Introduction
One essential tool used by governments to raise money to pay for public spending and promote economic growth is taxation. One of the key ideas of the Income Tax Act, 1961, which regulates income taxes in India, is the assessee’s residence status. The extent of taxable income is determined by a person’s residential status, which establishes whether their worldwide income or just their income produced in India is subject to taxation. This idea guarantees tax equity and prevents excessive burden on people who could have ties to several nations.
An assessee’s residence status is determined by their actual presence in India during a specific fiscal year rather than their nationality or citizenship. It is applicable to all kinds of assesses, including people, businesses, corporations, Hindu Undivided Families (HUFs), and other entities. According to Indian tax law, the categorisation of residence status has a significant impact on tax liabilities and compliance requirements. This blog discusses residential status, its classifications, how it’s determined, and how it affects tax obligations.
Meaning of Assessee
Under Section 2(7) of the Income Tax Act, 1961, an assessee is a person who is liable to pay tax or any other sum under the Act. It includes individuals, companies, firms, HUFs, and other entities. Every assessee must determine their residential status at the beginning of each financial year because it directly affects how their income will be taxed.
Concept of Residential Status
The classification of an assessee according to their physical presence in India during a fiscal year is known as residential status. It establishes the range of total income subject to Indian taxation. Assesses are categorised under the Income Tax Act based on whether they are considered residents or non-residents. It is crucial to remember that each fiscal year’s residence status is decided differently. Depending on how long they remain in India, a person may be a resident one year and a non-resident the next.
Residential Status of an Individual
The determination of residential status of an individual is governed by Section 6 of the Income Tax Act, 1961. An individual may fall into one of the following categories:
1. Resident and Ordinarily Resident (ROR)
2. Resident but Not Ordinarily Resident (RNOR)
3. Non-Resident (NR)
These categories are determined based on basic and additional conditions.
Basic Conditions
An individual is considered a resident in India if he satisfies any one of the following basic conditions:
1. He spends at least 182 days in India during the relevant fiscal year, or
2. He spends at least 60 days in India during the relevant fiscal year and 365 days or more throughout the four fiscal years prior.
A person is considered a resident if he meets any one of these requirements. He is regarded as a non-resident if he does not meet any of these requirements. For Indian nationals and Persons of Indian Origin (PIOs) travelling to India, however, specific rules apply; in some circumstances, the 60-day period is extended to 182 or 120 days.
Additional Conditions
Additional requirements are used to establish whether a person is normally resident or not if he meets the fundamental requirements for residency.
A person has both of the following requirements to be classified as a resident and ordinarily resident (ROR):
1. For at least two of the ten previous fiscal years, he has resided in India; and
2. He has spent at least 730 days in India during the last seven fiscal years.
A person is considered Resident but Not Ordinarily Resident (RNOR) if they meet the basic requirements but not both supplementary requirements.
Non-Resident
An individual is considered a Non-Resident (NR) if they do not meet any of the fundamental requirements. Foreign nationals employed outside of India and Indian citizens residing overseas for work or business are examples of non-residents.
Residential Status of Other Assessees
Apart from individuals, residential status is also determined for other entities.
Hindu Undivided Family (HUF)
A HUF is considered resident in India if its control and management is wholly or partly situated in India. If control and management is entirely outside India, it is treated as non-resident.
Firm and Association of Persons (AOP)
A firm or AOP is resident if its control and management is wholly or partly in India. Otherwise, it is treated as non-resident.
Company
A business is said to be an Indian resident if:
1. It is an Indian business; or
2. During the relevant fiscal year, India is where it is effectively managed.
The location where important management and business choices required for business operations are made is referred to as the “place of effective management.”
Importance of Residential Status in Tax Liability
The extent of taxable income is significantly influenced by residential status. The idea behind the money Tax Act is that non-residents are only taxed on money generated or received in India, whilst citizens are taxed on their worldwide income.
An assessee’s tax due is determined by whether they are classified as ROR, RNOR, or NR.
Tax Liability of Resident and Ordinarily Resident (ROR)
Taxes must be paid by residents and ordinarily residents on:
1. Income received in India or assumed to have been obtained there.
2. Earnings that originate or accrue in India.
3. Income that originates or accrues outside of India and Income that is obtained outside of India.
This implies that ROR is taxed on worldwide income, irrespective of the source of the revenue. For instance, both incomes are taxed in India if a resident receives a salary in India and interest from a foreign bank account.
Tax Liability of Resident but Not Ordinarily Resident (RNOR)
Compared to ROR, a resident who is not ordinarily a resident has a lower tax obligation. RNOR is taxed on:
1. Income received in India or assumed to have been obtained there.
2. Income that originates or accrues in India; and 3. Income that originates or accrues outside of India provided it comes from an Indian-controlled company or profession.
For RNOR, foreign income unrelated to India is not taxed.
People who have just returned to India after living outside for a long time might receive assistance under this category.
Tax Liability of Non-Resident (NR)
A non-resident is only subject to taxation on:
1. Income that is received or presumed to have been obtained in India.
2. Earnings that originate or accrue in India.
Non-residents of India are exempt from paying taxes on foreign income generated and received outside of the country.
For instance, a non-resident’s wage earned and received in another nation will not be subject to Indian taxation. Income from real estate in India, however, would be subject to taxes.
Examples to Understand Tax Liability; –
Consider three individuals:
Person A resides there and does so regularly. He makes money from a house in the UK and a salary in India. In India, both incomes are subject to taxes.
Although Person B is a resident, they are not typically there. In addition to his income from a foreign firm unrelated to India, he receives a salary in India. Taxable income is limited to Indian income.
The non-resident is Person C. He receives interest from an Indian bank account in addition to his pay from outside. Only Indian interest income is subject to taxes.
These illustrations demonstrate how tax obligation is influenced by residence status.
Impact on Double Taxation
Residential status also affects the application of Double Taxation Avoidance Agreements (DTAA). These agreements prevent the same income from being taxed in two countries.
Residents of India can claim relief under DTAA if their income is taxed both in India and another country. Non-residents can also claim relief based on treaty provisions.
This ensures fairness and promotes international trade and employment.
Compliance and Reporting Requirements
Residential status affects compliance requirements such as filing income tax returns and reporting foreign assets.
Resident and Ordinarily Resident individuals must disclose foreign assets and income in their tax returns. Failure to disclose may lead to penalties.
Non-residents and RNOR have fewer reporting obligations.
Special Provisions for Deemed Residency
The Income Tax Act also introduced the concept of deemed residency. An Indian citizen who is not liable to tax in any other country and whose total income exceeds a specified limit may be treated as a deemed resident in India.
This provision prevents tax evasion by individuals who attempt to avoid residency in any country.
Importance for Tax Planning
Residential status plays an important role in tax planning. Individuals working abroad or returning to India must carefully evaluate their residential status to understand tax implications.
Proper tax planning helps avoid legal complications, penalties, and double taxation.
Employers and businesses must also consider residential status while deducting tax at source.
Conclusion
A key idea under the Income Tax Act of 1961 is residential status, which has a direct bearing on an assessee’s tax obligation. It is determined by the length of time a person spends in India as well as other pertinent factors, not by their citizenship. Individuals are categorised as either non-resident, resident but not ordinarily resident, or resident and ordinarily resident based on certain characteristics.
Each group has a very different range of taxable income. While non-residents are solely taxed on income generated or received in India, citizens are taxed on their worldwide income. The categorisation guarantees equitable taxation and avoids placing an excessive burden on those with global ties. Planning, tax compliance, and avoiding legal problems all depend on knowing one’s residence status. Additionally, it assists taxpayers in avoiding double taxation and utilising international tax treaties. In conclusion, under Indian tax law, the basis for calculating tax liability is residential status. An essential component of income tax administration in India is the accurate assessment of residence status, which guarantees the taxation system’s efficiency, justice, and transparency.
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