Tax incidence on a taxpayer in India depends upon his residential status.
Tax incidence on a taxpayer in India depends upon his residential status. Whether an income earned by an individual, in or outside India, is taxable in India depends on the residential status of the individual rather than on his citizenship. People are often under the wrong impression that taking up foreign citizenship helps obtain tax benefits. However, the Income Tax Act, 1961 (Act) does not provide tax benefits on the basis of a person’s citizenship.
There are three different principles adopted internationally to identify the tax jurisdiction of the income of an individual. These principles—citizenship principles, source principle and residence principle are adopted by different countries as per their choice. In the US, income is taxed based on citizenship and source based principles, whereas India follows the residence based and source based taxation system. Under citizenship based taxation, income is taxed on the basis of citizenship of the taxpayer, whereas under residence based taxation system, income is taxed on the basis of residential status of the taxpayer.
Under the Income Tax Act, the residential status of an individual is determined on the basis of period of stay of taxpayers in India. Basis the longevity of the period of stay, residential status is further classified into further three categories (Residents and Ordinarily Resident (ROR), Residents but not Ordinarily Residents (RNOR) cumulatively referred as resident; and Non Residents (NR), depending upon which the income is charged to tax in India.
According to the categorisation of residential status, the Act specifies the scope of income to be taxable in the hands of RORs, NORs and NRs. It provides that RORs shall be required to pay tax on their worldwide income whereas RNORs are required to pay tax only on Indian income, plus any income accruing outside India from a business controlled in or profession set up in India. However, non-residents are taxed only on income that has its source in India. Entire process of evaluation of residential status under the Act nowhere requires any emphasis on the citizenship of an individual.
Another aspect that needs to be kept in mind is that the Double Taxation Avoidance Agreements (DTAA) also incorporates the concept of residential status. In order to qualify as a resident under a DTAA entered into by India, an expat should enjoy residential status either in the overseas country or in India under the domestic laws. There also citizenship has no role to play.
Citizenship has limited relevance as far as Indian taxation is concerned. A person taking up foreign citizenship, but continuing to stay in India, does not really get any tax benefit. Only if a person physically stays abroad that he gets the benefit of becoming an NR or an RNOR, who is liable to pay tax only on Indian income. However, certain HNWIs exploits loopholes in the aforesaid provisions by shifting their residence to foreign jurisdiction to qualify as non-resident Indians and liable to tax only on the income accruing or arising in India.
HNWIs plan in such a way that they do not get taxed in the foreign jurisdiction owing to the fact that they are not citizens of that country or the country is a tax haven that doesn’t tax migrating HNWIs. At the same time India also doesn’t have a taxation right once such HNWI becomes a non-resident Indian. A Working Group had been formed that aims to find a solution to this double non-taxation of the HNWIs migrating to foreign jurisdiction. It would be interesting to witness what changes this Working Group suggests in the Indian tax laws to plug this tax leak on account of migrating HNWIs.
The writer is executive director, Nangia Advisors LLP. Inputs from Radhika Arora