A Move Towards Citizenship As A Basis For Residential Status? The Marked Shift In Policy Brought About By The Finance Bill, 2020

The Finance Bill 2020 has sought to bring in a sweeping change in residential status of Individuals for the purpose of the Act. Advocate Aditya Ajgaonkar has conducted a detailed study of the proposed amendments and explained its nuances. He has argued that the proposed amendment is a harbinger of a shift in the policy of the government to move away from determining the residential status of an individual solely on basis of the individual’s stay in the country and moving towards citizenship as an emergent aspect in determining the residential status of a person

Introduction

The annual budget 2020 as reflected inthe Finance Bill 2020 that has been tabled in the Parliament by the Hon’ble Finance Minister has come and gone and has evoked considerable comment from varied sources.Amongst a slew of measures that were introduced by the said bill, the amendment made to Section 6 of the Income tax act, 1961, is perhaps significant in as much as it seems to be the harbinger of a not so subtle shift in the policy of the government to move away from determining the residential status of an individual solely on basis of the individual’s stay in the country and moving towards citizenship asan emergent aspect in determining the residential status of a person.

Considering the pivotal role that the residential status of an individual plays in determining the taxability of the said person in India, this move seems to be a precursor to a shift in the paradigm of in attempting to tax non-residents in India with the object of widening the tax base for the collection of income tax. The need for widening the tax bases has been re-iterated time and again in the last few budget speeches. Given the far-reaching implications of the amendment and the current uncertainty and confusion that the proposed amendment seems to have left in its wake, a closer look at this shift, not from the plain view of tax, but as a fundamental shift in policy is warranted. This amendment could perhaps be the first step that replaces a system of determining the residential status, based on ‘residence’ as the name itself suggests,that has withstood the test of time not only in our country but also globally with a few exceptions like the United States of America and the United Kingdom of Great Britain Scotland and Northern Ireland amongst a few select others.

Starting with the very basics, the power of taxation find the source in the Constitution of India. Article 265 of the Constitution of India provides that “no tax shall be levied or collected except by the authority of law”. The wording of the constitutional provision clearly indicates that no tax can be levied or collected in India unless specifically provided for by express legislation. The Income-Tax Act, 1961, (the Act) is the primary source of the providing authority to the central government to levy and collect tax on Income. Section 6 of the Act contains the statutory principles instrumental in determining the residential status of persons in India for the purposes of the Act. Given the wide ranging amendments made and the considerable literature that has been undoubtedly already been published on them, we endeavour to restrict the scope of our discussion to the residential status of Individuals in the light of the amendments made.

Relevant Extracts of the Statute
The Finance bill, 2020, has brought in a sweeping change in residential status of Individuals for the purpose of the Act through a few innocuous amendments contained in Chapter III, Section 4. The relevant extract of Section 6 of the Act is reproduced below for ease of reference:-
“6. For the purposes of this Act,—
 (1) An individual is said to be resident in India in any previous year, if he—
 (a) is in India in that year for a period or periods amounting in all to one hundred and eighty-two days or more ; or
 (b) [***]
 (c) having within the four years preceding that year been in India for a period or periods amounting in all to three hundred and sixty-five days or more, is in India for a period or periods amounting in all to sixty days or more in that year.
Explanation. 1—In the case of an individual,—
 (a) being a citizen of India, who leaves India in any previous year as a member of the crew of an Indian ship as defined in clause (18) of section 3 of the Merchant Shipping Act, 1958 (44 of 1958), or for the purposes of employment outside India, the provisions of sub-clause (c) shall apply in relation to that year as if for the words "sixty days", occurring therein, the words "one hundred and eighty-two days" had been substituted ;
 (b) being a citizen of India, or a person of Indian origin within the meaning of Explanation to clause (e) of section 115C, who, being outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply in relation to that year as if for the words "sixty days", occurring therein, the words "one hundred and eighty-two days" had been substituted.
Explanation 2.—For the purposes of this clause, in the case of an individual, being a citizen of India and a member of the crew of a foreign bound ship leaving India, the period or periods of stay in India shall, in respect of such voyage, be determined in the manner and subject to such conditions as may be prescribed.
 (2) A Hindu undivided family, firm or other association of persons is said to be resident in India in any previous year in every case except where during that year the control and management of its affairs is situated wholly outside India.”
(6) A person is said to be "not ordinarily resident" in India in any previous year if such person is—
(a) an individual who has been a non-resident in India in nine out of the ten previous years preceding that year, or has during the seven previous years preceding that year been in India for a period of, or periods amounting in all to, seven hundred and twenty-nine days or less; or
(b) a Hindu undivided family whose manager has been a non-resident in India in nine out of the ten previous years preceding that year, or has during the seven previous years preceding that year been in India for a period of, or periods amounting in all to, seven hundred and twenty-nine days or less.

The relevant extractfrom the Finance Bill, 2020 (Section 4 of the bill) reads as under:-

In section 6 of the Income-tax Act, with effect from the 1st day of April, 2021,–
– (a) in clause (1), in Explanation1, in clause (b), for the words “one hundred and eighty-two days", the words “one hundred and twenty days” shall be substituted;
 (b) after clause (1), the following clause shall be inserted, namely:–
–“(1A) Notwithstanding anything contained in clause (1), an individual, being a citizen of India, shall be deemed to be resident in India in any 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 criteria of similar nature.”;
(c) for clause (6), the following clause shall be substituted, namely:–
‘(6) A person is said to be “not ordinarily resident” in India in any previous year, if such person is—
(a) an individual who has been a non-resident in India in seven out of the ten previous years preceding that year; or
 (b) a Hindu undivided family whose manager has been a non-resident in India in seven out of the ten previous years preceding that year.’.

A reading of the words of the amendment make it apparent thatsubclause (a) and (b) are both directed at upsetting the status quo with regards to the residential status ofIndian citizens. Subclause (a) amends“clause (b)in Explanation1 to clause (1),”whilesubclause (B) introduces a new clause namely (1A).
At this moment it would be appropriate to take a look at the memorandum to the Finance Bill 2020 that explains the intent of the legislature in making these amendments. The said memorandum is reproduced as below:-

Clause 4 of the Bill seeks to amend section 6 of the Income-tax Act relating to residence in India. Clause (1) of said section provides for situations in which an individual shall be resident in India in a previous year. Sub-clause (c) thereof provides that the individual shall be Indian resident in a year, if he having within the four years preceding that year been in India for a period or periods amounting in all to three hundred and sixty-five days or more, is in India for a period or periods amounting in all to sixty days or more in that year. Clause (b) of Explanation 1 of said clause provides that in case of an individual being a citizen of India, or a person of Indian origin within the meaning of Explanation to clause (e) of section 115C of the Income-tax Act, who, being outside India, comes on a visit to India in any previous year, the provisions of sub-clause (c) shall apply in relation to that year as if for the words "sixtydays" occurring therein, the words "one hundred and eighty-two days" had been substituted. It is proposed to amend said sub-clause (b) of said Explanation 1 so as to substitute the words “one hundred and eighty-two days” with “one hundred and twenty days”.

Change to Section 6 (1)
What immediately springs to mind is that the amendment to Section 6(1) it is not with respectto the wordings of sub clause (1) of Section 6 itself, but with respect to subclause (b)of the Explanation 1 thereto which is a specific provision for Indian citizens and those individuals that are of Indian origin. The said subclause (b) carves out an exception for those people who are Indian citizens or people of Indian originand gives them a benefit of being able to stay in India for a cumulative period of a 182 daysper year as opposed to only the 60 days per year available to others. This exception is a beneficial provision so as to enable Indian citizens as well as people of Indian origin is to visit the country and keep their affairs in order if required. By the amendment proposed in the finance bill, 2020, this period shall see a sharp decline by almost 1/3 and be reduced to 120 days.

A hundred and eighty-two days signifiesas an approximation, a little less half a year to be spent in India by an Individual in India to be considered as a resident in India for the purposes of the Act. A hundred and twenty days however, as an approximation is around four months (depending on the months in which the individual is in India)which is approximately one third of the year in India. Without getting into the exactness of the calculation and keeping in mind theapproximation discussed earlier in this hypothesis, prior to the amendment, if anIndividualwho is a citizen of India or a person of Indian origin, spent more than half the financial year in India, the said Individual would be considered as a resident of India and the global income of the Individual would be taxable in India irrespective of the source jurisdictionin which the income aroseand was received subject to the conditions postulated in a Double taxation avoidance agreement if any. Prior to amendment the individual could spend 182 days in a previous year without being considered a tax resident Indian as long as the total stay did not exceed a cumulative of 365 days in the previous four year (inclusive of the year). However, ceteris paribus, post amendment, if a person spends more than a third of the year in India,in any of the preceding four years(as well as 365 days cumulatively) the said Individual shall be considered to be a tax resident of this country. This signifies approximately a 33.33% (1/3) reduction in the time an individual has available to spend in Indiaif the individual wishes to retain the non-residential status.

Keeping aside the fact that this amendment is in effect taking away a part of the benefit conferred by the statute in the guise of being ‘anti-abuse’ in nature, it clearly shows that the government of the day is seeking to widen the tax base by reducing the numberof days available for an Indian citizen or a person of Indian origin who is a non-resident to visit India during a calendar year without changing his residential status and subjecting his global income to tax in India. It can therefore be clearly seen that the people affected by this amendment are specifically non-resident Indian citizens or people of Indian origin. It does not however make any changes for other non-residents who are not Indian citizens or people of Indian origin. Given the fact that it is reducing a benefit available to people but is not discriminatory or could not be called unconstitutional, this amendment in my humble opinion would not be open to a constitutional challenge under Article 226 or Article 32 of the Constitution of India. It is also the first indicator of a change in policy where certain benefits that have been granted to Indian citizens or individuals of Indian origin are being partially rolled back.

Insertion of sub-clause ‘1A’ in Section 6 of the Act

However, the  amendmentthat has given rise to much comment and confusion and the one that may yet live to see itself tested upon the anvil of Article 14 of the Constitution of India (Right to equality) is the one encapsulated within Section 4(b) of the Finance Bill, 2020 that introduces clause (1A) in Section 6. The said Clauseis a deeming provision which prima facie appears to widen the tax net in a benign fashion. Clothed in the wordings of the amendment, however, are the seeds of a paradigm shiftin the policy of the government of India. In order to better appreciate the implications of this amendment, it is important to first go into the section that determines what incomes are taxable in India. Section 5 of the act determines the scope of total income.A perusal of the section would instantly make it clear that in the hands of an individual resident in India all the income that is received or is deemed to be received in India, accrues or arises or is deemed to accrue or arises to him in India or accrues or arises to him outside India during said year would be taxable in India. In short the global income of a resident individual is taxable in India as per the act subject tothe proviso that is relevant for a person not ordinarily resident in India. On the other hand, Section5 (2) that deals with the total income of a person who is non-resident in India, does not include that income that accrues or arises to the individual outside India in year. The relevant portions of the said section are reproduced below:-

5. (1) Subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived which—
 (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or
 (b) accrues or arises or is deemed to accrue or arise to him in India during such year ; or
 (c) accrues or arises to him outside India during such year :
Provided that, in the case of a person not ordinarily resident in India within the meaning of sub-section (6) of section 6, the income which accrues or arises to him outside India shall not be so included unless it is derived from a business controlled in or a profession set up in India.
(2) Subject to the provisions of this Act, the total income of any previous year of a person who is a non-resident includes all income from whatever source derived which—
 (a) is received or is deemed to be received in India in such year by or on behalf of such person ; or
 (b) accrues or arises or is deemed to accrue or arise to him in India during such year.
Explanation 1.—Income accruing or arising outside India shall not be deemed to be received in India within the meaning of this section by reason only of the fact that it is taken into account in a balance sheet prepared in India.
Explanation 2.—For the removal of doubts, it is hereby declared that income which has been included in the total income of a person on the basis that it has accrued or arisen or is deemed to have accrued or arisen to him shall not again be so included on the basis that it is received or deemed to be received by him in India.

The amendment sought to be brought out by inserting subclause (1A) in the Section 6 seems to be a deliberate attempt on behalf of the Government of India to widen the tax net by deeming those non-residents that are Indian citizens who are not paying tax in any other country to be resident in India during that particular year.  This amendment has the potential to open a Pandora’s box of issues. The residential status of an individual would be determined with respect to the provisions of Section 6 (let us for the moment exclude the operation of the freshly inserted 1A). However, if the individual is a citizen of India, ‘1A’ introduces a further step that would go into the fact of whether the person is not liable to tax ‘anywhere else in the world’. If the person is‘not liable to tax in any other country or territory by reason of his domicile or residence or any other criteria of similar nature’, the deeming provision encapsulated in ‘1A’ gets triggered and the said person shall be deemed to be an Indian resident for the said year even if he is a non-resident as per the other provisions contained in Section 6.

What is worthy of further examination is the phrase “not liable to tax in any other country or territory by reason of his domicile or residence or any other criteria of similar nature”. ‘1A’ would get triggered when the non-resident Indian citizen is not ‘liable to tax’ in any other country or territory ‘by reason of his domicile or residence or any other criteria of similar nature’. Interpretation of these phrases as of today areabstract at best and are leading to substantial confusion.

Let us take the example of two different Jurisdictions and examine the definition of the term ‘resident’ in the DTAA that they have with India. The United Arab Republic and the United States of America are both hot destinations for Indian citizens and a sizable population of Indians work there. It is interesting to note that Article 4 of the DTAA between India and UAE define a resident of India to be any person who, under the laws of India, ..is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.. This term, however, does not include any person who is liable to tax in India in respect only of income from sources in India.The proposed amendment seems to be a mere negation of the terms used in the DTAA. However, in the DTAA between India and the USA Article 4 of the DTAA defines resident of a contracting state ..under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature..” The take away from these similar looking provisions is that the United States of America has consciously incorporated ‘Citizenship’ into the definition of ‘Resident’ for the purposes of the DTAA. The United States taxes global income of all it’s citizens as well as people with ‘permanent residence’ while The Emirates does not offer citizenship to expatriates.

Delving deeper into the example, let us explore the example of the United Arab Emirates further. The United Arab Emirates does not levy any income tax as on date. It also does not confer citizenship upon any foreign citizens that may come and work within its territorial jurisdiction. Indian citizens as well as other foreigners work there for years on the end as expatriates. The children that are born during their stay in the Emirates end up getting citizenship of the country that the parents belong to. There are a large number of Indian citizens in the Gulf who have no connection to the country and are earning no income from it. Some of these may have never visited India in their lives. Arguably, the phrase ‘not liable to tax’ by itself is open to interpretation. Even if we assume that it would apply in this particular matrix of facts in the example brought out,it would need to be brought out that the said person is not liable to tax by the reason of his domicile or residence or other criteria of a similar nature. Considering that there is no tax on income of both the citizens as well as expatriates in the Emirates, this condition would not get fulfilled as a view can be taken that the words ‘any other criteria’ would beEjusdemGeneris to the words domicile or residence. Therefore, an Indian citizen being a resident of the Emirates for tax purposes would not be liable to tax in that jurisdiction by the reason of his domicile or residence but would be because the tax laws of the Emirates do not levy income tax uniformly upon all persons residing there. This example has been taken for illustrative purposes only. Similarly a view can be taken that if a taxing jurisdiction is exempting only the income of an expat while taxing the income of their citizens, then the plain wordings of ‘1A’ shall squarely apply. As we have already examined the contrast in the DTAA between India and the United States as well as the Emirates, a view can be taken that Citizenship may not be Ejusdem Generis to residence and domicile. This view ofcourse is argumentative and is one of the many possible interpretations of the statute. If this view is not plausible, then according to the amendment, the incomes of the Indian Citizens that are tax residents of the emirates shall be taxed in Indian (as long as they are not taxed in any other country).

The deeming provision incorporated in Section 6 ‘1A’ would still be subject to the DTAA if any between India and whatever foreign jurisdiction the Assessee claims the tax residence of. Subject to the treaty, the tie breaker test incorporated in the tax treaty (if any) would be invoked for ascertaining tax residency. If the tie breaker test would determine tax residency outside India, it is reasonable to presume that the residency of the Individual would be as determined by DTAA as opposed to just Section 6. This is because if the provisions of the DTAA are more beneficial to the Assessee over the domestic tax laws, the provisions contained in the DTAA would prevail over the words of the taxing statute. In the absence of a DTAA or if an assessee claims to be a tax resident of no country, then the operation ofSection 6 (1A) would be difficult toexcape.Section 90A (2) specifies that “Where a specified association in India has entered into an agreement with a specified association of any specified territory outside India under sub-section (1) and such agreement has been notified under that sub-section, for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee.” The Supreme Court in the case of UOI v. AzadiBachaoAndolan[2003] 263 ITR 706 (SC) has held that “Section 90 enables the Central Government to enter into a DTAC with the foreign Government. When the requisite notification has been issued thereunder, the provisions of sub-section (2) of section 90 spring into operation and an assessee who is covered by the provisions of the DTAC is entitled to seek benefits thereunder, even if the provisions of the DTAC are inconsistent with the provisions of Income-tax Act, 1961.”

Tested constitutionally, it is undeniable that the insertion of (1A) gives rise to two different classes of persons both of whom are non-residents. The first question that springs to mind is whether the principle of equality that is a fundamental right and also a part of the basic structure of the consideration of India is offended by this amendment? Article 14 and the Income Tax Act, 1961 have over the years enjoyed a relatively peaceful co-existence. The Supreme Court has on multiple occasions deemed taxing statutes that classify individuals into distinct groups subjecting them to different rigours of tax as not violative of the right to equality enshrined in Article 14 on the basis that the classification is reasonable. It canalso been observed that the Supreme Court has by and far except in express conditions of perversity not interfered with tax legislation on the basis of Article 14 in its writ jurisdiction.
Article 14 of the Constitution of India states that:—The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India.”
Article 14 forbids class legislation but it does not forbid reasonable classification. The classification, however, must not be “arbitrary, artificial or evasive” but must be based on some real and substantial bearing, a just and reasonable relation to the object sought to be achieved by the legislation. Article 14 applies where equals are treated differently without any reasonable basis. But where equals and unequals are treated differently, Article 14 does not apply. Class legislation is that which makes an improper discrimination by conferring particular privileges upon a class of persons arbitrarily selected from a large number of persons all of whom stand in the same relation to the privilege granted and between those on whom the privilege is conferred and the persons not so favoured, no reasonable distinction or substantial difference can be found justifying the inclusion of one and the exclusion of the other from such privilege. While Article 14 forbids class legislation, it does not forbid reasonable classification of persons, objects and transactions by the legislature for the purpose of achieving specific ends. But classification must not be “arbitrary, artificial or evasive”. It must always rest upon some real and substantial distinction bearing a just and reasonable relation to the object sought to be achieved by the legislation. Classification to be reasonable must fulfil the following two conditions: firstly, the classification must be founded on the intelligible differentia which distinguishes persons or things that are grouped together from others left out of the group. Secondly, the differentia must have a rational relation to the object sought to be achieved by the Act. The differentia which is the basis of the classification and the object of the Act are two distinct things. What is necessary is that there must be nexus between the basis of classification and the object of the Act. It is only when there is no reasonable basis for a classification that legislation making such classification may be declared discriminatory. [S. Seshachalam&Ors. State of Bihar &Ors. (2014) 16 SCC 72]
It shall of course finally be down to the courts in interpreting whether non-residents sharing the exact same circumstances can be discriminated against qua this deeming provision merely because the jurisdiction within which they have their tax residence does not levy income tax on them.The decision to levy tax is a sovereign decision of the jurisdiction of tax residence and merely because some jurisdictions decide not to tax expatriates were tax residents in their countries, whether the beneficiaries of this tax system could be considered to be a separate class of people is to be considered and answered by the courts.This is significant as the amendment does not specifically seek to bring all non-residents within the tax net but only those not liable to tax ‘in any other jurisdiction’.

As if the amendment as envisaged by the Finance bill, 2020,were not enough to create confusion, what has happened subsequently is even more fantastic.The government has brought out a clarification through a press release that states that “This is an anti- abuse provision since it is noticed that some Indian citizens shift their stay in low or no tax jurisdiction to avoid payment of tax in India.. ..In order to avoid any misinterpretation, it is clarified that in case of an Indian citizen who becomes deemed resident of India under this proposed provision, income earned outside India by him shall not be taxed in India unless it is derived from an Indian business or profession.” This clarification by the CBDT has further complicated matters instead of simplifying things. This is because the Indian income of a non-resident, whether a citizen of India or not is even prior to amendment taxed in India while global income that is not accrued, deemed to accrue, received or deemed to be received in India has not been taxed in India. If this clarification is to be taken at face value, it would render the amendment toothless and redundant. At any rate, as the proposed amendment stands as on today, a deemed resident will have to undergo all the rigours of being considered a resident to tax in India which would mean paying income tax on that income that is derived outside India also.If an individual is considered to be deemed a ‘resident’, could differential treatment be meted out to him as compared to other tax residents?

At any rate, a circular of the CBDT cannot overturn the express wordings of the statute.Such circulars, however, are not meant for contradicting or nullifying any provision of the statute. They are meant for ensuring proper administration of the statute, they are designed to mitigate the rigours of the application of a particular provision of the statute in certain situations by applying a beneficial interpretation to the provision in question so as to benefit the assessee.[ UCO Bank v. CIT [1999] 237 ITR 889 (SC)]. It is in best interests of the populace at large if this press release is taken with a pinch of salt. Further clarity shall only come when the Finance bill, 2020 is passed and the consequent amendments to the income tax act, 1961 are made. Until then we can only hypothesiseas to what the actual effect of this amendment shall be. No matter what the end result of this confusion is, one thing is very clear that these proposed amendments are a clear that shift in policy where the government is perhaps looking not only a tax residence but also at citizenship to determine the taxability of income in the hands of an individual.