NRI Tax Planning And Double Tax Treaty

Generally, while NRIs go abroad to pursue better career prospects, many of them do not intend to return to India, but they do leave their footprints behind in the form of ancestral (or self-acquired) property, bank deposits, shares in companies and other investments. The Income-tax Act, 1961 (Act) taxes India-sourced income in the hands of all kinds of assessees, irrespective of their residential status determined, based on their physical presence in India. Accordingly, even when they are away, they continue to be liable to tax in India, including obtaining Permanent Account Number (PAN Card), and filing annual tax returns. Additionally, while they are away from India qualifying as a resident of the country they work in or have immigrated to, becoming liable to be taxed on the same income not only in India, but also in that country. In such circumstances, depending upon his / her residential status, such an individual may be eligible to take advantage of the Double Taxation Agreement (Tax Treaty) entered by India with the relevant country, if any.

An attempt has been made to analyse the provisions relating to an NRI’s residential status under the Act, as well as, the general principles applicable for determining the residential status of the NRI under the Tax Treaty.

As per the Act, the predominant condition for qualifying as a ‘Resident’ is physical presence in India during the relevant tax year. Accordingly, once an individual breaches the threshold number of days presence in India (currently being either at least 182-days during the tax year or at least 60-days during the tax year where he / she was in India for 365-days in the immediately preceding 4-tax years), he / she qualifies as an ‘Ordinary Resident’ under the Act (liable to tax in India on their global income). This situation typically arises when the individual leaves India for the first time or in the 2nd or 3rd year of his / her return.

Individuals, who do not breach the threshold limit, qualify as ‘Non-Residents’ (liable to tax only on income received or sourced in India). Further, there is an exception in the case of persons whose stay in India exceeds the threshold number of days, wherein if their physical presence in India in the earlier years was not substantial, they qualify to become ‘Not Ordinarily Resident’ instead of ‘Resident’, and would be liable to tax in India in the like manner as a ‘Non-Resident’.

Besides, the domestic fiscal laws of other countries also have tests for determining residency in that country, which are generally based on nationality or physical presence during the relevant fiscal year. For an individual to avail the benefit under any Tax Treaty, it is essential to examine whether he / she qualifies as a Resident in a particular country, as usually, the Treaties seek to allocate the taxing rights with respect to specific types of income, as well as, method of allowing credit of taxes paid between the country of residence and the country of source.

Generally, the residency clause in most Treaties provides for determination of residential status as per the respective domestic laws. Therefore, in case the NRI qualifies to be a tax resident of only one of the two Treaty-countries, then he / she would qualify to be a resident of that country for the purposes of the Tax Treaty, as well. However, a tricky situation arises in case the NRI qualifies to be resident of both the countries and even more rarely, a non-resident in both the countries (possible in case of highly mobile personnel). In the latter case, as the NRI does not qualify to be a resident of either of the Treaty-countries under the respective domestic laws, such person may not be able to avail the benefit of the Tax Treaty, and thus would be governed by the domestic tax laws of those countries relating to residence and taxability.

Coming to the situation of dual residency, most Treaties provide for a set of rules (referred to as ‘tie-breaker rules’) to ‘break the tie’ and decide the country of residence for the purpose of interpreting the Tax Treaty. A typical set of tie-breaker rules, to be applied sequentially, are listed below:

1. Permanent Home Location

The NRI tie-breaks with the country where a permanent home (whether owned or rented) is available to him / her. However, the permanent home must have a sense of continuous availability to the person or continuous use by the person.

2. Centre of Vital Interests

In case, the NRI has a permanent home available to him / her in both the Treaty-countries, then the tie would have to be broken by resorting to his / here centre of vital interests. The vital interests of an NRI can be said to lie in the country where he / she has a place of business and / or maintains a family. If, the NRI satisfies this criterion in both (or neither of) the countries, then the country of residence is the one, in which the personal and economic interests are greater. In order to determine the centre of vital interests, the individual’s family and social relations, his / her occupations, his / her political, cultural or other activities, his / her place of business, the place from which he / she administers his / her property, etc are also to be taken into account. In a nutshell, a person’s centre of vital interests lies in the country in which he / she has greater personal and economic relations.

3. Habitual abode

If an NRI is said to have a permanent home in neither of the Treaty-countries or where his / her centre of vital interests cannot be determined, then the tie would be broken in the country where he / she habitually lives. The habitual abode of the NRI can be said to be in the country towards which he / she is inclined for the purpose of his / her business or leisure, which would be demonstrated by the length of the stay in that country.

4. Nationality

If the above-mentioned criteria does not break the tie to resolve the NRI’s residency under the Tax Treaty, the same can be determined based on his / her nationality. The nationality of the NRI (usually India, unless he / she has taken up citizenship of a different country) is to be determined as per the domestic laws of the relevant countries.

Even after applying these tie-breaker rules, a situation may arise where the issue regarding the NRI’s residential status under the Tax Treaty cannot be resolved. In such cases, the Treaty-countries can invoke the Mutual Agreement Proceedings to decide his / her residential status.

Another vexing issue i.e. direct consequence of the residential status is the availability of foreign tax credits, while paying tax in the country of residence. Typically, the country of residence gets the right to tax all income, wherever earned, and subject to the relevant Tax Treaty, the NRI would also be eligible to claim a set-off for the taxes paid in the source-country(s) while computing the tax liability in the country of residence.

Accordingly, where the residency under the Tax Treaty can be established to one of the Treaty-countries, the NRI’s final tax liability would be lower in the country of residence on account of the credit being available of the taxes paid in the source country(s). However, in a case where the NRI does not qualify to be a Resident in any of the countries, then it is very likely that he / she would have to discharge taxes on the income earned in the respective countries.

In view of the above, it is very important for NRIs to plan their presence in India during the relevant tax year, so that they are able to not only plan their residential status under the Act, but also obtain optimum advantage under the Tax Treaty.

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