Residency test under taxation treaty
Imagine this. You are an Indian working for an information technology (IT) company and have been recently transferred to Singapore.
Six months into the job, you are gripped by a niggling doubt: Will I be a resident of Singapore or India, and in which country will my income get taxed? Or will I be asked to pay taxes in both countries?
It’s a pertinent question for employees who travel frequently and work in cross-border locations as they may sometimes face a situation of “dual tax residency” i.e. acquiring tax residency of two countries simultaneously in a particular tax year and, accordingly, becoming liable to pay taxes in both countries on their income.
To provide relief to such employees, India has entered into Double Taxation Avoidance Agreements (or treaties) with several countries. The individual who wishes to take relief under the treaties has to qualify as a tax resident of one of the contracting states.
Most tax treaties have stipulated residency rules/tie-breaker tests for resolving the conflict of dual residency. Residency tests are special rules whereby preference of residency can be established in one state over the other state. These have been discussed under Article 4 of the relevant tax treaties.
On an analysis of Article 4 of the relevant treaty, the following tests have to be conducted to determine the ultimate tax residency of an individual:
— The first test to establish ultimate residency is to determine the permanent home.
Under this test, an individual would qualify as a resident of the country where he has a permanent home available to him. A permanent home in a literal sense would not mean owning a house. Any form of home, including a rented apartment or rented room which brings some degree of permanence at all times continuously can be considered as permanent home.
It should be noted that a parental home or a home rented in someone else’s name, even if available to the individual in which he does not have any ownership, is not considered as a permanent home available to him.
It may so happen that an individual may have a permanent home in two states (in India on account of family stay and in Singapore by virtue of employment). In such cases, the next test needs to be analysed.
— The second test is identifying the centre of vital interest.
Under this test, an individual would be a resident of the country where he has retained his personal and economic ties. That is where the individual’s family, social relations, investments, occupation, political and cultural activities are closer. These circumstances need to be examined in totality. In case social and economic interests are split between two states or are undeterminable, the subsequent test applies.
— The third test is determining the habitual abode.
Under this test, an individual would tie-break his residency to the country in which he has a habitual abode i.e. the place where he has stayed for a longer duration or the country he would like to stay after completion of the deputation.
For example, an Indian origin person working and living overseas comes on an assignment to India. In such a scenario, typically he would have permanent home and centre of vital interest in both countries. Then, habitual abode could be the basis for deciding the residency. However, if nothing can be concluded under this test, i.e. habitual abode is determined to be in both the states or neither of the states, the following test is done.
— The fourth test is nationality.
When the residency cannot be determined by any of the above tests, the next step is to determine an individual’s nationality. In case the individual is a national of both the countries or neither of the countries, the competent authorities of India and the other country shall endeavour to settle the question by mutual agreement.
As it is evident from above, the tests would resolve the conflict relating to an individual’s ultimate residency and tie-break in favour of one of the two countries. In a few countries like Japan, such detailed test analysis for concluding ultimate residency is not available. If an individual is a resident of Japan, the residency would be settled by a mutual agreement between the competent authorities.
When could a foreign national on secondment to India encounter a situation of dual residency?
Residential status in India is determined on the basis of the number of days of physical presence of an individual in India during a particular fiscal year (1 April to 31 March). Generally, an individual arriving in India for the first time is likely to qualify as non-resident/not ordinarily resident for the first three fiscal years. In the fourth year of assignment, an individual qualifies as Resident and Ordinarily Resident (ROR) for that particular FY, provided he stays in India for 182 days or more in an FY (or for 60 days or more in an FY coupled with a stay of 365 days or more in the previous four FYs) and more than 729 days in India in the previous seven years.
Hence, in the fourth year of assignment i.e., when an individual qualifies as ROR in India, a situation of dual residency can be encountered as most foreign nationals on secondment to India would also qualify as resident of their home country on account of their nationality/citizenship.
Are the tests under residency rules to be satisfied sequentially or could any other test be applied first?
In order to determine the country of ultimate residency, the residency rules/tie-breaker test have to be evaluated in a sequential order. The first condition is to determine the permanent home. If undetermined, then the next is social and economic interests i.e., centre of vital interest. If this is also unsettled, then the next is the country where the person is normally living i.e., habitual abode. If still undecided, the nationality of the individual needs to be applied.
If unresolved, the final test is to determine residency based on mutual agreement by competent authorities. Accordingly, the test needs to be examined at each stage.
In case of dual residency situation, why is it necessary to determine the country of ultimate residence?
It is necessary to determine the country of ultimate residency as this has a direct impact on taxability of the income. Generally, a person is subject to tax on global income in the resident country. Further, where the income is doubly taxed, the benefit of avoiding double taxation i.e., either by credit method or exemption method, can be claimed in the country of ultimate residency.
Akhil Chandna contributed to this article.
Vikas Vasal is national leader-tax at Grant Thornton India LLP
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