Are You Subject to Income Taxes in Another Country?

This article is  meant as a primer for any person splitting his or her time between the U.S. and India, and can be a quick reference guide for anyone wondering whether they will be subject to tax in India. I will focus primarily on individual residence; however, company residence will be discussed briefly as a major change in the definition of a taxable company occurred recently.

Introduction

In India, the basis for imposing income taxes is the residence of the individual, and unlike in the United States, the domicile or citizenship of the individual plays no part in determining whether the person is subject to taxation.[1] Rather, tax residency is dependent on the stay of the individual in India, irrespective of the purpose of the stay.

An individual is liable to pay taxes in India based on his/her tax residency during a fiscal year. The Indian fiscal year runs from April 1st to March 31st. There are two categories of taxable individuals: (1) residents and (2) non-residents. Residents are further classified into two sub-categories (i) resident and ordinarily resident; or (ii) resident but not ordinarily resident. Therefore, an individual can have one of three tax residency classifications: (1) Resident and Ordinarily Resident (ROR), (2) Resident but not Ordinarily Resident (RNOR); or (3) Non-Resident (NR).[2]

Section 6 of the Income Tax Act 1961 (“ITA”) deals with residence. Under the ITA, persons who meet the test of residence in India are taxed on their worldwide income whereas non-residents are taxed only on income that is sourced in India. These rules vary depending on the entity involved and different residence criteria apply to individuals, companies and unincorporated entities.[3] 

It is also worth noting that an individual’s tax residency is different than an individual’s residency for regulatory purposes under the Indian Foreign Exchange Management Act (“FEMA”) of 1999. Generally, the difference between residency for tax purposes and exchange control purposes, is that for tax purposes, the duration of the stay is the only relevant factor; while for exchange control purposes, both duration and purpose (i.e. intent) of stay matters.[4] Thus, an individual could be a resident for exchange control purposes, but not for tax purposes, and vice-versa.

Company Residence Classification

On January 4, 2017, the criteria for a company to be a tax resident and subject to taxation changed. Section 6(3) of the ITA previously stated that a company is said to be resident in India in any previous year, if— (i) it is an Indian company; or (ii) during that year, the control and management of its affairs is situated wholly in India.

Section 6(3) of the ITA now states that a company is said to be resident in India in any previous year, if— (i) it is an Indian company; or (ii) its place of effective management, in that year, is in India. According to guidance provided by the Government of India, the previously stated definition of a resident company “allowed tax avoidance opportunities for companies to artificially escape the residential status under these provisions by shifting insignificant or isolated events related with control and management outside India.”[5] Whether a company has its “effective management” in India depends on the facts and circumstances of a given case and the concept is one of “substance over form”. Id.

Residence for Individuals

Resident and Ordinarily Resident (“ROR”): Section 6(1) provides that an individual is a ROR, if the individual satisfies one of the following two conditions: (i) is in India in that year for an aggregate period of 182 days or more; or (ii) having within the four years preceding that year been in India for a period of 365 days or more, and is in India in that year for an aggregate period of 60 days or more.[6]

However, a special concession for Indian citizens and foreign citizens of Indian origin exists, and the period of 60 days referred to in (ii) above may be extended to 182 days in two cases: (i) where an Indian citizen leaves India in any year for employment outside India; and (ii) where an Indian citizen or a foreign citizen of Indian origin (Non-Resident Indian), who is outside India, comes on a visit to India. Stated more succinctly, a Non-Resident Indian (NRI) whose total stay in India in four (4) preceding years exceeds 364 days, will not lose his non-resident status in the following year(s) if his total stay in India in the subject year, from April 1 to March 31, does not exceed (i) 181 days, if he is on a “visit” to India; or (ii) 59 days, if he comes to India on “transfer of residence”.[7] Moreover, an individual is said to be an NRI if the individual, either of his parents, or any of the individual’s grandparents were born in undivided India.

An Indian resident individual is taxed on income: (i) which is received in India; (ii) which accrues or arises in or outside India; and (iii) which is deemed under the ITA to be received or to accrue or arise in India.[8] An Indian resident individual would be taxed on income at progressive tax rates of 10%, 20% or 30% depending on the relevant tax bracket (“Income Slab”) under which he/she would fall.[9]

Resident but not ordinarily resident (“RNOR”): According to Section 6(6) of the ITA, an individual is considered RNOR in India if such individual satisfies one of the following two conditions: (i) an individual who has been a non-resident in India in nine (9) out of the ten (10) previous years preceding that year; or (ii) has during the seven previous years preceding that year been in India for a period of, or periods amounting in all to, seven hundred and twenty-nine (729) days or less. However, “in the case of a person not ordinarily resident in India within the meaning of sub-section (6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India.”[10]

The RNOR is a special status afforded to Non-Residents Indians in order to provide certain benefits for returning to India and is particularly beneficial for those thinking of returning to India permanently. Generally, RNORs only need to pay taxes on his or her Indian sourced income and any income abroad will not be taxed (like NRs discussed below). Additionally, for a period of two years, no taxes would need to be paid on income from interest or dividends on foreign securities; capital gains on foreign assets; withdrawal from foreign retirement accounts; interest earned on Foreign Current Non-Resident (FCNR) bank accounts or deposits held in India; and interest on foreign currency accounts held in India. Id. RNOR is a transitional state from Non-Resident Indian to Resident and RNOR status can be used for up to three (3) years. RNOR status is likely best explained with an example.

Example:

An Indian citizen has been living abroad for 20 years, during those 20 years he did not visit India once, in the middle of year 1 his mother becomes ill and he returns to India.

If in Year-1, he spends 183 days in India, he would ordinarily qualify as a resident in Year-1, but because he was an NRI for 10 out of the last 10 years preceding Year-1, he would receive RNOR status for Year-1.

If in Year-2, he spends 365 days in India, he would ordinarily qualify as a resident in Year-2, but because he was an NRI for 9 out of the last 10 years preceding Year-2, he would receive RNOR status for Year-2.

If in Year-3, he spent 365 days in India, he would ordinarily qualify as a resident in Year-3, and because he was an NRI for 8 out of the last 10 years preceding Year-3, he would not receive RNOR status under the first test. However, because he spent less than 729 days in the 7 years preceding Year-3 (548), he would nonetheless receive RNOR status for Year-3.

Non-Resident (“NR”): In every other case, an individual would be considered a NR for Indian tax purposes. A non-resident is taxed only on income that is sourced in India, i.e., income received, accrued or arisen in India and income which is deemed under the ITA to be received, to accrue or arise in India.

Conclusion

Like the United States, the number of days an individual spends in India is extremely important and someone spending time in India needs to make sure he or she spends less than the requisite number of days or else risk being taxed on worldwide income. Unlike the United States, Indian citizens living abroad and spending less than 182 days in India for the year (and who spent less than 365 days of the prior 4 years and less than 60 in the current year) do not have to worry about being taxed on their worldwide income in India. Also unlike the U.S., Non-Residents of Indian origin who have lived outside India for several years have a grace period for their foreign income in the form of “Resident but not ordinarily resident” status, and are given the opportunity to transition into becoming a resident without being overly taxed. This can be quite an attractive prospect for anyone thinking of returning to India.

 

[1] “Wealth & Estate Planning – Indian & International Perspectives”, Nishith Desai Associates, August 2014. Available at: http://www.nishithdesai.com/fileadmin/user_upload/pdfs/Research%20Papers/Wealth___Estate_Planning.pdf

[2] “Indian regulations for expatriates working in India – Ready for all your queries”, Deloitte Touche Tohmatsu India Private Limited, 2013. Available at: https://www2.deloitte.com/content/dam/Deloitte/in/Documents/tax/thoughtpapers/in-tax-indian-regulations-for-expatriates-working-in-India-noexp.pdf

[3] Supra Note 1

[4] Supra Note 1

[5] Circular No. 06 of 2017, F. No. 142/11/2015-TPL, January 24, 2017. Available at: http://www.incometaxindia.gov.in/communications/circular/circular06_2017.pdf

[6] Section 6 of the Income Tax Act.

[7] “Guide Book for Overseas Indians on Taxation and Other Important Matters”, Overseas Indian Facilitation Centre. Available at: https://www.mea.gov.in/images/pdf/OIFCPublication2009GuidebookonTaxationforOI.pdf

[8] Section 5 of the Income Tax Act

[9] Supra Note 2

[10] Supra Note 7