Residential Status & Tax Incidence | UGC NET Commerce Preparation Course PDF Download

Residential Status and Incidence of Tax in India

Indian income is subject to taxation based on the residency status of the individual. Similarly, foreign income is taxable in India only for residents. Understanding the taxation rules is crucial for determining tax obligations. The rules differ for citizens and residents of India, making it essential to establish residential status for tax purposes. Income tax serves as a significant revenue source for the government, with taxpayers required to adhere to regulations and file returns. Residential or citizenship status under the Income Tax Act plays a key role in this process. Calculating taxable income across various categories is also vital.

What is Residential Status?

The concept of residential status pertains to where a person resides. For instance, an Indian citizen can be a resident of India or any other country where they currently live. The key consideration is the individual's current place of stay in terms of residential status. Here are some essential details regarding residential status:

• The residential status holds varying interpretations within the Income Tax Act.
• It is possible for a person to be a citizen of India but not a resident. Conversely, an individual who is not a citizen can still be a resident of the country. Both these scenarios necessitate tax filing after determining one's residential status and tax liability.
• The Act establishes distinct rules for the residential status and tax implications concerning entities such as companies, Hindu Undivided Families, bodies of individuals, associations of persons, individuals, and firms.

Determining the residential status and tax incidence of a company and an individual is done on a yearly basis. An individual might be a resident in one financial year and a non-resident in the subsequent year based on their status.

Importance of Residential Status 

Residential status and incidence of tax are both vital for electronic filing of taxes. The government applies different tax regulations based on these classifications, making it crucial to understand and determine one's residential status. Let's delve into the significance of residential status in tax matters.

• Payable Income Tax: Determining your residential status is fundamental for calculating the amount of tax you owe. Individuals and businesses need to ascertain the laws governing residential status to categorize themselves correctly. Subsequently, they must evaluate their income for the financial year. Once the total income is calculated, taxpayers need to adhere to the income tax slab regulations corresponding to their residential status. These guidelines, in conjunction with residential status considerations, are instrumental in effective income tax planning.
• Tax Deductions: Understanding your residential status and tax incidence enables you to identify various tax deductions applicable to your category. By following the prescribed rules for your classification, you can determine if you qualify for any deductions. This knowledge not only reduces your tax liability but also facilitates better income tax planning, allowing you to retain more disposable income instead of channeling it towards taxes.
• Tax Exemptions: Tax exemptions refer to income sources exempt from taxation. For instance, house rent allowances received as part of a salary are considered exempt income. Different exemptions apply to different residential categories. It is imperative to ascertain your residential status and tax incidence to ascertain if you have any income sources that qualify for exemption from taxation.
• Income Tax Return: Filing income tax returns is a crucial responsibility for all taxpayers in India. The rules for filing ITR vary based on an individual's residential status, so it's important to identify this status to file returns correctly. Doing so simplifies the process for both taxpayers and the government.
  Understanding residential status and how taxes apply is key to grasping the economic impact on different taxpayer groups. To ensure accurate tax calculations, the government classifies taxpayers into different categories.

Types of Residential Status for Taxation in India 

There are different types of residential statuses in India that classify taxpayers based on their income, duration of stay in the country, and other factors. Understanding your residential status is crucial for following the correct tax rules, claiming exemptions, and deductions. Below are the different categories of residential statuses in India:

• Resident
• Resident not Ordinarily Resident (RNOR)
• Non-Resident (NR)

Resident

To be considered an Indian Resident for tax purposes, an individual must meet the following conditions:

• The person should have stayed in India for at least 182 days in the financial year.
• For senior citizens aged 60 years or above, the minimum stay requirement is reduced to 120 days.
• Individuals who have lived in India for more than 60 days but less than 182 days may still be considered residents if they have spent over 365 days in the previous four years.
• Exceptions are made for Indian citizens working abroad or crew members of Indian ships.

Type 1: An Indian citizen who departs from India for employment abroad or as part of the crew on an Indian ship.

• Such a person can be a resident only if they stay for at least 182 days in the country during the financial year.
• They stay for at least 365 days in the four preceding financial years and 182 days or more in this financial year.

Type 2: An individual who is either an Indian citizen or of Indian origin, residing abroad, but makes frequent visits to India during the financial year. 

• They must stay for at least 182 days in the country during the financial year.
• They should have stayed for at least 365 days in the four preceding financial years and at least 182 days in the current financial year.
• If an individual earns more than INR 15,00,000 in the year, the income should not include any from foreign sources.

Deemed Resident Status

Deemed resident status can apply to individuals who meet specific conditions:

• If they are not liable for income tax payments in any other country.
• The concept of "Deemed Resident" was introduced in 2020, amending the Income Tax Act, 1961. It outlines conditions under which a non-resident may be deemed a resident of India for a particular financial year.
• Deemed residency applies if they earn an income exceeding INR 15,00,000 in the financial year, excluding any foreign account sources.
• Non-taxability in other countries may be due to the person's domicile or residency.

Residential Status for Entities

Residential status in Indian taxation also extends to entities such as companies, firms, and other assessable entities, each with unique considerations:
Residential status and tax implications vary for corporations, firms, etc., which do not fall under the individual taxpayer category.

• Hindu Undivided Families: Hindu Undivided Families are considered residents unless the management and control of the company are located outside India.
• Firms or Other Associations: Firms or other associations are considered residents unless the management and control of the company are situated outside India.
• Company: A company must either be Indian or have its management and control decisions made in India during the financial year to be considered a resident entity.

Resident Not Ordinarily Resident (RNOR)

In the realm of Indian taxation, the term "Resident Not Ordinarily Resident" (RNOR) is a classification that specifically applies to individuals as outlined in the Income Tax Act of 1961. This designation is relevant to individuals who qualify as residents of India but do not meet the criteria to be categorized as "Ordinarily Resident."
The distinction between residential statuses and tax implications also encompasses residents who are not ordinarily resident. To determine whether an individual is an RNOR or an ordinary resident, they need to satisfy specific conditions to be classified as an RNOR:

Residential Status in India

• Individual: They are considered a non-resident if they have been outside India for nine out of the previous ten financial years, or if they have spent 729 days or less in India over the preceding seven financial years.
• Hindu Undivided Family (HUF Karta or manager): If the HUF Karta or manager has been a non-resident for nine out of the last ten financial years, or if they have stayed in India for 729 days or less in the preceding seven financial years, they are considered a non-resident.
• Indian Citizen or an individual of Indian origin: Individuals in this category are considered residents if their total annual income exceeds ₹15,00,000, excluding foreign sources, and if they have stayed in India for 129-182 days in the current financial year.
• Indian Citizens: Indian citizens are deemed residents of India.

Relationship Between Residential Status and Incidence of Tax

This table below illustrates how residential status impacts tax obligations, rates, filing requirements, and benefits under tax treaties, showcasing the significant influence of residency on the taxation incidence in different regions.

Determination of Residential Status and its Effects on Tax Incidence 

Determining residential status and its effects on tax incidence vary across countries, but generally follow similar principles. Here's a breakdown of how residential status is determined and its effects on tax:

Determination of Residential Status

The determination of residential status is crucial in understanding tax obligations. Here are the key factors that determine residential status:

Effects of Residential Status on Tax Incidence

Residential status can significantly impact tax obligations. Here are some effects:

• Residential Status Determination: Countries utilize various criteria like physical presence, having a permanent home, economic ties, intentions, and legal status to ascertain if an individual or entity is a resident for tax purposes.
• Taxable Income: Residents are generally taxed on their global income, while non-residents are usually taxed solely on income earned within the country's borders.
• Tax Rates: Residents commonly encounter progressive tax rates, meaning that tax rates increase as income levels rise. In contrast, non-residents may face flat or higher tax rates specifically on local income.
• Tax Credits and Deductions: Residents typically have access to claiming all available tax credits and deductions to lower their tax burden. Conversely, non-residents have restricted eligibility for these benefits, potentially leading to higher effective tax rates.
• Double Taxation Treaties: Residents benefit from tax treaties that help prevent double taxation on income earned abroad. Non-residents, on the other hand, have limited treaty advantages and might encounter double taxation if their income is taxed both in their home country and where it was earned.
• Filing Obligations: Residents are mandated to submit annual tax returns, disclosing worldwide income. Non-residents typically only file returns for income earned within the country, simplifying their reporting obligations.
• Social Security Contributions: Residents typically contribute to local social security systems, while non-residents might have minimal or no obligations depending on the regulations of the country.

Conclusion 

Residential status and the occurrence of tax implications are fundamental concepts crucial for grasping the basics of taxation. Understanding these aspects is imperative for assessing one's tax obligations accurately and enhancing overall income tax comprehension, which is pivotal for effective financial management. Determining residential status and tax implications aids individuals in categorizing themselves as residents or non-residents for a given financial year. It is essential to adhere to the corresponding regulations to fulfill tax obligations and contribute to the nation's progress.