planning is a legitimate activity. The court upheld the ‘look at’ test, stating

that if a transaction is genuine, the court cannot look through it, to find an underlying substance.

As long as it’s within the framework laid down by the law, tax planning is not illegal. It did hold

that colourable devices for the same are not permissible, as it does not constitute tax planning.

Here, CGP was in place since 1998, and the transaction could therefore not be deemed a sham

transaction. It was not undertaken to avoid taxes.

Therefore, the offshore transaction between two nonresident entities falls outside the jurisdiction

of Indian tax law.

However, post- Vodafone, the legislature has amended the IT Act, which has overruled the

decision of Vodafone. Further, these changes have been drafted to be retroactive. Indirect

transfers are now covered under the provision of section 9, which makes the Vodafone judgment

bad law. Now, any transaction outside India, between foreign residents shall fall within the

jurisdiction of India, if the transaction has any effect on an asset situated in India..

42 Section 9(1)(i), Income Tax Act, 1961.

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However, it has been held in Sanofi Pasteur Holding v. The Department Of Revenue 43 that these

amendments do not override tax treaties. Therefore, if India has entered into a treaty agreement

with any other country, providing against double taxation, these amendments leave the treaty

provisions untouched.

CHAPTER V

CONCLUSION

Though the provisions laying out the tests to determine residential status is quite simple and

clear, tax issues are complex in reality. As seen through the three cases discussed, particularly

the high profile case of Vodafone, while determination of individual residential status is simple

enough, there are several externalities and other factors that increasingly complicate the issues.

The provisions of the IT Act are simple enough, and lay down the requirements for the three

categories of assessees. It also provides for conditions when the assessee is an individual, and

association of partners, or a company. The text requires a literal reading to understand the tax

liability of each category of assessees.

Every assessee will try to reduce his or her tax liability. However, in the process, they may cross

the law and take steps to evade tax. Setting up sham corporations is an example of using dubious

methods to evade tax. The law seeks to prevent this. While the law isn’t against tax planning, it

is certainly against using dubious methods to evade taxes.

These methods are going beyond the contours of the law, and are actually violating the law. The

first two cases, McDowell and Azadi Bacaho, both deal with the legality of tax planning. The

relevance of these cases to ‘residence’ is that since the statutory liability on a nonresident is the

lowest, most tax planning will be aimed at securing that status. However, in doing so, these cases

lay down that colourable devices cannot be legitimately used. Tax planning is legal, but tax

evasion is not. The Vodafone judgment is a real- world application of these principles. The

Indian tax authorities tried to bring a transaction between two nonresidents, taking place outside 43 (2013) 354 ITR 316.

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India, within the ambit of Indian law. However, the Supreme Court held against this. The

government then went on to reverse this decision by passing retroactive amendments which

allow taxing foreign residents for a transaction outside India which has any bearing on assets

situated within India. This was to ensure that the Indian government does not lose out on large

amounts of tax from these types of transactions in the future.

However, this is extremely troubling for foreign investors, as it increases their liability, and in

turn, would deter them from coming anywhere near India. The Sanofi decision is the only relief

for these investors.

The concept of residence is extremely important, and can get very technical, as seen with these

cases. With a multitude of parties involved, the residential status of each, and the form of the

transactions need to be determined. This topic has far - reaching implications for foreign entities

who are party to transactions that are connected to India.

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BIBLIOGRAPHY

Books and Articles:

Black’s Law Dictionary, 9th edn., 2009

Kanga and Palkhivala, LAW OF INCOME TAX, 10th ed

Kanga, Palkhivala and Vyas, THE LAW AND PRACTICE OF INCOME TAX, 9th ed

Mathews George and Pankhuri Agarwal, ‘Use of the Corporate Vehicle for Tax Planning: The

Vodafone Case and Direct Taxes Code’ 3 NUJS L. REV. 201 (2010) 201.

Sampath Iyengar’s, LAW OF INCOME TAX, 10th ed

SP Gupta, ‘The McDowell Dictum- Vanishing Line between Tax Avoidance and Tax Evasion’,

(2003) 5 SCC (Jour) 15

V Venkatesan, ‘The Tax Avoidance Debate’, Frontline, Vol 29, Issue 5, Mar 10-23, 2013

VK Singhania and K Singhania, TAXMANN’S DIRECT TAXES LAW & PRACTICE, 46th ed

Websites:

http://www.taxmann.com

http://www.itatonline.org/

http://www.frontline.in/

http://www.thehindubusinessline.com/

http://law.incometaxindia.gov.in/