Liberalisation has resulted in a large number of foreign citizens / NRIs /PIOs coming into India for different reasons, including employment, over the past few years. They are taking up employment with Indian companies, as well as with subsidiaries / offices of foreign companies. These individuals are liable to tax in India depending on their residential status.
Generally, they are liable to tax on their global income in India after three to four years of their arrival. This article discusses the provisions of residential status of an individual and his taxability in India under the Income-Tax Act, 1961, so that the Indian assignments of foreign expatriates / NRIs / PIOs may be well planned.
The residential status of an individual could be resident or non-resident (NR). A resident is further classified as resident and ordinarily resident (ROR) and not ordinarily resident (NOR).
Scope of taxable income
An NR and NOR is generally taxable in India on the income which is earned or received in India. For example, salary received by a foreign citizen outside India for services rendered in India, is liable to tax in India. Unlike the above two categories, an ROR is liable to tax in India not only on income earned or received in India but also on income earned or received outside India. In other words, an ROR is taxable in India on his worldwide income.
For instance, salary received in India and the US, rental income from house property earned in the UK, interest income from deposits in Germany, gains from sale of shares in Switzerland, will all be liable to tax in India. In view of the substantial difference in the tax liability of ROR as compared to the other two categories, it is essential to understand as to when an individuals residential status changes from NR/NOR to ROR.
Resident / Non-Resident
A person may be resident or non-resident based on his physical stay in India during the tax year. A person is a resident in India if he is present in India for a period of 182 days or more in a tax year. He may also become a resident if his physical stay in India is 60 days or more in a tax year and 365 days or more in the four tax years preceding the current tax year. In case neither of these two conditions is satisfied, he is treated as a non-resident for tax purposes.
A person who is a resident can qualify to be an NOR if either of the following two conditions is satisfied: (1) the individual is a non-resident in India in nine out of the 10 tax years preceding the current tax year, or (2) has been in India for a maximum of 729 days in seven tax years preceding the current tax year. If neither of the above conditions is fulfilled, then the person is treated as an ROR.
Usually, a foreign citizen remains an NR or NOR for the first two to three years of his first arrival in India. He is likely to become an ROR in the third or the fourth tax year depending on his physical stay in the earlier years. Once he crosses the threshold limit of 729 days on March 31 of a particular tax year, then w.e.f. April 1 of the following tax year, his residential status is likely to be of an ROR and accordingly, his global income may be liable to tax in India.
The matter does not end here. The foreign citizen / NRI / PIO may also be a tax resident of some other country and be liable to tax on his income in that country in accordance with its domestic tax laws, which are generally based on domicile, residence, nationality, etc. This may result in the same income being taxed in India as well as the other country, i.e., double taxation. Therefore, besides the Indian tax provisions; the tax laws of the other country should also be taken note of.
Double Taxation Avoidance
To avoid a situation of double taxation, India has entered into Double Taxation Avoidance Agreements (Treaty) with over 60 countries. The provisions of the applicable treaty are also required to be analysed with respect to the residential status of the expatriate under the treaty. There may be a situation wherein the person is a tax resident of both India and the foreign country.
In such a case, it is important to identify the country of which he would ultimately be considered a resident. The treaties have a tie-breaker clause, which lays down the rules for determining the residential status in case of dispute between the two countries.
Depending on the residential status of the individual as per the treaty, three possibilities may arise: (1) his overseas income is liable to tax only in India, (2) his overseas income is exempt from tax in India, or (3) the overseas income is liable to tax both in India and the other country. In the first two scenarios, double taxation is avoided by exempting income from tax in one of the countries. However, in the third scenario, where the income is likely to get taxed in both the countries, the treaty usually provides for a tax credit mechanism whereby the individual gets credit in one of the two countries.
Treaty benefit not available
There may be a situation where the expatriate is neither a tax resident of India nor of the other country. In that case, the treaty benefits cannot be availed. This is because the person is required to be a resident of either of the two countries under consideration. Therefore, this fact should be kept in mind as it might result in a situation where the same income is taxed twice without any corresponding tax relief under the treaty.