Decoding Complexities of Non-Resident Taxation

Introduction

Taxation for non-residents in India is shaped by specific provisions of the Income Tax Act, 1961 (‘the Act’). Non-residents, defined as individuals or entities not meeting the residency criteria, are subject to unique tax obligations that differ from those of residents. Understanding these regulations is vital for ensuring compliance with Indian tax laws and effectively managing the tax implications of income sourced from India.

As the tax liability of an individual hinges on their residency status, the first crucial step is to evaluate whether one qualifies as a resident in India. This article explores the key taxability provisions applicable to non-residents and the implications for their income in the Indian context.

A. Determination of residential status:

According to Section 6 of the Act, an individual is considered a resident in India if they meet specific criteria:

Basic Conditions:

1. The person must stay in India for at least 182 days during the relevant previous year (PY).

2. Alternatively, the person should stay for at least 60 days in the relevant PY and have an aggregate stay of at least 365 days over the four PYs preceding it.

Additional Conditions:

1. The person must be a resident for at least two out of the ten PYs immediately before the relevant financial year (FY).

2. The person must have stayed in India for a minimum of 730 days during the seven PYs prior to the relevant PY.

If any one of the basic conditions is satisfied, the individual is classified as a resident. To determine if they are a Resident and Ordinarily Resident (ROR) or a Resident But Not Ordinarily Resident (RNOR), both additional conditions must also be assessed.

Example:

A foreign national who visits India for 200 days in the current PY qualifies as a resident based on the first basic condition. If they also meet one of the additional conditions, they would be classified as an ROR; otherwise, they would be an RNOR.

B. Taxability of Residents vs. Non-Residents

The tax obligations for residents and non-residents differ significantly. Section 9 of the Act outlines income types considered to accrue in India, including income earned by foreign entities or non-residents. For example, if a non-resident earns income from a business operated in India, that income is deemed to arise in India and is therefore taxable. Understanding these provisions is crucial for non-residents to navigate their tax obligations effectively and avoid potential pitfalls.

We have outlined below in the tabular format the types of income that would be chargeable to a Non-Resident:

C. Taxability of different income types for Non-Residents in India

i. Dividend Income

Tax Implications:

• Dividends received from an Indian company are always deemed to accrue in India and are subject to Indian taxation.
• In contrast, dividends received from a foreign company are considered to have accrued outside India and are not taxable in India.

Case Study: Mr. X, a non-resident, receives a dividend of INR 50,000 from an Indian company. Under Indian tax laws, this income is taxable in India due to its source. However, if Mr. X received the same amount as a dividend from a foreign company, it would be exempt from Indian tax.

Supporting judicial precedents:

In Principal Commissioner of Income Tax-2, Mumbai vs. M/s. D. J. Malpani (2023), the Bombay High Court affirmed that dividend income from Indian companies is taxable for non-residents. The ruling highlighted that domestic tax laws supersede treaty provisions unless a specific exemption is stated in the treaty.

ii. Royalty and Fees for Technical Services (FTS)

Tax Implications:

Royalty or FTS are deemed to accrue in India under the following conditions:

• Payments made by the Indian government.
• Payments made by a resident, unless used for purposes outside India.
• Payments made by a non-resident, provided they support business activities within India.

Case Study: Taxability of royalty in India

• Y, a non-resident entity based in Germany, provides technical consulting services to an Indian company, Tech Solutions Pvt. Ltd. As part of this engagement, Mr. Y grants Tech Solutions the right to use a patented technology developed in Germany. For this licensing arrangement, Tech Solutions agrees to pay Mr. Y a royalty of USD 10,000.

Tax Implications

According to Indian tax laws, particularly Section 9 of the Act, royalty payments made to a non-resident are considered to accrue or arise in India under certain conditions. In this case, since the payment is for the use of a patented technology utilized in India, the following points are relevant:

• Source of Income: The royalty is deemed to accrue in India because it is paid by an Indian resident for the use of technology within India.
• Tax Obligations: As a result, Tech Solutions Pvt. Ltd. is required to withhold tax on the royalty payment before making the transfer to Mr. Y. The applicable withholding tax rate on royalty payments is generally 21.84% under the Act, subject to any lower rates specified in tax treaties between India and Germany. Incase the tax treaty is opted, Mr. Y will be required to produce documentation for lower tax deduction and accordingly avail the treaty benefits.

After the tax has been withheld and remitted, Mr. Y will receive USD 7,816 from Tech Solutions. He will also need to consider the tax implications of this income in Germany. If there is a double taxation agreement (DTA) between India and Germany, Mr. Y may be able to claim credit for the taxes paid in India when filing his taxes in Germany.

Case Study: Taxability of fees for technical services in India

Mr. Z, a non-resident individual based in the United Kingdom, is a highly skilled software engineer. He is contracted by an Indian IT firm, Innovatech Pvt. Ltd., to provide technical consultancy for a software development project based in India. As part of this agreement, Innovatech agrees to pay Mr. Z USD 15,000 for his consulting services.

Tax Implications

Under Indian tax law, particularly Section 9 of the Act, fees for technical services (FTS) are considered to accrue or arise in India if:

• The payment is made by an Indian resident.
• The services are utilized in India.
• The payment is not for services rendered outside India for a business operated outside India.

In this case, since Innovatech Pvt. Ltd. is an Indian resident and the consultancy services are related to a project being executed in India, the following points are relevant:

• Source of Income: The fees paid to Mr. Z are deemed to accrue in India because the services are provided for a project based in India.
• Tax Obligations: Innovatech is required to withhold tax on the payment made to Mr. Z. The applicable withholding tax rate for fees for technical services is generally 21.84%, but it may vary depending on tax treaties.

After withholding the tax, Mr. Z will receive USD 11,724 for his services. He must also consider how this income will be treated in the UK. If there is a double taxation agreement (DTA) between India and the UK, Mr. Z can claim a credit for the taxes paid in India when filing his tax return in the UK, potentially reducing his overall tax liability.

However, there are certain treaties wherein fees for technical services is taxed basis make available clause (eg. India and US tax treaty). In these scenarios, the tax is levied only if the specific conditions are satisfied as per the treaty.

Supporting judicial precedents:

In Engineering Analysis Centre of Excellence Pvt. Ltd. vs. Commissioner of Income Tax (TDS) (2021), the Supreme Court ruled that royalty payments to non-residents are taxable in India under the Income Tax Act. While tax treaties may offer reduced rates, the fundamental principle of Indian taxation applies unless specifically altered by treaty terms.

• Interest Income

Interest income is deemed to accrue in India under these conditions:

• Paid by the Indian government.
• Paid by a resident, unless the funds are used for activities outside India.
• Paid by a non-resident, if used for business activities within India.

Case Study: Taxability of interest income for a non-resident in India

Mr. A, a non-resident individual from Australia, invests in an Indian company, GreenTech Ltd., by lending them USD 100,000 at an interest rate of 8% per annum. The loan agreement states that the interest payments will be made quarterly.

Tax Implications

According to Indian tax law, interest income is deemed to accrue in India under the following conditions:

1. Interest Paid by the Indian Government: This does not apply in this case.

2. Interest Paid by a Resident: If the interest is paid by a resident, it is taxable unless the funds are used for business activities outside India.

3. Interest Paid by a Non-Resident: Interest paid by a non-resident is taxable only if it is for business activities conducted within India.

In this case, since the interest is paid by a resident company (GreenTech Ltd.) to Mr. A, the relevant conditions are:

• Source of Income: The interest payment will be considered to accrue in India because it is made by an Indian resident company.
• Tax Obligations: GreenTech Ltd. is required to withhold tax on the interest payment before transferring it to Mr. A. The standard withholding tax rate for interest payments is typically 20% (plus cess), although this can vary depending on applicable tax treaties.

Tax Withholding Process

GreenTech Ltd. calculates the withholding tax on the interest payment:

• Interest Amount: USD 100,000 at 8% per annum results in an annual interest of USD 8,000.
• Withholding Tax Rate: 20% plus cess (21.84%)
• Tax Deducted at Source (TDS): USD 1,747

GreenTech Ltd. must remit this USD 1,747 to the Indian tax authorities and provide Mr. A with a TDS certificate reflecting this deduction.

After withholding the tax, Mr. A will receive USD 6,252 in interest payments (USD 8,000 – USD 1,747). Mr. A will also need to report this income in Australia. Depending on the provisions of the double taxation agreement (DTA) between India and Australia, he may be able to claim a credit for the taxes paid in India when filing his Australian tax return.

Relevant Case Law:

In Principal Commissioner of Income Tax-3, New Delhi vs. M/s. TCS E-Serve International Ltd. (2022), the Delhi High Court held that interest income from Indian sources earned by a non-resident is taxable in India, reinforcing that such income is deemed to accrue or arise in India under the Income Tax Act.

Understanding the nuances of these tax implications is essential for non-residents engaging in various income-generating activities in India. Awareness of specific cases and legal precedents can aid in effective tax planning and compliance.

D. Income not to be included in the total income of NR

a) Interest on moneys standing to the credit of individual in his Non-resident external (NRE)

According to section 10(4)(ii), an individual is entitled to an exemption on income earned as interest on funds held in a Non-Resident (External) Account (NRE Account) in any bank in India, provided that such income is earned in compliance with the Foreign Exchange Management Act, 1999 (FEMA, 1999) and its associated rules. This exemption applies if the individual is a person residing outside India, as defined under FEMA, 1999:

b) Income of a specified fund on transfer of certain asset

The following types of income accrued to or received by a specified fund are exempt from taxation:

i. Income from the transfer of a capital asset, such as any type of bonds

ii. Income from the transfer of securities, excluding shares in an Indian company.

iii. Income from securities issued by a non-resident (who is not a permanent establishment in India), provided that such income does not otherwise accrue or arise in India.

iv. Income from a securitization trust that is taxable to the extent that it is attributable to units held by a non-resident (excluding a permanent establishment in India) or to the investment division of an offshore banking unit, computed as prescribed.

c) Income of a non-resident as a result of transfer of non-deliverable forward contracts/ offshore derivative instruments/ over the counter derivatives entered into with an offshore banking unit of an IFSC

d) Income of a non-resident by way of royalty or interest, on account of lease of an aircraft or a ship in a previous year, paid by a unit of an IFSC

e) Income received by a non-resident in an account maintained with an offshore banking unit in any IFSC shall be exempt, provided that such income accrues or arises outside India and is not considered to accrue or arise within India.

E. Compliances if DTAA provisions are availed

As a precondition for claiming treaty benefits, domestic law requires non-residents to furnish a certificate establishing that they are a tax resident (a tax residency certificate, or TRC) of the relevant treaty country. The person is also required to provide details regarding their status, nationality, tax identification number, and address, and the period for which residential status applies, if that information is not already contained in the TRC. The information is required to be given in Form 10F, prescribed by the Indian tax authorities. The details to be submitted to claim DTAA benefit is as below:

• Tax Residency Certificate (TRC): Essential for proving your tax status in a foreign country.
• Indemnity or Self-Declaration Form: To declare relevant tax details.
• Self-Attested Copy of PAN Card: For your Permanent Account Number verification.
• Self-Attested Visa: As proof of your current residency status.
• Person of Indian Origin (PIO) Proof Copy: If applicable, confirm your Indian origin.
• Self-Attested Passport Copy: For identity and nationality verification.
• Submit the TRC to the Tax Deductor: This is crucial for claiming tax benefits under the DTAA.
• Form 10F

Conclusion

Non-residents in India are taxed only on income that accrues within the country, such as dividends, interest, and rental income. This discussion has concentrated on the specific provisions applicable to individual non-residents. Double Taxation Avoidance Agreements (DTAAs) play a crucial role in mitigating the risk of double taxation by offering reduced rates or exemptions. It is vital for non-residents to adhere strictly to Indian tax regulations, including accurate withholding and reporting requirements, to meet their tax obligations effectively and navigate the complexities of international tax law. By understanding these provisions and ensuring compliance, non-residents can optimize their tax positions while engaging in business or investment activities in India.

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The contributors to the Article are Sumit Mahajan, AccuWiz Consulting LLP along with inputs from Sonakshi Sood.

Disclaimer: The content/information is only for general information of the user and shall not be construed as legal advice. The facts stated are based on information available in public domain. Views expressed above are personal.