1. Preliminary

    Cross-border income could be described as when income arises in one State to a resident of another State. The taxation of such income is of two kinds: one, taxation by the State where income arises (Source State taxation), and the second, taxation of the person by the State of which he is resident (Resident State taxation). Source State exercises its taxing rights by the reason of income sourced in that country while the Residence State taxes the person earning the income due to his close connection with that country. This juridical double taxation is different from economic double taxation (for example, taxing the company on its profits and also taxing the shareholders on the dividends distributed out of those profits). The former is alleviated to some extent by the double tax avoidance agreements and not the latter.

    The double taxation resulting from the same income getting taxed by both the Source State and the Residence State disincentivises cross- border trade and requires to be mitigated. Countries have adopted various ways in which to relieve this double taxation: some countries enter into bilateral and multilateral agreements to avoid double taxation. Some provide unilateral relief while some others limit the scope of taxation of their residents to income remitted into their countries.

  2. Scope of taxation under the Income-tax Act, 1961

    Section 5 of the Income-tax Act, 1961 (the “Act”) provides for the scope of total income

    for persons. The scope differs according to the residential status of the person. For a non- resident, his total income consists of income received or deemed to be received in India in a previous year or income accruing or arising or deemed to accrue or arise in India in a previous year.

    In contrast, the scope of total income of a resident in India includes apart from the income covered within the scope for non-residents, also covers income accruing or arising outside India during such year. In effect, a resident is taxable on his global income. At the same time, the total income of a resident but not ordinarily resident as defined in section 6(6) of the Act excludes income accruing or arising outside India unless it is derived from business controlled in or profession set up in India.

    The expressions “accrue” and “arise” is not defined under the Act but has been judicially explained in several decisions. Section 9 contains the list of instances where income is deemed to accrue or arise in India. It may be noted that section 9 does not deem income or its accrual or arising but only deems the place of income accruing or arising to be in India.

  3. Residential status

    The scope of total income of a person and the applicable tax rates vary according to his residential status. Also, only a resident in India under the Act can access a double tax avoidance agreement which India has entered with another country or jurisdiction. This aspect is discussed in more detail in section 4 below.

    A person is said to be resident in India in accordance with the rules contained in section 6 of the Act. The residential status for (a) individual, (b) company, (c) Hindu Undivided family, firm or association of persons and (d) other persons is to be determined by different rules. The aspect of nationality does not enter in the determination of residential status under the Indian income-tax law. A non-resident means a person who is not a resident [section 2(30)]. When a person may be said to be “not ordinarily resident” is provided in section 6(6).

    1. 3.1   Individuals An individual is resident in India for any assessment year, if he fulfils either of the following tests (which tests are alternative and not cumulative): (i) if he is in India in the previous year relevant to the assessment year for a period amounting in all to one hundred and eighty-two days or more or (ii) having within the four years preceding the previous year been in India for a period or periods amounting in all to three hundred and sixty-five days or more, he is in India for a period or periods amounting in all to sixty days or more in that year.

      Relaxation from the second test is given in some instances. Explanation 1(a) to section 6(1)(c) provides for substituting stay in India for 60 days by 182 days, if the assessee is an individual he is a crew of an Indian ship or is out of India for purposes of employment outside India. It provides that where an individual who is a resident in India leaves India in any previous year for the purpose of employment outside India, he will not be treated as resident in India in that year unless he has been in India in that year for 182 days or more. The Explanation is applicable to that previous year in which the assessee, being a citizen of India, leaves India. Explanation 1(b) to section 6(1)(c) provides for a concession for Indian citizens or persons of Indian origin, who being outside India come on a visit to India in any previous year wherein the prescribed period of 60 days in India to be considered a resident under clause (1(c) is relaxed to 182 days.

      On the other hand, where citizens or persons of Indian origin have total income, other than the income from foreign sources, exceeding fifteen lakh rupees during the previous year, the time-period in India in section 6(1)(c) of sixty days is substituted with 120 days. This amendment restricts the relaxation of 182 days available in clause (b) (before this amendment) of the Explanation which was available to an individual who is a citizen or a person of Indian origin being outside India who comes on a visit to India.

      1. 3.1.1   Deemed Resident [section 6(1A)]A new category of deemed resident for individuals was introduced with effect from 1-4- 2021 to catch within the Indian tax net Indian citizens who are “stateless persons”’; that is, those who arrange their affairs in such a fashion that they are not liable to tax in any country during a year. This arrangement is typically employed by high net worth individuals to avoid paying taxes to any country/ jurisdiction on income they earn.

        Under this clause, an individual, who is a citizen of India, having a total income, other than the income from foreign sources, exceeding fifteen lakh rupees during the previous year shall be deemed to be resident in India in that previous year, if he is not liable to tax in any other country or territory by reason of his domicile or residence or any other criteria of similar nature. This clause, which is an additional rule of residence for individuals, shall not apply if the individual is resident under clause (1).

        Under the Citizenship Act, 1955, citizenship is possible by birth (section 3), by descent (section 4), by registration (section 5), by naturalisation (section 6) and by incorporation of territory (section 8) all of which categories will be covered under clause (1A). However, an Overseas Citizen of India under section 7A of that Act is not a citizen and is not covered under this clause.

        Clause (1A) applies only where an Indian citizen is liable to tax by reason of the various connecting factors. A similar rule for residence is found in the double tax avoidance agreements.

        Explanation to section 6 defines the term ‘income from foreign sources’ to mean income which accrues or arises outside India (except income derived from a business controlled in or a profession set up in India) and which is not deemed to accrue or arise in India.

    2. 3.2   Control and management criteria for HUFs, Firms, etcThe control and management of the affairs of Hindu undivided families (as also firms and association of persons) might easily be in two or more places, one or more coparceners/partners/ members being within the taxable territories and the other or others, without. To prevent the escape of tax and to get at the income of such families having multiple places of control and management, it is provided that the whole of the control and management must be outside India for the assessee to be non-resident.

      The test for residence in respect of three other classes of assessees enumerated in the Act, viz, a body of individuals, a local authority, and an artificial juridical person is the same as it is in the case of a Hindu undivided family.

      The expression ‘control and management of affairs’ is borrowed from the law in United Kingdom. It refers to the controlling and directing power, ‘the head and the brain’. The ‘head and brain’ is situate where decisions are taken concerning the vital policies of the institution, such as expansion or contraction of business (territories) or extension thereof (to new activities), raising of finances and their appropriations for specific purposes, the appointment and removal of staff, etc. The concept of control and management is a composite test, not to be split; it is designed to identify where decisions of fundamental policy are made as opposed to the place where

      the day-to-day profit earning activities are undertaken.

    3. 3.3   CompanyA company is resident in any year of assessment if during the relevant accounting year (i) it is an Indian company, or (ii) its place of effective management, in that year, is in India. The earlier test for residence, viz. whether, during the year under consideration, the control and management of the affairs of the company was situate wholly in India existed upto AY 2016-17.

      A company will be regarded as an Indian company (i) if the company is formed and registered under any law relating to companies which was or is in force in any part of India, and (ii) if the registered office of the company is in India [section 2(26)].

      1. 3.3.1  Place of effective management [PoEM] The expression PoEM is defined in Explanation to section 6(3) to mean a place where key management and commercial decisions that are necessary for the conduct of business of an entity, as a whole are, in substance, made.

        The earlier requirement for a company to become resident in India was that its control and management should be situated wholly in India, which could have been easily avoided by simply holding a board meeting outside India. This facilitated creation of shell companies which were incorporated outside but controlled from India.

        According to the Explanatory Memorandum accompanying the Finance Bill, 2015, the modification in the condition of residence in respect of company by including the concept of effective management aligns the provisions of the Act with the Double Taxation Avoidance Agreements entered into by India with other countries and would also be in line with international standards. It would also be a measure to deal with cases of creation of shell companies outside India but being controlled and managed from India.

        The reference to the “business of an entity as a whole” in the Explanation does not refer to the whole of the POEM but to the key decisions related to the conduct of the entire business of the entity as opposed to the decisions relating to a part of the business of the entity.

        The CBDT issued Guidelines for the PoEM vide Circular No. 6 of 2017 dated 24-1-2017. The Circular provides for certain relaxation for companies with active business outside India. Another Circular (No. 8 of 2017 dated 24-2- 2017) provides that that the PoEM requirement in section 6(3)(ii) shall not apply to a company having turnover or gross receipts of Rs. 50 crores or less in a financial year.

    4. 3.4   Resident and not ordinarily resident:A ‘not ordinarily resident’ status is available only to individual and HUF and not to other categories of persons. Under this provision, an individual should be a non-resident for nine years out of ten preceding years or during his seven ‘previous years’ preceding the previous year in question, he was present in India in the aggregate for seven hundred and twenty-nine days or less.

      A not ordinarily resident is a sub-category of person resident. The scope of his total income is the same as that of resident assesses but excludes income accruing or arising outside India unless it is derived from a business controlled in or profession set up in India.

  4. 4   Treaty residence

    Residential status under the domestic tax law is relevant to accessing a double tax avoidance agreement and to be eligible for the reliefs available under the agreement. Some of these reliefs that are available to a non-resident in the State where income arises (the “Source State”) under the concerned treaty are obtaining a lower rate of tax for interest, dividend, royalties and fees for technical services, taxability of business income in that State only if there is a permanent establishment and exemption

    from taxation in that State for certain kinds of income. The non-resident also is entitled to relief from double taxation in his state of residence by obtaining exemption from taxes or credit for foreign taxes.

    Double tax avoidance agreements entered by India are bilateral agreements and modelled on the OECD Model Convention and the United Nations Model Convention. in order to access these benefits, the person should be a resident of one or either of the Contracting States (i.e., parties to the double tax avoidance agreement) (Article 1 of the OECD /UN Model). The term residence is usually defined in Article 4 of the Agreement and is for the purposes of that Agreement. Article 4 of the OECD Model states as follows: “For the purposes of this Convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, ”

    1. 4.1   Connecting factors:The treaty definition of residence refers to residence under the domestic tax law of the Contracting State concerned but the two residence concepts have different purposes. The ‘liable to tax’ (in the definition of residence in Article 4) must be by reason of the specified connecting factors, viz., residence, domicile or any other similar criteria. Any taxation in a Contracting State merely because the income arises in that State will not be sufficient to fall within the definition of treaty residence. This condition of being liable to tax by reason of certain connecting factors is described by the OECD Commentary as a comprehensive liability to tax – full tax liability – based on the taxpayers’ personal attachment to the State concerned (the “State of residence”)”. There is a causal relationship between the listed factors and extent of taxability that is required for the factors to become connecting factors. What is necessary to qualify as resident of

      a Contracting State is that the taxation of income in that State is because of one of these factors and not merely because income arises therein.

      A not ordinary resident is a resident under the Act and is eligible to access a double tax avoidance agreement to enjoy relief available under the agreement in the Source State. Though he is not taxable on income accruing or arising outside India unless such income is derived from a business controlled in or profession set up in India, he is taxable on such income precisely because he is resident and not because it accrues or arises to him in India. Thus, he satisfies the condition that he is liable to tax in India by reason of his residence.

    2. 4.2   Dual residentsArticle 1 of the OECD/UN Model envisages that a person could be resident (as defined in Article 4) of one or both Contracting States. For example, an individual may be resident of one State because of the number of days stay in that State while he could be resident of the other State under its domestic law since he has his domicile in that State. Another example is of a company that could be resident of one State under its domestic law since it is incorporated in that State while it is resident of the other Contracting State because its place of effective management is in that State. By design, double tax avoidance agreements provide for distribution of taxing rights between the two States. A person is necessarily to be determined as resident of one State only for that structure to operate. Accordingly, tie breaker rules are provided in Article 4 to determine a single treaty residence for persons who are dual resident.

      In case of companies, the tie breaker rule is the place where the place of effective management of the company is situated. Pursuant to developments in the Base Erosion and Profit Shifting Project (BEPS Project), a Multilateral Instrument (MLI) was signed by more than 100 countries (including India). Under the MLI, the tie breaker provision has been done way with and the competent authorities of the two States need to agree in which State the dual resident company is resident for the purposes of the concerned treaty on a case-by-case basis.

      A person’s residential status under the Act does not change due to the determination of treaty residence. Thus, a person who is resident under the Act could be a resident of the other Contracting State for the purposes of the agreement by the operation of its tie-breaker provisions or through competent authority agreement.

  5. Conclusion

Residence is one of the important concepts in understanding international taxation. The term affects the scope of taxation under the Act as also the ability of a taxpayer to access a double tax avoidance agreement. The meaning of residence under a double tax avoidance agreement necessarily refers to the meaning under domestic law but they serve different purposes. Treaty residence is for the purposes of that agreement. Comprehensive or full taxation in a Contracting State that results in a taxpayer becoming treaty resident arises because of the connecting factors to a State (including the residence under its domestic tax law) and not due to being chargeable to tax on income arising in that State.

The concept of POEM that exists under the double tax avoidance agreements has been introduced under the Act to determine the residential status of companies under the Act. The POEM under the agreements is to break the tie in case of dual resident companies. Significantly, double tax avoidance agreements mitigate juridical double taxation while economic double taxation remains unaddressed.