Residential Status and Tax Liability

Residential Status plays a crucial role in determining an individual’s tax liability in India under the Income Tax Act, 1961. The Act classifies individuals into three categories based on their residential status for a particular financial year: Resident, Non-resident, and Resident but Not Ordinarily Resident (RNOR). Each category entails different tax implications, especially regarding the scope of total income and the taxation of global income.

Determination of Residential Status:

The determination of an individual’s residential status is primarily based on the physical presence in India during the relevant financial year (April 1 to March 31) and preceding years. Section 6 of the Income Tax Act lays down the following criteria for determining residential status:

1. Resident:

An individual is considered a resident if they satisfy any of the following conditions:

• They are present in India for 182 days or more during the relevant financial year.
• They are present in India for 60 days or more during the relevant financial year and 365 days or more in the preceding four years.

2. Non-resident:

An individual who does not meet any of the criteria mentioned above is classified as a non-resident.

3. Resident but Not Ordinarily Resident (RNOR):

An individual is categorized as RNOR if they are a resident but do not qualify as an ordinarily resident. This status applies when the individual has been a non-resident in India for nine out of ten preceding financial years, or they have been in India for a total of 729 days or less during the preceding seven financial years.

Taxation of Resident Individuals:

Residents are subject to tax on their global income, which includes income earned within and outside India’s territorial jurisdiction. Their total income encompasses income accruing or arising in India, income received or deemed to be received in India, and income accruing or arising to them globally. Residents are liable to pay tax at applicable rates on their total income, after claiming deductions and exemptions allowed under the Income Tax Act.

Taxation of Non-resident Individuals:

Non-residents are taxed only on income earned or received in India or deemed to be earned or received in India. Their total income is restricted to income derived from Indian sources, such as salaries for services rendered in India, interest income from Indian investments, capital gains from the sale of Indian assets, etc. Non-residents are subject to tax at applicable rates on their Indian-sourced income, with certain exemptions or concessions available under the Income Tax Act or applicable Double Taxation Avoidance Agreements (DTAA).

Taxation of Resident but Not Ordinarily Resident (RNOR) Individuals:

RNOR individuals enjoy a more favorable tax treatment compared to ordinary residents. They are taxed in a manner similar to non-residents, i.e., only on income earned or received in India or deemed to be earned or received in India. Their global income is not taxable in India unless it is derived from a business controlled or profession set up in India. This status provides relief to individuals transitioning between non-resident and resident status, allowing them to organize their affairs without immediate tax consequences.

Special Provisions for Returning Indians:

Income Tax Act incorporates special provisions for returning Indians or individuals of Indian origin who resume residency in India after a prolonged period abroad. These provisions offer certain tax reliefs or exemptions for a specified period to encourage the repatriation of funds and skills. Returning Indians may avail benefits such as exemption from taxation on foreign income for a specific period, relaxation in the taxation of specified assets acquired abroad, and other concessions to facilitate their reintegration into the Indian tax system.

Taxability of Foreign Income for Residents:

Residents are taxed on their global income, which includes income earned both within and outside India’s territorial jurisdiction. This means that residents are liable to pay tax in India on income generated from foreign sources, such as salaries earned abroad, income from investments in foreign assets, rental income from properties located overseas, etc. However, residents may avail relief from double taxation through provisions such as Foreign Tax Credit or Double Taxation Avoidance Agreements (DTAA) to avoid being taxed twice on the same income in India and the foreign country.

Exemptions and Deductions for Non-residents:

While non-residents are taxed only on income earned or received in India, certain exemptions and deductions may be available to them under the Income Tax Act. For example, non-residents may be eligible for exemptions on specific types of income, such as interest on certain bonds or securities, capital gains on certain investments, etc. Additionally, deductions for expenses incurred in earning Indian-sourced income may be allowable to non-residents, subject to specified conditions.

Tax Residency Certificate (TRC):

For claiming benefits under Double Taxation Avoidance Agreements (DTAA) or foreign tax credits, non-residents often need to obtain a Tax Residency Certificate (TRC) from the tax authorities of their home country. The TRC serves as proof of residency for tax purposes and helps in availing treaty benefits or claiming relief from double taxation. Non-residents should ensure compliance with TRC requirements to optimize their tax position and avoid disputes with tax authorities.

Tax Planning Opportunities for RNORs:

Resident but Not Ordinarily Resident (RNOR) individuals have a unique tax status that provides opportunities for tax planning. Since their global income is not taxable in India unless derived from a business controlled or profession set up in India, RNORs can structure their affairs to minimize tax liabilities during the RNOR period. They may strategically time the repatriation of foreign income, plan investments in tax-efficient instruments, and utilize available exemptions and deductions to optimize their tax position.

Impact of Dual Residency:

In certain cases, individuals may qualify as residents of more than one country under their domestic tax laws, leading to dual residency. Dual residency can give rise to complex tax implications, including the risk of double taxation on the same income. In such cases, taxpayers may need to rely on the tie-breaker rules provided in tax treaties or the domestic laws of the countries concerned to determine their tax residency status and allocate taxing rights between jurisdictions.