Law related to residency in India & role of exemption under DPS

Article explains Law related to residency in India & role of exemption under Dependent Personal Service (‘DPS’) when a person is providing services in more than one country

The deduction of TDS while making any payment depends upon the three major factors i.e.

1. Residential Status of the person;

2. DTAA between the country of his residence and where his source of income lies; and

3. The law of the country in which he has provided the services

Please find below a short note on the above-mentioned aspects i.e.

1. Residential Status of the person:

It depends upon the law of the country where the person is physically residing or providing the services. The applicability of tax can be residence based or source based. Different countries have different rules & regulations regarding the residential status of the company. Residential status of an individual under the Income Tax Act, 1961 (‘the Act’) applicable to India is appended below as Annexure – 1.

Residential Status of an ‘Individual’ – under the ‘Income Tax Act.

(i) Resident (Ordinary Resident) [Section 6(1)] – To determine the residential status of an individual, section 6(1) prescribes two tests. An individual who fulfils any one of the following two tests is called Resident under the provisions of this Act. These tests are:

(a) If he is in India during the relevant previous year for a period amounting in all to 182 days or more.

(b) If he was in India for a period or periods amounting in all to 365 days or more during the four years preceding the relevant previous year and he was in India for a period or periods amounting in all to 60 days or more in that relevant previous year.

After fulfilling one of the above two tests, an individual becomes resident of India but to become an ordinary resident of India an individual has to fulfill both the following two conditions (Under Section 6(6)):

(1) He has been resident of India (fulfilling at least one test given above) in at least 2 previous years out of 10 previous years immediately prior to the previous year in question.

(2) He has stayed in India for at least 730 days in 7 previous years immediately preceding the previous year in question.

This means that an individual will not become an ordinary resident of India by simply staying in India for a period of 182 days or more in a previous year. He will become ordinary resident only if. he fulfills one of these two tests and was also fulfilling one of the tests in at least 2 previous years preceding the relevant previous year and did stay in India for at least 730 days in 7 previous years preceding the relevant previous year.

(iii) Resident but Not Ordinarily Resident – An individual who satisfies one or more of the basic conditions laid down in section 6(1), but does not satisfy the two additional conditions laid down in section 6(6) is treated as resident but not ordinarily resident India.

(iv) Non-resident – An individual is a non-resident in India during the previous year if he satisfies none of the basic conditions laid down in section 6(1).

2. Double Taxation Avoidance Agreement (DTAA) between the country of his residence and where his source of income lies

DTAA is a tax treaty signed between two or more countries. Its key objective is that tax-payers in these countries can avoid being taxed twice for the same income. Different countries have different rules regarding the taxability of income depending upon the status of the person, in such a case to avoid the circumstances where a person can be taxed twice, these agreements are get signed. These agreements provide relief to the person in the form of non-taxability of the income or refund of the tax paid twice depending upon the terms & conditions of the DTAA.

Now-a-days, due to globalization, it is quite common that a person performs his services in his employment in more than one country during the year and he is liable to be taxed in both countries. Number of countries have made provisions in their law and have entered in DTAA with other countries to provide relief to the taxpayers. Dependent Personal Service (‘DPS’) Article which provides such an exemption can be descried as under:

Businesses are no longer restricted to the local geographical boundaries. With globalization and liberalization, the modern-day businesses have spread their reach out of their home countries. MNCs are looking to capture every business opportunity available on this planet. We will witness a high inclination in mobility of employees to India, being one of the top investment destinations. Such movement has triggered issues relating to taxation of remuneration received by these personnel. The tax treaties between the countries have specifically tackled these issues in order to facilitate business ties and eliminate double taxation. One of the clause of such treaties is ‘Dependent Personal Services’.

This article will guide the contracting states to a treaty in ascertaining the correct taxability of employment remuneration in the country of residence as well as the source country. Since treaty is related to international transactions, this Article is applicable to employees performing their services in a country other than the country of their residence. For eg:

• Employee deputedon assignment outside his own country of residence;
• Employee permanently relocatingto a different country for employment; and
• Employee required to travel to different countriesin course of his employment.

The major points to be taken under consideration for evaluation of taxability of an individual under DPS clause of the treaty are given as under:

– Applicability is restricted to employment income where recipient has employee-employer relationshipwith the payer;

– Place of exerciseof employment;

– Residencyof employee vs. Source rule;

– Exemptionfrom tax in ‘source country’

Who is the real employer?

The draft OECD report suggests the following factors to be considered for determining who is the real employer:

• Who has the authority to instructthe individual regarding the manner in which the work has to be performed;
• Who controlsand has responsibility for the place at which the work is performed;
• The remunerationof the individual is directly charged by the formal employer to the enterprise to which the services are provided;
• Who putsthe tools and materials necessary for the work at individual’s disposal;
• Who determinesthe number and qualifications of the individuals performing the work.

Place of exercise of employment

Salary income is taxable in the country where the employment is actually exercised. Employment is exercised in the place where the employee is present when performing the activities for which the employee is physically present when performing the activities for which the employment income is paid, i.e. physical presence of an employee is the pre-condition to exercise of employment.

It is pertinent to note that the following points are not relevant in deciding the exercise of employment:

• Place where the result of work is exploited
• Place of signing contract
• Place of headquarters of employer
• Residence of employer
• Nationality of employee
• Place of remittance of emoluments

Residency of employee vs. Source rule – Exemption under paragraph 1 of DPS Article

In order to explain this clause Paragraph 1 of Article 16 of India and US treaty is reproduced below:

“….., salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived there from may be taxed in that other State.”

Paragraph 1 of DPS recognizes that the country of which the employee is a tax resident as per treaty will have right to tax his salary income. As per this recognition, the state of residence can tax salary income even if it is earned by exercise of employment in some other country. However, if the employment is exercised in some other country, the income may be taxed in that country as well. To illustrate, salary earned by a person resident of India will be taxable in India even if the employment is exercised in the US. Also, such income may be taxed in the US.

This article relates to a typical outbound situation where the person while working on overseas assignment continues to receive salary in India. Such salary income is taxable under Income Tax Act on receipt basis. But as the intention of DPS is to give right to tax to the source country and section 9 also states that salary is taxable in India if services are rendered in India, any salary received by an outbound assignee in India may be considered as not taxable in India if,

• The outbound assignee is a treaty residentof other country; and
• Salary received in India is not related to the services rendered in India

3. The law of the country in which he has provided the services

The law of the country in which the person is physically present and he has source of income also impact his tax liability & rate of tax deduction. Due to relief under DTAA, it is possible that the persons’ liability of tax reduced drastically in the source country. In such a case, the Local law of the country can provide him the option of lower rate of deduction of tax.

In India, as per the Act, Section 197 provides such a remedy where the person can apply to the Income Tax Department for lower tax deduction certificate (LTDC) justifying his position. The details of the provision u/s 197 of the Act can be defined as below:

Section 197(Certificate for deduction at lower rate)

(1) Subject to rules made under sub-section (2A), where, in the case of any income of any person or sum payable to any person, income-tax is required to be deducted at the time of credit or, as the case may be, at the time of payment at the rates in force under the provisions of sections 192, 193, 35[194,] 194A, 36[194C,] 194D, 36[194G] 37[, 194H] 38[, 194-I] 39[, 194J] 40[, 194K, 194LA and 195, the Assessing Officer is satisfied] that the total income of the recipient justifies the deduction of income-tax at any lower rates or no deduction of income-tax, as the case may be, the Assessing Officer shall, on an application made by the assessee in this behalf, given to him such certificate as may be appropriate.

(2) Where any such certificate is given, the person responsible for paying the income shall, until such certificate is cancelled by the Assessing Officer, deduct income-tax at the rates specified in such certificate or deduct no tax, as the case may be. The Board may, having regard to the convenience of assessees and the interests of revenue, by notification in the Official Gazette, make rules specifying the cases in which, and the circumstances under which, an application may be made for the grant of a certificate under sub-section (1) and the conditions subject to which such certificate may be granted and providing for all other matters connected therewith.

Certificate for deduction at lower rates or no deduction of tax from income other than dividends.

28AA. (1) Where the Assessing Officer, on an application made by a person under sub-rule (1) of rule 28 is satisfied that existing and estimated tax liability of a person justifies the deduction of tax at lower rate or no deduction of tax, as the case may be, the Assessing Officer shall issue a certificate in accordance with the provisions of sub-section (1) of section 197 for deduction of tax at such lower rate or no deduction of tax.

(2) The existing and estimated liability referred to in sub-rule (1) shall be determined by the Assessing Officer after taking into consideration the following: —

(i) tax payable on estimated income of the previous year relevant to the assessment year;

(ii) tax payable on the assessed or returned income, as the case may be, of the last three previous years;

(iii) existing liability under the Income-tax Act, 1961 and Wealth-tax Act, 1957;

(iv) advance tax payment for the assessment year relevant to the previous year till the date of making application under sub-rule (1) of rule 28;

(v) tax deducted at source for the assessment year relevant to the previous year till the date of making application under sub-rule (1) of rule 28; and

(vi) tax collected at source for the assessment year relevant to the previous year till the date of making application under sub-rule (1) of rule 28.

(3) The certificate shall be valid for such period of the previous year as may be specified in the certificate, unless it is cancelled by the Assessing Officer at any time before the expiry of the specified period.

[(4) The certificate for no deduction of tax shall be valid only with regard to the person responsible for deducting the tax and named therein.

(5) The certificate referred to in sub-rule (4) shall be issued direct to the person responsible for deducting the tax under advice to the person who made an application for issue of such certificate.

(6) The certificate for deduction of tax at lower rate shall be issued to the person who made an application for issue of such certificate, authorizing him to receive income or sum after deduction of tax at lower rate.]