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Paper No. 1 The Income Tax Appellate Tribunal Residential Training Programme Maharashtra Judicial Academy, Mumbai Presentation on “Residence” & “Tax Incidence” Sunday, 12 th 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 1 – 3 2. Indian Tax Base: Graph 4 3. Jurisdiction. 5 – 8 4. Scope of Total Income. 9 – 12 5. Residence 13 – 19 Ann. I Evolution of Tax Rates in India 20

Transcript of The Income Tax Appellate Tribunal€¦  · Web viewTo avoid the Indian Income-tax, a Non-Resident...

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Paper No. 1The 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. Sanghviwww.rashminsanghvi.com

Contents

Sr. No. Particulars Page No.1. Summary of Legal Provisions 1 – 3

2. Indian Tax Base: Graph 4

3. Jurisdiction. 5 – 8

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

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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 Government’s point of view it is the charge by Government on a person’s income.

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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, India’s tax base is India’s 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 resident’s foreign income will NOT be taxable in India.

Sections 90 & 91 provide for these reliefs.

Classical system of taxation attempts to extend India’s tax base beyond its geographical boundaries; and DTAs try to manage the conflict between two jurisdictions.

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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

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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

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3 Rest of the World GDP

2 IndianGDP

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7 ?

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1 - Global GDP.2 - Indian GDP3 - Rest of the world GDP 4 - Indian income earned by Non-residents.5 - Foreign income earned by Indian residents6 - Foreign income received in India by Indian

residents.7 - Foreign income received in India by Non-

residents.

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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 Vodafone’s case. We will not go into that controversy in this paper. Let us see what that “Connection” means.

A Government’s tax jurisdiction is determined by Connecting factors.

3.1 Scope & Residence:

There are two essential pillars of taxation. (i) Assessee and (ii) Income. An assessee’s 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

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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 businessman’s 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

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Within India, the portion of profits made in India, is taxable in India.

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 SBI’s permanent establishment outside India. The PE’s 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

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for goods and services. It is a weakness built into International Taxation because of historical developments. Also 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

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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.

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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.

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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 arm’s length price.) Now HO sells the software for Rs. 1,00,000.

What is taxable in India, is only Indian PE’s profits. ABC’s 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.

Vodafone’s case involved two issues:

(i) Whether Hutchison’s 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:

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(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”.

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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 assessee’s 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.

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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 firm’s 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: “Don’t 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

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(26). 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

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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,

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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 HUF’s NOR status is made dependent upon its manager’s 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)

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It may be noted here that under section 6(2) an HUF’s 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

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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.

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Next – Annexures I to III

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Annexure I.

Evolution of tax rate in India.

In the decade of 1970’s 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.No.

Particulars Amount(Rs.)

1 Income. 2,00,0002 Income-tax @ 97.5%. 1,95,0003 Wealth-tax @ 8%. 80,0004 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.

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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.

2 directors 2 directors from U.S.A. from Europe

1 director from Japan

Production.

Where is the Company Truly Resident?

Where should it pay its main tax on the Global Income?

Additional ThoughtsAnnexure III

1. Tax Burden:

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Board meetings held by Video conferences. No central place for control and

Shares quoted at Mumbai – NSE, Chicago, Tokyo and Frankfurt stock exchanges. Share holders from 50 different

Company registered in

BVI. Tax Haven.

Marketing & Distribution. Facilities at 50 different countries; and also through Internet, T.V., radio & cable

Software development & website maintenance facilities; and mirror servers located at :

Malaysia

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

Board of Directors.

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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 Government’s 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; andLobbying 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 9Attribution 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.

ITAT / RashminIndia

Assessee Mr. I

U.K.

Assessee Mr. U

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In the above diagram, there are several Interactions

Between Struggle

1. Mr. I and Indian tax department

Mr. I tries to reduce his Indian tax and wants maximum relief from India for taxes suffered in U.K.

2. Mr. I and U.K. Government

Mr. I wants to minimise his UK tax.

3. Indian & U.K. Government

Both Governments try to snatch each other’s tax base.

4. Mr. U & Indian Government

Mr. U tries to minimise Indian tax.

5. Mr. U & U.K. Government

Mr. U tries to minimise U.K. Tax & 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 conventionsITAT / Rashmin

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