Residential Status, Scope Of Total Income Under Income Tax, and Foreign Tax Credit

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1 1 KARTHIK RANGANATHAN ASSOCIATES Residential Status, Scope Of Total Income Under Income Tax, and Foreign Tax Credit Seminar on NRI Taxation ICAI SIRC, Chennai April 29, 2017 Karthik Ranganathan Tax and Corporate Lawyer

2 Contents Residential Status Scope of Total Income General concept Special provisions applicable to income of NRIs Exemptions and Concessions available to NRIs Foreign Tax Credit 2

3 Residential Status 3

4 Residential Status Taxability of persons under the Income Tax Act, 1961 ( IT Act ) is on the basis of their residential status. Nationality in not relevant. Section 6(1) of IT Act 2 categories of taxable entities: (i) resident and ordinarily resident ( ROR ) and (ii) resident but not ordinarily resident ( RNOR ). Conditions of Resident - (a) is in India in Previous Year ( PY ) for aggregate period of at least 182 days; or (b) is in India in PY for aggregate period of at least 60 days and is in India for at least 365 days in 4 years preceding PY. Special concession for NRIs - the period of 60 days referred to in Clause (b) above not required to be met in 2 cases: (i) where Indian citizen leaves India for employment outside India; and (ii) where Indian citizen or foreign citizen of Indian origin (NRI), who is outside India, comes on a visit to India. 4

5 Residential Status Person of Indian Origin - if he or either of his parents or any of his grand parents was born in undivided India (Explanation to cl.(e) of s.115c). The requirement of the aforesaid special concession is not leaving India for employment but leaving India for the purposes of employment outside India. The fact that a person is already an employee at the time of leaving India, for instance leaving on deputation-basis, is not relevant. The benefit u/s 6(1) will still be available to such individuals British Gas India (P) Ltd. In re., 285 ITR 218 (AAR). Non-resident - person who does not satisfy either of the tests of residence. Conditions of RNOR (i) if he is a non-resident in India for 9 out of 10 preceding PYs; or (ii) he has during the 7 preceding PYs been in India for an aggregate period of at least 729 days. KARTHIK RANGANATHAN ASSOCIATES 5

6 Points to note: Residential Status It is not necessary that the stay should be for a continuous period. It is not necessary that the stay should be at one place in India. The residence tests requires the personal presence of the assessee in India in the course of the previous year (Vijay Mallya v. ACIT 263 ITR 41 (Cal)). Both the day of entry and the day of exit should be treated as the day of stay in India irrespective of however short the time spent in India on the days of entry and exit may be (P. No. 7 of 1995, In re. 223 ITR 462 (AAR-New Delhi)). 6

7 Residential Status Test for determination of residential status is very different under IT Act and FEMA making it possible to be a resident under one law and non-resident under the other. However, there are only two instances where the residential status under FEMA will be treated status quo under IT Act, they are: i. For exemption of IT in respect of deposits in certain accounts of nonresidents i.e., the Non-Resident Rupee (NRE) account and the Foreign Currency Non-Resident (FCNR) account, an investor should be a non-resident under FEMA; and ii. The special tax rate concessions on income and LTCGs on specified assets, purchased in convertible foreign exchange are available to non-residents under IT Act. 7

8 Scope of Total Income 8

9 Scope of Total Income The incidence of tax depends upon a person s Residential Status. Residential status Nature of income (Section 5) (a) Resident All income whether received/ accrued or deemed to receive/ accrue in India or outside India. (b)not resident ordinarily All income : (i) received/ accrued or deemed to receive/ accrue in India; and (ii) all income received/ accrued or deemed to receive/ accrue outside India if the same is derived from a business which is controlled in India or from a profession which is set up in India. (c)non-resident All income received/ accrued or deemed to receive/ accrue in India. Thus, a non-resident pays tax only on his taxable Indian income. His foreign income (earned and received outside India) is totally exempt from Indian taxes. Income earned in India means income directly/ indirectly received in India or if it accrues in India or the law deems it as having accrued in India. 9

10 Scope of Total Income The liability to tax depends upon locality of receipt, and if the receipt is in India the question of place of accrual does not arise CIT v. Matthias, 7 ITR 48 (PC). Where income is received or deemed to be received in India, there is no scope of apportionment as there is in cases where income accrues or is deemed to accrue in India. The whole amount received is chargeable to tax in India CIT v. Ahmedbhai Umarbhai, 18 ITR 472. Actual v. Constructive Receipt Receipt by an authorised agent would be constructive receipt by a person entitled to receive Distinction laid down in Pereira v. CIT, 61 ITR 371. Receipt v. Accrual Accrual is the point in time when the right to receive arises. Income may accrue at a point of time prior to its quantification or computation. However, receipt indicates the actual receipt of the income that has accrued or arisen and is always quantified CIT v. Thiagaraja, 24 ITR 525. KARTHIK RANGANATHAN ASSOCIATES 10

11 Scope of Total Income The definition of total income is subject to the provisions of the Act. This implies that s.5 may be overridden by other provisions of the IT Act, which principally involve: 1. Section 9 (deeming fiction provisions) 2. Sections 10-13A (Exempt Income provisions) 3. Sections 80HH 86 (General Deductions) 4. Double Taxation Avoidance Agreement ( DTAA ) entered into between India and other countries under s.90 of the IT Act. Once income that is deemed to accrue or arise is made chargeable u/s 5, provisions of s.9 will also be applicable if deemed income is covered by various clauses of s. 9 Mustaq Ahmed, In re., 307 ITR 401 (AAR) 11

12 Scope of Total Income Section 9 lays down some of the instances when the law deems the income to have accrued in India: i. Income from business arising through any business connection in India; ii. Income from property if such property is situated in India; iii. Income from any asset or source if such asset or source is in India; iv. Income from salaries if the services are rendered in India. In such cases, salary for rest period or leave period will be regarded as earned in India if it forms a part of service contract; v. Income from salaries payable by the Government to a citizen of India even though the services are rendered outside India; vi. Income from dividend paid by an Indian company even if the same is paid outside India; vii. Income by way of interest payable by the Government or by any other person in certain circumstances; viii. Income by way of royalty, if payable by the Government or by any other person in certain circumstances; ix. Income by way of fees for technical services, if such fees is payable by the Government or by any other person in certain circumstances. 12

13 Scope of Total Income Special provisions relating to certain incomes of non-residents: Chapter XIIA (ss.115c to 115-I) S. 115C comprises of definitions, ss. 115D and 115E prescribe manner in which total income or capital gains has to be computed u/s 115E. Applicability of Chapter - An NRI who acquires any of the specified assets in convertible foreign exchange is entitled to the benefit of this Chapter in respect of income derived from, and Long Term Capital Gains ( LTCG ) relating to, such assets. Specified Assets shares in Indian company, debentures or deposits with public Indian company, securities and other notified assets of Central Govt., and deposits made in public banking companies. U/s 115D(2) when assessee is an NRI, law provides for taxation of the income on gross income basis, which means that the tax liability is determined on the basis of gross receipts. Here, no deduction based on the expense incurred by him, is permitted under Chapter VIA of IT Act. 13

14 Scope of Total Income Gross receipt basis taxation operates in two ways : (a) Either by laying down the rate of tax to be applied on gross receipts - Rates are determined at a value lower than general rate of tax applicable to total income as it takes account of possible expenses in earning the income. Instances where this is applicable under the NRI provisions are : 1. Tax on dividend (other than dividend from domestic companies), interest, royalty, fee for technical services and income from units. 2. Tax on income and capital gains in respect thereto from units purchased in foreign currency by off-shore funds. 3. Income and capital gain in respect thereto from bonds and shares purchased in foreign currency or acquired in resulting or amalgamated company as a result of demerger or amalgamation. 4. Tax on income other than dividend of foreign/institutional investors from securities and capital gains arising from their transfer. 5. Income of sportsman or Sports association. 14

15 Scope of Total Income (b) Or by laying down a percentage to be applied on gross receipts to determine the net income The tax is then calculated at the normal rate of tax on such presumptive income. Some instances where this is applicable under the NRI provisions are : 1. Profits of shipping business. 2. Profits from business of providing services, etc., to be used in the business of prospecting, exploration or production of mineral oils. 3. Profits from operation of aircraft. 4. Profit from business of civil construction, etc., in certain turnkey power projects.. 15

16 Scope of Total Income Section 115F - Exemptions for LTCGs Capital gains arising on transfer of a specified asset, is exempt from levy of any tax on fulfilment of the following conditions : a) The asset transferred must be a long-term capital asset. b) Net consideration must be invested in certain specified assets. c) Investment to be made within 6 months of transfer. d) If only a portion of the net consideration is reinvested, then proportionate exemption is allowed. e) New asset must be held for at least 3 years. S.115H permits applicability of the chapter relating to Special Provisions for NRIs (Chapter XIIA) to income of an NRI even after he becomes a resident, if he furnishes a declaration along with the return of income to that effect. Tax would then be levied at 20% until there is transfer/conversion into money of such assets. 16

17 Scope of Total Income Where an NRI, invested his foreign exchange in bank deposits and after becoming a resident he converted the deposits into rupees, he would not be entitled to the benefit of s.115h. If the foreign exchange asset is not converted, then the assessee is entitled to the benefit even if he becomes a resident CIT v. N.P. Matthew, 280 ITR 44. Under s.115g an NRI has an option to not file income-tax return, if a) his total income consists only of investment income or income by way of LTCGs or both, and b) TDS has been deducted from such income. As per s. 115-I, an NRI may alternatively elect not to be governed by provisions of Chapter XIIA for any AY by furnishing a written declaration to the Assessing Officer ( AO ) with his return of income. His total income for that AY shall be computed and tax on such total income shall be charged in accordance with other provisions of IT Act. 17

18 Scope of Total Income Other exemptions applicable to NRIs Chapters VII to X of the IT Act list the exemptions granted to NRIs on their income in India: 1. Incomes totally exempt for non-resident Interest on notified securities or bonds and premium on redemption of such securities, Interest on NRE/FCNR/accounts, Interest from notified bonds, etc. 2. Income-tax concessions available to non-resident i. Accounts held by NRI Tax concessions are available to NRIs on balances/deposits held in NRE/FCNR accounts. Income from interest on funds standing to the credit of NRE/FCNR accounts is exempt from income-tax and gift-tax. The benefit is applicable on Income from the deposits, etc. 18

19 Scope of Total Income ii. Capital gains While computing capital gains, the benefit of indexation is not available to NRI. Explanation to s.48(1)(a) of IT Act provides for conversion of original cost, expenditure on transfer and sale consideration into foreign currency in which investment was made (at prescribed rates) and reconversion of capital gains into rupees again. A gain or the excess of sale price over cost that arises on transfer of a capital asset is taxed under the head Capital gains. iii. LTCG Subject to tax at the rate of 20% (or 10%in certain cases) plus applicable surcharge, and education cess, a gain, from sale of equity shares in company or units of equity-oriented fund is not chargeable to tax. iv. STCG STCGs arising on sale of equity shares in company or units of equity-oriented funds is chargeable to tax at the rate of 10%. When received on the transfer of bonds or global depository receipts made outside India by a non-resident to another non-resident, it will not be liable to capital gain tax in India. 19

20 Scope of Total Income In Trishala Jain v. DCIT (011 ITR (Trib) 579) it was observed that the term investment income referred in s.115e does not specifically exclude STCGs. However, a later judgment of the Mumbai ITAT in Sunderdas Haridas v. ACIT, ([1998] 67 ITD 89 (Mum.)), includes STCGs in the term investment income on the ground that such exclusion is necessary to prevent short-term movement of foreign exchange. v. Dividend income - All dividends, received from domestic companies are exempt from tax under the Income-tax Act. Income received in respect of units of specified mutual funds and the UTI is exempt from tax. vi. Income from House Property - Income from house property is the annual value of house property, of which the assessee is the owner. One self-occupied house property or a part of such property owned by an individual (including NRI) and used for personal purpose but not let out in the previous year, will not be taxable. 20

21 Scope of Total Income vii. Interest on borrowed capital - Interest on borrowed capital is permitted as deduction if capital is borrowed for purpose of purchase, construction, repair, renewal or reconstruction of the house property or in case where more than one property is occupied for own residential purposes, only one house is treated as self-occupied and all other houses are deemed to be let out. viii.interest income - Any income arising on a deposit with a bank or any financial institution will be treated as interest income and will be chargeable under the head Income from other sources. Interest income may be treated as investment income and chargeable at a special rate under certain circumstances. 21

22 Foreign Tax Credit 22

23 Foreign Tax Credit The need for obtaining a tax credit arises where there is an unintended double taxation due to principles of residence-based and source-based taxation in different jurisdictions. Where there is no tax treaty in place between India and another country or in terms of Article 23 of a Double Taxation Avoidance Agreement ( DTAA ), s.91 of the IT Act provides for unilateral relief to such persons who maybe subject to double taxation. To strengthen the framework of Foreign Tax Credit ( FTC ) laws, recently, the CBDT came out with the FTC Rules, 2016 ( Rules ). The Rules provide clarity on the mechanism of obtaining FTC in India, on foreign taxes paid. The intended beneficiaries of the Rules are Indian residents that earn foreign-sourced income. Similarly, even a nonresident who has paid his taxes abroad on his foreign income will be entitled to FTC under the rules of the foreign country he is paying his taxes in for the taxes he maybe liable to pay in India for his income that is accrued/ arising or deemed to accrue or arise in India. This can be well understood by studying the mechanism under its Indian counterpart namely, the FTC Rules,

24 Foreign Tax Credit Foreign tax credit rules Rule 128 Taxes covered Mode of credit When to claim Compliance DTAA country Taxes covered by DTAA Non DTAA country Section 91(iv) Tax, surcharge or cess not interest, penalty No tax credit if the amount of foreign tax/ part thereof is in dispute Ordinary credit Source by source and country by country No carry forward of credit excess ignored Foreign tax conversion - TT Buying rate on last day of month preceding the month in which taxes paid / deducted Credit available against MAT liability In the year when the income offered to tax Can be claimed proportionately as and when income offered Furnish Form 67 before due date of filing tax return (even for carry back losses) Income and Tax certificate from deductor, deductee or tax authority Proof of payment/ deduction of tax

25 Foreign Tax Credit Illustrations 1. Where tax credit is claimed in resident state of NRI when income is earned from one or more foreign jurisdictions (including India): Consider A to be an NRI to be a tax resident of country R 30%) as well as three foreign countries F1 (India) 20%), F2 35%) and F3, with whom R does not have tax treaties. Let the net income and taxes paid in foreign jurisdictions for FY be: Particulars F1 (India) F2 F3 R Total Net income from business (Total Income) Tax paid in foreign jurisdictions under respective tax conventions Gross income tax liability in India (before Foreign Tax Credit) (90) Rule in India: CIT vs. Bombay Burmah Trading Corporation Ltd., [2003] 126 Taxmann 403 (Bom) 25

26 Foreign Tax Credit 2. Relief where there is a loss in India and profits from several foreign countries: Applying tax rates at 20% in F1 (India), 35% in F2,10% in F3 and 30% in R, on the previous data, consider the following: Particulars F1 (India) F2 F3 R Total Net income from business (Total Income) Tax paid in foreign jurisdictions under respective tax conventions Gross income tax liability in India (before Foreign Tax Credit) (90)

27 Questions? 27