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Application of Tax Treaty – Controversies on Residential Status

In the last two papers, we have discussed tax ability of Non-Residents in India as per Indian Income tax Act and the relief available under tax treaties on doubly tax income. As determination of tax and computation of relief is quite simple but interpretation of tax laws and treaty provision always add to the controversies. We shall discuss all these controversies in the forthcoming papers one by one. In the present paper, we shall discuss issues relating to Application of Tax Treaty – Controversies on Residential Status of the tax payers in tax laws and treaty provisions.

Every tax law have the provisions leading to determination of residential status of the tax payer based on his status as individual, companies and other entities. Almost all tax treaties provides that residential status of tax payer is to be determined as per his domestic tax laws of the respective Country.

Now let us discuss, some of the controversies with regard to the residential status of tax payer as arises:

  1. If an Individual is resident of both the states in the same taxing period as per the domestic tax laws of both the states, almost all tax treaties provides very effective mechanism to determine residential status of the individual tax payer based on tie-breaker rule in the tax treaty.
  2. Tie-breaker rule is play a vital role in the cases of Split Residency. To illustrate: If a US citizen after working in India for last four years went back to USA in financial year 2020-21 after his stay of more than 183 days in India during 2020-21. Any income earned by that person in USA as salary in the financial year 2020-21 may be excluded by the virtue of tie-breaker rule as otherwise being Resident and ordinary resident in the financial year 2020-21, his worldwide Income might be taxed in India.
  3. If a tax payer other than individual (Company and other entity) is resident of both the states in the same taxing period as per the domestic tax laws of both the states, tax treaties generally provides that it shall be deemed to be resident of the Country in which its ‘Place of Effective Management’ (POEM) is situated NOT based on place of registration or incorporation. However, some tax treaties also provides that if a company is resident of both Countries, then it shall be considered outside the scope of tax treaty, except for certain general article of tax treaty such as Non-discrimination (Article-26), Mutual Agreement Procedure (MAP) (Article-27 and Exchange of Information (Article-28) as in case of India-USA tax treaty or shall be decided through Mutual Agreement Procedure (MAP) between authorities of both the Countries.
  4. Sub section 4 and 5 of Section-90 of Income tax act made it very clear that the benefit of the tax treaty can be availed by the tax payer who is a resident of the Country outside India only if holds tax residency certificate (TRC) issued by tax authorities of that Country and must have requisite information and also provide self-signed Form 10F if TRC do not have requisite information.
  5. The matter of tax residency is being highly disputed due to tax avoidance through treaty abuse or treaty shopping practices by tax payers by artificially creating conduit/paper entities in the Countries where they get more tax relief which they are otherwise not entitled for.
  6. The practice of tax avoidance through treaty abuse or treaty shopping is being ring-fenced by recently implemented BEPS Action Plan through Multilateral Instrument (MLI) there by amending more than 3000 bilateral tax treaties at single stroke to include effective Limitation of Benefit (LOB) clause wherever it was absent in tax treaties.

To conclude, most of the controversies with regard the residential status of tax payers under tax treaties has been ring-fenced after implementation of MLI with most of the treaty Countries.

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

Please feel free to write for discussion on Application of Tax Treaty – Controversies on Residential Status on sanjay@dsrvindia.com or contact at: +91 9810116321

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