Introduction
India’s tax system operates primarily based on an individual’s or company’s residency status. Understanding these rules is crucial for anyone earning income within or from India. This guide will demystify the concepts of tax residency, explaining how it impacts your tax liability and what criteria are used to determine your status.
The Indian financial year runs from April 1st to March 31st of the following year. Your tax obligations are directly linked to your residential status during this period.
Understanding Residence-Based Taxation
In a residence-based tax system, residents are typically taxed on their global income – that is, income earned both within India and from sources abroad. Conversely, non-residents are only taxed on the income they generate from within India. This distinction is fundamental to Indian tax law. For detailed information, you can refer to the official Income Tax Department portal.
Tax Residency for Individuals
The Income Tax Act in India lays down specific rules for determining an individual’s tax residency. Your status as an ‘Ordinarily Resident’ (ROR), ‘Resident but Not Ordinarily Resident’ (RNOR), or ‘Non-Resident’ (NR) depends largely on the duration of your stay in India during a financial year and preceding years.
1. Ordinarily Resident (ROR)
Generally, an individual is considered an Indian resident if they stay in India for 182 days or more during the financial year. However, there are some specific scenarios to consider:
| S. No. | Type of Individual | Total Income from Indian Sources | Period of Stay in India |
| 1 | Indian Citizen or Person of Indian Origin | Less than INR 1.5 million during the tax year | 182 days or more during the tax year |
| 2 | Indian Citizen or Person of Indian Origin | INR 1.5 million or more during the tax year | 182 days or more during the tax year; OR 120 days or more during the tax year AND 365 days or more in the preceding 4 financial years |
| 3 | Individual who is not an Indian Citizen or Person of Indian Origin | Not applicable | 182 days or more during the tax year; OR 60 days or more during the tax year AND 365 days or more in the preceding 4 financial years |
2. Resident but Not Ordinarily Resident (RNOR)
An individual is classified as ‘Resident but Not Ordinarily Resident’ if they meet certain residency conditions but also fulfill specific criteria related to their past residency. This status provides some tax relief compared to being an ‘Ordinarily Resident’. Here’s when an individual might be treated as an RNOR:
- You have been a Non-Resident in India for at least 9 out of the 10 financial years immediately preceding the current tax year.
- Your total stay in India has been 729 days or less in the 7 financial years immediately preceding the current tax year.
- You are an Indian citizen or a person of Indian origin with Indian-sourced income (excluding foreign income) exceeding INR 1.5 million during the tax year, and you have been in India for 120 days or more but less than 182 days.
- You are an Indian citizen with Indian-sourced income (excluding foreign income) exceeding INR 1.5 million during the tax year, and you are not liable to pay tax in any other country due to your domicile, residence, or any similar reason. This is often referred to as “deemed resident” status.
An RNOR is typically taxed in India on income received in India, income that arises or accrues in India, and income arising outside India if it is from a business controlled from India. This means their foreign income, unless connected to a business controlled from India, might not be taxed in India.
3. Non-Resident (NR)
Individuals who do not satisfy any of the conditions for being an ‘Ordinarily Resident’ or ‘Resident but Not Ordinarily Resident’ are classified as ‘Non-Residents’. A Non-Resident is only taxed in India on income that is received in India or income that accrues or arises in India. This typically includes salaries for work performed in India, rental income from Indian property, or capital gains from the sale of assets located in India.
Special Considerations and Dual Residency
The rule of staying in India for more than 182 days to be deemed a resident has, at times, led to individuals facing tax liabilities in multiple countries. This can be complex. In cases of dual residency, where an individual might be considered a tax resident in two different countries, Double Taxation Avoidance Agreements (DTAAs) come into play. India has DTAAs with numerous countries to prevent taxpayers from being taxed twice on the same income. These agreements often include “tie-breaker rules” to determine which country has the primary taxing rights.
Tax Residency for Corporations
For companies, determining tax residency in India follows a different set of criteria. A corporation is considered a resident in India if it is legally incorporated in India or if its “Place of Effective Management” (POEM) is situated entirely within India.
A resident company, regardless of its ownership (Indian or foreign), is taxed on its worldwide income. However, non-resident companies are typically taxed only on income derived from a “business connection” in India or from other Indian sources, or through a “Permanent Establishment” as defined in the relevant tax treaties.
1. Place of Effective Management (POEM)
The concept of POEM is internationally recognized and aims to identify the true location where the core management and commercial decisions of a business are made. A company registered outside India but whose key management and commercial decisions are substantially made in India will be considered a resident in India for tax purposes. This is a “substance over form” test, meaning that merely holding formal board meetings outside India might not be enough if the real decisions are made in India.
2. Permanent Establishment (PE)
A foreign company can be deemed to have a “Permanent Establishment” in India if it has a fixed place of business in India or conducts business through specific activities within the country. This can include:
- A place of management, branch, office, factory, workshop, or warehouse.
- A building site, construction, installation, or assembly project, or related supervisory activities, if they continue for more than 180 days.
- Furnishing services for a period exceeding 180 days.
- An agent (who is not genuinely independent) who habitually concludes contracts, regularly delivers goods, or consistently secures orders on behalf of the foreign company in India.
If a foreign company is determined to have a Permanent Establishment in India, the business income directly attributable to the operations carried out through that PE will be taxable in India.
Exceptions and Recent Developments
There are specific exceptions and interpretations regarding what constitutes a PE, especially in the context of evolving work environments:
- Home Office Permanent Establishment: If employees work from home in a jurisdiction different from their company’s usual place of business, it could potentially create a PE. The key tests are “degree of permanency” and whether the home office is “at the employer’s disposal.” Guidelines, such as those from the OECD (Organisation for Economic Co-operation and Development), have clarified that working from home due to extraordinary events like public health crises (e.g., COVID-19 lockdowns) generally does not create a PE due to a lack of permanency and being outside the employer’s direct disposal. However, if such arrangements become long-term after restrictions are lifted, a home office could be considered a PE.
- Agency Permanent Establishment: An agent working from home on behalf of a company could create an agency PE if they habitually conclude contracts for the enterprise. Similar to home office PEs, temporary work-from-home arrangements during public health emergencies are less likely to be considered “habitual.”
- Construction Permanent Establishment: A construction site typically creates a PE if it continues for more than twelve months. Temporary interruptions due to weather are usually included in the duration. However, periods where construction is prevented by government-imposed public health measures might be excluded from this threshold. The specific approach can vary across different tax jurisdictions.
FAQs
Q1: Does my citizenship affect my tax residency in India?
No, your tax residency in India is determined by your physical stay and other criteria, not by your citizenship. An Indian citizen can be a non-resident for tax purposes, and a foreign citizen can be a resident.
Q2: What is the primary difference in taxation for a Resident vs. a Non-Resident?
A Resident (Ordinarily Resident) is taxed on their global income (income from India and abroad), while a Non-Resident is only taxed on income earned or accrued in India.
Q3: How does a Double Taxation Avoidance Agreement (DTAA) help?
DTAAs are agreements between India and other countries to prevent individuals and companies from being taxed twice on the same income. They provide clarity on which country has the primary right to tax certain types of income and often include tie-breaker rules for dual residency situations.
Q4: What is POEM in simple terms?
POEM, or Place of Effective Management, is where the most important decisions about a company’s business are actually made. Even if a company is registered elsewhere, if its key decisions are made in India, it can be considered an Indian tax resident.
Q5: Can working from home lead to a Permanent Establishment for a foreign company?
Generally, temporary work-from-home arrangements, especially those due to extraordinary circumstances like pandemics, are less likely to create a PE. However, if an employee’s home office becomes a permanent and habitual place of business at the company’s disposal, it could potentially lead to a PE.
Conclusion
While the rules can be intricate, particularly with the nuances of Ordinarily Resident, Resident but Not Ordinarily Resident, POEM, and PE, the core principle remains consistent. India primarily taxes residents on their global income and non-residents on their Indian-sourced income. Always remember that tax laws are dynamic, and it’s advisable to consult with a qualified tax professional for personalized guidance based on your specific circumstances.