Taxation issues faced by RNOR individuals in India

Current Status of Taxation for RNOR Individuals

Taxation issues for Resident Not Ordinarily Resident (RNOR) individuals in India encompass the complexities of tax liabilities that arise due to their unique residential status. Under the Income Tax Act of 1961, RNORs are distinguished from other taxpayers based on their duration of stay in India and previous tax residency. This classification significantly influences tax obligations, particularly concerning income from foreign sources, making it a critical topic for expatriates and non-resident Indians (NRIs) navigating India’s tax landscape. The provisions also include relevant Double Taxation Avoidance Agreements (DTAAs), which aim to prevent double taxation on income sourced internationally, further complicating the issue. The notability of taxation for RNORs arises from its implications on economic activity and compliance for a growing population of individuals who maintain ties with India while residing abroad. Recent legislative changes, including amendments to tax rates for non-residents, reflect an evolving framework that poses new challenges and opportunities for tax planning and compliance for RNORs. For instance, the increase of the tax rate on royalty and technical service fees to 20% has heightened the need for strategic financial management among affected individuals. Additionally, long-standing provisions that have become redundant signal a pressing need for reform to align legal frameworks with current practices and international standards. Controversies surrounding taxation issues for RNORs often revolve around perceived discrimination in tax treatment compared to non-residents and potential double taxation scenarios. Article 24(1) of DTAAs aims to ensure equitable treatment, yet inconsistencies in implementation can lead to disputes and financial burdens for tax-payers. Furthermore, the reliance on strict day-counting methodologies to determine residential status can inadvertently penalize individuals whose international travel affects their tax classification, necessitating robust compliance measures. To navigate these challenges, effective solutions include understanding residential status implications, leveraging tax treaties, and engaging in strategic tax planning. Compliance with documentation requirements is essential to mitigate the risks of double taxation and optimize tax liabilities, making it crucial for RNORs to seek professional guidance in managing their unique tax situations.

Legal Framework

The Income Tax Act, 1961 delineates the criteria for determining the residential status of taxpayers, which is pivotal for assessing tax liability. Under Section 6, individuals are classified as either Resident or Non-Resident, with Residents further categorized into Ordinary Residents and Non-Ordinary Residents (NOR). An individual qualifies as a Resident if they fulfill one of two conditions: they must either spend 182 days or more in India during the relevant year, or they must have spent 60 days in India during the relevant year while also having spent 365 days or more in the preceding four years.

For RNOR’s, Section 6(6) outlines the specific conditions under which an individual may be classified as a Non-Ordinary Resident. These include: having been a Non-Resident in nine out of the ten previous years prior to the relevant year, or having stayed in India for 729 days or less during the seven years preceding the relevant year. This classification allows for certain tax exemptions, particularly in relation to income from fixed deposits, as illustrated in the case of Jayram Rajgopal Poduval vs. Assistant Commissioner Of Income, where the court ruled in favor of the taxpayer’s NOR status, thereby granting the exemption from tax on accrued interest.

To mitigate double taxation, individuals facing tax liabilities in multiple jurisdictions can utilize Double Taxation Avoidance Agreements (DTAAs). Under Sections 90 and 91 of the Income Tax Act, individuals can claim credits for taxes paid abroad on income also taxed in India, ensuring they are not subject to double taxation. This framework is essential for individuals with international income sources, providing a pathway for tax relief.

Recent amendments to the Income Tax Act, including changes introduced by the Finance Act 2023, have adjusted tax rates applicable to non-residents. Specifically, the tax rate on royalty and fees for technical services received by non-residents has been increased to 20% from the previously established 10%, effective from 1 April 2023. This shift reflects an evolving tax landscape and its implications for international operations in India.

While Section 6(5) of the Income Tax Act has remained unchanged since 1961, its practical application has become redundant due to the uniformity of previous years (PYs) introduced in 1989-90, which eliminated the possibility of different PYs for various sources of income. This persistence of outdated provisions highlights the need for legislative updates to align the law with current tax practices.

Legal Issues

• Taxation discrimination can occur when a state subjects its nationals to a more comprehensive tax liability than non-nationals, creating a disparity in treatment that is scrutinized under Article 24(1) of the Double Taxation Avoidance Agreements (DTAAs). This article prohibits discrimination based on nationality, ensuring that nationals of a Contracting State are not treated less favorably than nationals of the other Contracting State in comparable situations. However, legitimate distinctions, such as differences in tax liability or ability to pay, may justify certain tax classifications.
• For individuals classified as “Resident but not ordinarily resident” (RNOR), the taxation of employment income is determined under the provisions of the DTAAs. Generally, salaries and wages are taxed in the country of residence unless the employee is present in the source jurisdiction for more than 183 days within a tax year or if the employer is a resident of the source jurisdiction. This framework aims to prevent double taxation and ensures that individuals are taxed fairly based on their residency status.
• The determination of residential status is heavily reliant on the counting of days spent in India. According to section 6 of the Income Tax Act, the physical presence of an individual is assessed to establish residency, with specific guidelines on how to calculate days of stay. Notably, the first day of arrival in India is excluded from the counting, as established by legal precedents such as the Manoj Kumar Reddy case. This exclusion is crucial for accurately determining an individual’s residential status and subsequent tax obligations.
• Despite the provisions aimed at preventing double taxation, situations may arise where individuals find themselves liable for taxes in both India and their country of residence. The OECD guidelines and various domestic laws suggest that there should not be a possibility of double taxation for the assessment year 2020-21 under the applicable DTAAs. However, the Central Board of Direct Taxes (CBDT) is advised to collect relevant information from individuals experiencing potential double taxation due to prolonged stays in India and to consider any necessary relaxations or exemptions on a case-by-case basis.
• Taxation must be consistent for both nationals and foreigners under similar circum-stances. This consistency encompasses the basis of charge, method of assessment, and compliance formalities, ensuring that no additional burdens are placed on non-nationals. This principle supports the broader goal of fairness and equity in taxation, irrespective of an individual’s nationality.

Solutions

1. Determining the residential status of taxpayers is crucial, especially for those classified as Resident but Not Ordinarily Resident (RNOR) in India. The distinction impacts tax liabilities significantly, as non-residents are taxed differently than residents, withspecific provisions applicable to each status. An individual is deemed a resident in India if their total income (excluding foreign sources) exceeds 15 lakh and they are not liable to tax in any other country.
2. To address taxation issues for RNORs, it’s essential to ascertain the Place of Effective Management (POEM). The POEM is determined by identifying who makes key management decisions and where these decisions are made. It is the substance of these management decisions that is conclusive, rather than merely the formalities surrounding their implementation. Companies should ensure that the Board retains authority and makes substantial decisions necessary for business operations.
3. RNORs can benefit from tax treaties with various countries, such as the UK, Canada, and the USA, which may provide lower tax rates—typically around 15%—compared to the domestic rates. Utilizing these treaties allows for reduced tax burdens, although it necessitates compliance measures such as obtaining tax registrations and filing income tax returns in India. Non-residents should thus carefully evaluate their eligibility for treaty benefits to optimize tax liabilities.
4. With increased tax rates on royalties and fees for technical services (FTS) for non-residents, compliance becomes even more critical. Non-residents are required to file tax returns and submit documentation like Form 10F to claim treaty benefits. This increased layer of compliance underscores the need for effective tax planning strategies, ensuring that taxpayers are not only compliant but also aware of potential tax liabilities.
5. It is advisable for RNORs to engage in tailored tax planning strategies to navigate the complexities of Indian tax laws. This includes understanding the implications of opting in or out of presumptive tax schemes, which can affect the ability to set off losses against profits in subsequent years.

Jayram Rajgopal Poduval vs Assistant Commissioner of Income

The Mumbai Bench of ITAT emphasized the requirements for claiming non-ordinary resident status. The taxpayer sought this status to gain exemption on interest accrued from fixed deposits. The court ruled that an individual must satisfy specific conditions under both sections 6(1) and 6(6) to qualify as RNOR. This case illustrates the meticulousness required in meeting legal criteria for tax benefits.