Basic Concepts and Residential Status

Weightage: Chapters 1 and 2 of ICAI's Paper 3 Section A, together roughly 8 marks. Short and foundational — every later chapter assumes this vocabulary without re-explaining it.

Why residential status comes before everything else

Before computing a single rupee of income, one question must be settled: whose income, earned where, is taxable in India at all?

A resident is taxed differently from a non-resident — most importantly, on a different scope of income altogether. Get the residential status wrong and every subsequent computation, however careful, answers a question that was never actually asked. This is why residential status is Chapter 2 of the syllabus and not an afterthought.

Basic concepts

Assessee

Assessee means a person by whom any tax or any other sum of money is payable under the Act, and includes: every person in respect of whom any proceeding has been taken for the assessment of his income, of the income of any other person for whom he is assessable, or of the loss sustained by him or by such other person, or the amount of refund due to him or to such other person; a person who is deemed to be an assessee under any provision of the Act; and a person who is deemed to be an assessee in default under any provision of the Act.

The third limb matters more than it looks: a person who has failed to deduct tax at source, for instance, is deemed an assessee in default even though the tax was never his own income, and the definition catches him.

Previous year and assessment year

Previous year is the financial year immediately preceding the assessment year, running 1 April to 31 March. It is the year in which income is earned.

Assessment year is the period of twelve months commencing on the 1st day of April every year, immediately following the previous year, being the year in which that income is assessed and taxed.

The rule is that income of the previous year is taxed in the assessment year, at the rates applicable for that assessment year — not the rates in force when the income was earned. There are specific exceptions where income of the previous year is assessed in the same year it is earned, called cases of accelerated assessment, covering situations such as income of a person leaving India permanently, income of a discontinued business, and income of an association of persons or body of individuals formed for a particular event likely to be dissolved in the same year.

Person

Section 2(31) defines person to include: an individual; a Hindu undivided family; a company; a firm; an association of persons or a body of individuals, whether incorporated or not; a local authority; and every artificial juridical person not falling within any of the preceding categories.

Association of persons and body of individuals are distinguished in practice by whether the members combine to earn income together with a common purpose and volition (association of persons, which can include non-individual members) as against a looser grouping without that combining intention (body of individuals, confined to individuals).

Income

Income is defined inclusively rather than exhaustively, and the inclusive list is worth knowing because it extends the ordinary meaning of "income" considerably: profits and gains; dividend; voluntary contributions received by certain trusts and institutions; the value of any perquisite or profit in lieu of salary; any capital gains; profits of certain insurance business; income from winnings from lotteries, crossword puzzles, races, card games and other games of any sort, gambling or betting; deemed income under sections dealing with cash credits, unexplained investments and similar provisions; and any sum received under a keyman insurance policy.

Charge of income-tax — section 4

Income-tax is charged for any assessment year at the rates prescribed by the relevant Finance Act, in respect of the total income of the previous year of every person, subject to and in accordance with the provisions of the Act. Section 4 is the charging section, and its structure — a fixed statutory framework (the Act) combined with an annually varying rate schedule (the Finance Act) — is why rates change every year while the computational rules generally do not.

Residential status

Why it exists as a separate test from citizenship or nationality

Indian tax law does not tax on the basis of citizenship. An Indian citizen who has been outside India for years may be a non-resident and taxed accordingly; a foreign citizen who has spent most of the year in India may be resident and taxed on a wider scope of income. Residential status is determined afresh for every previous year, based on physical presence and specified conditions, and it can change from year to year for the same person.

Residential status of an individual — section 6(1)

An individual is resident in India in a previous year if either of two basic conditions is satisfied:

• he is in India for a period or periods amounting in all to 182 days or more in that previous year; or
• he is in India for 60 days or more in that previous year and for 365 days or more in the four years immediately preceding that previous year.

If neither condition is satisfied, he is a non-resident.

The exceptions that relax the 60-day condition to 182 days

Two categories of individuals get relief from the shorter 60-day limb, so that only the 182-day condition can make them resident:

An Indian citizen who leaves India during the previous year for the purposes of employment outside India, or as a member of the crew of an Indian ship — for such a person, the 60-day condition is replaced by 182 days.

An Indian citizen or a person of Indian origin who, being outside India, comes on a visit to India during the previous year — for such a person too, the 60-day condition is ordinarily replaced by 182 days, subject to a further condition explained below.

The high-income visiting-citizen refinement

Where an Indian citizen or person of Indian origin, being outside India, comes on a visit to India in the previous year, and his total income, other than income from foreign sources, exceeds ₹15 lakh during the previous year, the relaxed 182-day figure is itself narrowed to 120 days — that is, such a person becomes resident if present in India for 120 days or more in the previous year and 365 days or more in the preceding four years.

Deemed residency for high-income individuals with no tax liability anywhere. An Indian citizen having total income, other than income from foreign sources, exceeding ₹15 lakh during the previous year, is deemed to be resident in India in that previous year if he is not liable to tax in any other country or territory by reason of his domicile or residence or any other criterion of similar nature. This provision exists to prevent a person from arranging affairs so as to be resident nowhere at all and therefore taxed nowhere.

Resident and ordinarily resident, and resident but not ordinarily resident

Once an individual is found to be resident under section 6(1), a further question determines the scope of income taxable: is he resident and ordinarily resident (ROR), or resident but not ordinarily resident (RNOR)?

An individual is resident and ordinarily resident if he satisfies both of two additional conditions:

• he has been resident in India in at least 2 out of the 10 previous years immediately preceding the relevant previous year; and
• he has been in India for a period or periods amounting in all to 730 days or more during the 7 years immediately preceding the relevant previous year.

If either additional condition is not satisfied, the individual, though resident, is resident but not ordinarily resident.

RNOR status also attaches automatically to certain categories regardless of the two additional conditions: an individual who has been a non-resident in India in 9 out of the 10 previous years preceding that year, or who has been in India for 729 days or less during the 7 years preceding that year; and, under the deeming provisions, an Indian citizen deemed resident under the high-income-nowhere-taxed provision described above is always treated as RNOR, and an Indian citizen or person of Indian origin who becomes resident under the 120-day rule described above is also always treated as RNOR.

Residential status of a HUF, firm and association of persons

A Hindu undivided family, firm or association of persons is resident in India in any previous year except where, during that year, the control and management of its affairs is situated wholly outside India. Control and management means the seat of the decision-making, the "controlling and directing power," not the location of business operations.

A resident HUF is further ordinarily resident if the karta or manager satisfies the two additional individual-level conditions (2 out of 10 years, 730 days in 7 years) described above; otherwise it is not ordinarily resident.

Residential status of a company

An Indian company is always resident in India, regardless of where its control and management is situated.

Any other company (a foreign company) is resident in India in a previous year if its place of effective management, in that year, is in India.

Place of effective management (POEM) means a place where key management and commercial decisions necessary for the conduct of the business of an entity as a whole are, in substance, made. The word "in substance" is deliberate: POEM looks past where board meetings are formally held to where the decisions are actually made, precisely to prevent a shell arrangement of holding formal meetings in a low-tax jurisdiction while real decision-making happens elsewhere.

Residential status of every other person

Every other person is resident in India in any previous year except where, during that year, the control and management of its affairs is situated wholly outside India.

Scope of total income — the consequence of residential status

This is the payoff of the whole chapter: residential status determines what income is taxable, and it is tested by three categories of income.

• Income received or deemed to be received in India, whether earned in India or elsewhere.
• Income that accrues or arises, or is deemed to accrue or arise, in India, whether received in India or elsewhere.
• Income that accrues or arises outside India.

Resident and ordinarily resident: taxable on global income — all three categories, wherever earned or received.

Resident but not ordinarily resident: taxable on the first two categories, and on income accruing outside India only if it is derived from a business controlled from India or a profession set up in India. Foreign income from other sources — a foreign salary, foreign investment income unconnected to an Indian business — is not taxed.

Non-resident: taxable only on the first two categories — income received or deemed received in India, and income accruing or deemed to accrue in India. Genuine foreign income, wherever it may have been received, is entirely outside the Indian tax net for a non-resident.

The RNOR category exists precisely as a transitional buffer: it recognises that a person returning to India after a long period abroad should not be taxed immediately on the full global scope that a lifelong resident faces, and it phases that person into full ROR taxation over time as the years of residence and days of presence accumulate.