The Institute of Chartered Accountants of India

Page No. 1

Webcast

by

The Institute of Chartered Accountants of India

Presentation on

The Concept of “Residence”

in International Taxation

26th April, 2013.

By

CA Rashmin Sanghvi.

CA Naresh Ajwani.

CA Rutvik Sanghvi.

This paper formed the background for Webcast by the Authors on the same subject on 26th April 2013. The webcast can be viewed at http://icaitv.com/?p=2085

Contents Page

I. Preface:

1. International Tax is not a complicated subject. In fact, for an Indian CA, no financial/commercial law in the world is beyond his comprehension. Still we sometimes find it difficult to practice in International Taxation. Some of the reasons may be:

(i) During our Articleship, we may not have had good exposure on International Taxation.

(ii) In our syllabus for CA Examinations, very little is covered on International Taxation.

(iii) The concepts relevant for International Taxation have not been explained to us. They are quite different from the concepts that we use in traditional taxation.

Let us consider those issues in this session.

2. International Tax is not an independent practice by itself. One has to be a master of the Indian Income-tax. Then only he can be a good practitioner on International Tax. Within Indian tax – sections 4, 5, 6 and 9; 90 & 91, 195 & 201 are normally not used in our domestic tax practice. We have to again refresh our knowledge of these sections.

3. Indian Income-Tax involves only the Government of India and the assessee. If there is a difference of opinion, either party can appeal to the appropriate Indian Court of Law. International Tax involves two or more countries and their assesses. And if there is a difference of opinion between the two Governments, to which court do they appeal! Well, Governments don’t appeal. The assessee suffers.

4. International Tax practice involves FEMA, Vienna Convention, Double Tax Avoidance Agreement (DTA), Transfer Pricing and E-Commerce. These issues are not relevant for domestic tax practice. (Now of course Transfer Pricing is applicable in domestic tax practice also.) Hence one needs to study these provisions for International Tax Practice.

Not a big deal. All these provisions together will be less than 10% of the syllabus that we study for final C.A. examination. We have studied more. This we can study.

5. There is a myth that International Tax is involved only in big matters like foreign collaborations. And only big firms can practise it. Far from it. Today so many individuals go abroad for employment or own business. Many NRIs return to India. So many businessmen make payments to non-residents where tax has to be deducted at source. Today residential houses are available in many countries at prices lower than the prices prevalent in Bangalore.

All students whether from Manipur, Rajkot or Trivendrum – give the same CA exams. All CAs are equally competent to do International tax practice. Only issues that separate CAs from metro cities is: they have more exposure and they can attend more conferences on international taxation. This webcast is a serious attempt to reduce this difference between opportunities to study.

International Tax Practice – is not reserved only for the “Big” CAs. Any CA/ advocate can practise it. And needs to practise.

6. In this presentation, let us discuss the concept of Residence from different angles:

Residence under Indian Income-tax Act.

Residence under the Double Tax Avoidance Treaty (DTA).

Relationship between the two concepts – under domestic law and under DTA.

Tax controversies under DTA arising out of Residence.

These different aspects have been discussed at length in this paper. They are not necessarily in the same order.

Note: Participants for this presentation would not have read this paper before our presentation. However, this will serve as a reference material after the presentation is over.

Note: In this presentation we are referring to the Indian Income-tax Act. As far as International taxation principles & issues are concerned, the same are applicable to almost all countries.

7. Indian Direct Tax System

Indian Tax System is one of the BEST in the world - from the assessee’s point of view.

7.1 It is good for the wealthy.

We have no Estate Duty, no Gift tax; (except as an anti-avoidance measure - S. 56). Almost negligible wealth-tax; and Reasonable rates of Income-tax. In the U.S., individuals in the highest tax brackets want to give up U.S. citizenship to avoid estate duty that can reach 40%. They cannot give up.

7.2 With a reasonable rate structure, a large part of tax planning has become redundant on – “Cost – Benefit” analysis. This has simplified life for the businessman.

7.3 Our rate structure is good for the poor. Our average per capita income per year is more than Rs. 80,000 at current prices (Economic Survey –Feb. 2013). As against this, income upto Rs. 2,00,000 per year is exempt from tax (assessment Year – 2013-14). 2.5 times the average income. Many nations around the world have lowest tax brackets starting at or below the average per capita income.

7.4 It is good for the middle class people. Upto an income of Rs. 5,00,000 per year the tax payable is only Rs. 26,000 or 5.2%. This calculation is without considering Chapter VIA reliefs.

When we know that we are better than other countries, we deal international tax with confidence.

8. Some of the important concepts in International Taxation are listed below. In this presentation, we will focus on the Concept of Residence. Other concepts will be considered very briefly and if relevant to Residence.

9. Concepts of International Taxation.

Considered in this Presentation:

9.1 Structure of Treaty.

9.2 Residence. For Individuals.

For companies. Registered Office.

For Others.

9.3 Residence under Income-tax Act distinguished from

Residence under the Treaty.

9.4 Nexus or Connecting Factors: Jurisdiction.

9.5 Elimination of Double Tax.

Not Considered in this Presentation:

9.6 Tax Base.

How Tax havens erode tax base.

9.7 Source of Income – Concept.

9.8 Categorisation of Income.

9.9 Permanent Establishment.

9.10 Allocation of taxing rights.

9.11 Elimination of Double Tax.

9.12 Vienna Convention

9.13 OECD Model & Commentary.

9.14 UN Model & Commentary.

9.15 Indian Competent Authority’s reservations on both commentaries.

There will be different sessions in this series of webcast by the ICAI covering different concepts.

Preface Completed

Next: Main Presentation

Main Presentation

1. Structure of DTA:

To understand the real significance of the Concept of Residence, it is necessary to understand the structure of Double Tax Avoidance Treaty. Very briefly, in this paragraph, we cover the structure of the treaty.

Article 1 of the Treaty specifies: “who is entitled to the treaty benefit”. Any person wanting to claim the benefit of a DTA must be a resident of any one or both of the countries that have signed the treaty. Hence the concept of residence becomes important to understand – right from the beginning.

Article 2 provides the list of taxes that are covered under the treaty. Only the Income-tax & wealth are covered. Municipal Taxes, Indirect taxes etc. are not covered. India does not impose Estate Duty. Many countries around the world do impose estate duty. Wherever estate duty is to be covered, a separate treaty is signed by the Governments.

Articles 3 to 5 provide for different “Definitions”. Article 4 provides for the “Definition” of Resident. Articles 6 to 22 provide for Categorisation of Income. Article 23 provides for Elimination of Double Taxation. Articles 24 to 31 cover other important issues.

Note: The article numbers given above are as per OECD Model Treaty. Different models and different treaties may have some variations in the numbers. Broadly the numbers remain the same.

2. Connecting Factors: Jurisdiction

How does a country get jurisdiction to levy Income-tax? When we practice the domestic law for regular clients resident in India, we never examine the issue of jurisdiction. All Indian residents are liable to tax in India on their global income. Hence when an Indian resident earns any income - whether from within India or outside India; we take it for granted that the assessee is liable to tax.

The moment there is a cross border income, the issue of jurisdiction arises. It may be interesting to note that almost 40% of the tax litigation is on the concept of jurisdiction to tax, another 40% of the litigation is on the concept of categorisation of income. Jurisdiction to tax is determined by two factors:

(i) Residence of the Assessee; and

(ii) Source of Income.

In international taxation these factors are referred to as “Connecting Factors” or “Nexus”.

It is an internationally accepted principle that when an assessee is resident of a country, the Government of that country has the jurisdiction to tax the global income of that assessee. Connecting factor of “Residence” is applied to the assessee.

It is also accepted that if the income is “Sourced” in a country, then the Government of that country has jurisdiction to tax that income. Connecting factor of “Source” is applied to the income.

These principles of jurisdiction may be stated in different manners: When a person is resident of India and has his income sourced in India, without any doubt the income is taxable in India. When the assessee is a non-resident of India, and the income is sourced outside India, then the income is certainly not taxable in India. India has no jurisdiction to tax such income. This issue was the bone of contention in Vodafone case.

When a non-resident of India has income sourced in India, then Indian Government has the jurisdiction to levy full tax on the income sourced in India. However, wherever India has signed a Double Tax Avoidance Agreement (DTA) with the Country of Residence (COR) of the assessee, India may levy a lower tax than the normal tax. What rate to levy will depend upon the category of income – Articles 6 to 22.

When an Indian resident earns income sourced outside India, then the Country of Source of Income (COS) may levy lower than normal tax. India as the COR will levy full tax. And from the Indian full tax, India will give credit for the taxes paid abroad. This is how the Governments try to eliminate double taxation. And this is how the two concepts of Residence and Source become important.

This may be illustrated as under: Mr. Patel is an Indian resident. He earns Rs. 10,000 as interest income from UK. We assume that the rate of Income-tax in India is 30% and in UK also it is 30%.

Total tax suffered by Mr. Patel remains Rs. 3,000. Double tax is avoided by the “Credit mechanism”.

3. Residence:

Article 4 of the DTA provides that for the purposes of DTA, the assessee will be considered to be resident of a country, if he is resident of that country as per the domestic Income-tax Act. Hence let us first consider Indian domestic law. Language of Article 4 is complex. It tries to use a common language that can be applied to the tax laws of several countries. We are trying to explain the reason of complexity. Then simplify & explain the provision:

3.1 Residence under Domestic Law:

How do we determine the residential status of an assessee? In India, section 6 of the Income-tax Act provides for the definition of residential status of different categories of persons. Similarly, every Government will have its own legislation providing for its own definition of residential status. There can be very wide differences amongst different definitions. For example, consider an individual. Section 6 of the Indian Income-tax Act, provides for physical stay of the individual. If the individual is physically present in India for the specified number of days, then he is an Indian resident. If he is present less than the specified number of days, then he is a non-resident of India. Very simple definition.

However, the US Internal Revenue Code (IRC) provides as under: Every citizen of USA is tax resident of USA. Even a Green Card holder is a tax resident of USA. This would be true even if the assessee has left USA for a job/ business abroad for many years.

In United Kingdom (UK), the concept of residential status is highly complex. Consider Mr. U, a resident & citizen of UK. He goes abroad for job and stays abroad for five years. On vacation he visits his parents in UK. He continues to own a home, bank account and investments in UK. These may be considered adequate connections to decide that he continues to be a Resident of UK.