Concept of tax residency redefined

The canons of the Direct Tax Code (“Code”) as asserted by the Hon’ble Finance Minister Mr. Pranab Mukherjee are to modulate a stable, equitable and economically efficient tax system. In order to achieve the said objectives, the Code aims to simplify, amend and consolidate the existing direct tax legislation and also proposes to minimize the scope of litigation.

The law on residency is the keystone of any direct tax legislation as it determines the scope of income. Hence, the soundness of such a provision is imperative for the success of the Code.

The proposed Code adopts a blend of residence and source based taxation. The residence and source based taxation are being made applicable to residents (liable to be taxed on global income) and non residents (liable to be taxed only in respect of accruals and receipts in India, including deemed accruals and receipts) respectively.

Section 4(1) of the Code defines an individual to be resident, if he has resided in India for a period of one hundred and eighty two days or more in the financial year or if he has resided for a period of sixty days in the financial year in addition to being in India for a period of three hundred and sixty five days or more in the preceding four financial years. Further, the Code has done away with the further classification of residents into resident and ordinary resident and resident but not ordinarily resident.

Further, Section 4(3) of the Code provides that the company shall be resident in India in a financial year if it is an Indian company or its place of control and management, at any time in the year, is situated wholly, or partly, in India.

The Code does not provide the definition of concept of “control and management” and therefore continued reliance is required on the existing jury's-prudence on the subject. In common parlance, “control and management” means the place where the key decisions of the company are taken.

The proposed definition of residency may intricate the taxation of foreign companies in India. The existing provisions of Section 6(4) of the Income Tax Act, 1961 (“Act”) provides that a foreign company shall be considered to be resident in India, if the control and management wholly lies in India.

However, the provisions of Section 4(3) of the Code provides that a foreign company shall be treated as resident, if its control and management, wholly or partly, at any time in the year, is situated in India.

In the spate of globalization, it is not uncommon for the companies to have dual residency. The control and management of the company may lie in two or more countries at a given point of time esp. foreign company.

In consequence of this, a foreign company, whose control and management partly lies in India, may expose itself to Indian tax laws.

If one were to take recourse of benefits of the tax treaty, Article 4 of the OECD model defines resident as any person who, under the laws of that state, is liable to be taxed therein by reason of domicile, residence or place of management and other similar criterion. Further, the said Article also provides that if a person is a resident of both contracting states, then it shall be deemed to be a resident only of the state in which its place of effective management is situated.

Accordingly, the foreign company, on the basis of place of effective management outside India, may qualify as resident of other contracting state under the tax treaty. This may provide the foreign company, being resident of other contracting state, exemption from the Indian tax on certain incomes as per the provisions of the applicable tax treaty.

In such a situation, what is required to be considered is whether the tax treaty would have a preferential status over the Code.

Section 258(8) of the Code provides that in case of a conflict between the provisions of a treaty and the provisions of the Code, the one that is later in point of time shall prevail.

Therefore, whether the concession available in the tax treaty would be available or not shall be a contentious issue leading to high level of uncertainty with regard to the incidence of tax.

The author is partner, Amarchand & Mangaldas & Suresh A. Shroff & Co. All views are personal.