EY ITS Course Session 2 Article-4 - Residence

25th April 2012

Article 4 - Objective

In terms of Article 1, in order to claim treaty benefit, a person should be resident of one of the contracting states. "The concept of 'resident of a Contracting State' has various functions and is of importance in three cases:

in determining a conventions personal scope of application in solving cases where double taxation arises in consequence of double residence in solving cases where double taxation arises as a consequence of taxation in the State of residence and in the State of source or situs.

The following articles of a treaty can be brought into operations even if a person is not a resident of either of the contracting states.

Article 24 : Non Discrimination : The application of this article is based on nationality rather than residence. Article 26 : Exchange of Information : The contracting states can exchange information in respect of persons who are not resident of either of the contracting states.
Article 4 - Residence

Article 4 of OECD /UN Model Tax Convention on Income and on Capital

For the purposes of this Convention, the term resident of a Contracting State means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management or any other criterion of a similar nature, and also includes that State and any political subdivision or local authority thereof. This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein. Definition of the term resident under the OECD and UN Model Tax Conventions is primarily identical

UN Model Tax Convention additionally mentions that a person liable to tax by reason of his place of incorporation shall also be regarded as resident.

The US Model has two additional criteria in paragraph 1 i.e. citizenship & place of incorporation. Income derived and paid by partnership, estates or trusts has also been specifically dealt with.

Article 4 - Residence

Tax Treaty - Residency Rules

A person is a resident of a country if it is 'liable to tax in the country by virtue of:

Domicile Residence Place of management Any other criterion of a similar nature

In case a person is resident of both countries

In the case of an individual -- tie breaker rule determines residency In any other case -- the place of effective management determines residency

Article 4 - Residence

Residency - Individuals

Article 4 - Residence

The Tie Breaker Clause

Where the individual qualifies as a resident of both Contracting states then his status is determined as follows: 1) he shall be deemed to be a resident of the State in which he has a permanent home available to him;

2)

f he has a permanent home available to him in both States, he shall be deemed to be a resident of the State with which his personal and economic relations are closer (centre of vital interests);
if the State in which he has his centre of vital interests cannot be determined, or if he does not have a permanent home available to him in either State, he shall be deemed to be a resident of the State in which he has an habitual abode; if he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident of the State of which he is a national; if he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

3)

4)

5)

Article 4 - Residence

Tie Breaker Clause contd

Start Closer with One state R
Permanent Home

Both

Centre of Vital interest

In one state R

Not available in either state

Not determinable

Both / Neither

Both or none
Nationality

Habitual abode

Dispute Resolution

In one state

In one state
To be decided by mutual agreement or by Competent Authority

Article 4 - Residence

The Tie Breaker Tests - Permanent Home Test:

The individual will be resident of the state in which he has permanent home available to him. The concept of home, means any form of dwelling place, or apartment belonging to or rented by the individual, rented furnished room. Permanence of the home is the most essential. Dwelling place should be available at all times, and not occasionally for the purpose of a stay or for short duration (say for example travel for pleasure, business travel, educational travel, attending a course at a school, etc). Size, quality, value of premises does not matter.

Article 4 - Residence

The Tie Breaker Tests - Centre of Vital Interest Test:

The term Centre of Vital Interest means the place where personal and economical interests of an individual are concentrated. Personal interest generally means family, social relations, political & cultural activities.

Economical interest generally means occupation business or profession i.e. source of livelihood.

Article 4 - Residence

The Tie Breaker Tests - Habitual Abode Test

This test is applicable in two distinct type of situations:

If the individual has permanent home in neither of the states; or While the individual has permanent home in both states and centre of vital interest cannot be determined.

Habitual abode implies the continuous, repeated and persistent stay. While the permanent home is available to a person in both the states, the frequency of his stay in a particular state will become the deciding factor. While considering his stay in a particular state, the period for which he stays at the permanent home as well as the period for which he stays in some other place in the same state will also be considered. Comparison must cover a sufficient length of time for it to be possible to determine whether the residence in each of the two States is habitual and to determine also the intervals at which the stays take place - Neither the Model Conventions nor the commentaries specify the length of time.

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Article 4 - Residence

The Tie Breaker Tests Nationality and MAP

If the habitual abode test also does not resolve the tie, the individual is considered to be a resident of the state of which he is a national. The term National will have the same meaning as given by Article 3 (Definitions). Ordinarily the term national means any individual possessing the nationality or citizenship of a Contracting State Mutual Agreement Procedure: In case where an individual is national of both states, or national of a third state the competent authorities will have to resolve the situation. In most of the cases, the nationality tests will break the tie of dual residence. However, recently many advanced countries have started accepting the concept of Dual Citizenship. Thus in such cases a Mutual Agreement Procedure under Article 25 will have to be initialed to resolve the difficulty.

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Article 4 - Residence

Residence of individuals

Residency in India As per domestic tax laws Resident Non resident

Residency in other country - As per domestic tax laws Non resident Resident

Residency as per Tax Treaty

Resident of India Resident of other country Tie breaks to India resident of India

Resident

Resident

Resident

Resident

Tie breaks to other country resident of other country

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Article 4 - Residence

Lets understand : Case Study 1

Mr P, an individual, is resident, but not ordinarily resident (RNOR) in India under Indian income tax laws

Mr P is living in State S and is also employed in State S His wife and 3 children stayed in State S for 6 years and then returned to India for better education

He has permanent home available in State S and India Family members go to State S for vacations every year Mr P owns two flats and a motor car in India Shares and debentures in Indian companies where investment made out of NRI account on which tax duly withheld.

Determine the treaty residence. Would the tie break in India or S?

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Article 4 - Residence

Lets understand: Case Study 2

Singh , NRI has temporarily settled in US for last 4 years and carries on business in US He qualifies as RNOR in India under Indian income tax laws He is staying in US in a house owned by him His wife and other family members are in India and they are staying in a house belonging to the family

Before Singh left for US, he made substantial investments in India and has continued to make investments in India thereafter also out of his income in US

Singh substantial income annually from such investments and the same is also reinvested in India

Mr Singh is a tax resident in US and regularly visits India

Would R but NOR be considered as treaty resident under India US treaty ? Would it make any difference if Singh would have gone to UK instead of US ?

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Article 4 - Residence

Lets understand: Case Study 2 Relevant Provisions

As per the India US treaty the term "resident of a Contracting State" means any person who, 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, provided, however, that

(a) this term does not include any person who is liable to tax in that State in respect only of income from sources in that State..

As per the India UK treaty the term "resident of a Contracting State" means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature.

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Article 4 - Residence

Lets understand : Case Study 3

Mr. Bhatt, employed as doctor in Government hospital in Japan from where drawing salary of 25 million p.a.;

Other source of income in Japan are interest on FDs. The asset value in Japan of about 15 million p.a.;

He is ordinarily residing in Japan in apartment allotted by the employer; His wife and children are residing in India; Mr. Bhatt had no desire of taking family to Japan; He has made substantial investment in shares, debentures and Mutual Fund in India; Dividend and interest equivalent earned in India amounts to 50 million p.a. in India Income and property value in India more in comparison to Japan. Mr Bhatt is a resident under the Japan domestic laws and also treaty resident in India since his income liable to tax in India.

Determine the treaty residence. Would the tie break in India or Japan? Would the answer be different in terms of the provisions of UK treaty ?
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Article 4 - Residence

Lets understand : Case Study 3 Relevant provisions of India Japan tax treaty
(1) For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of head or main office or any other criterion of a similar nature of income from sources in that State. (2) Where by reason of the provisions of paragraph 1 a person is a resident of both the contracting states, then the competent authorities of the Contracting States shall determine by mutual agreement the Contracting State of which that person shall be deemed to be a resident for the purposes of this Convention.

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Article 4 - Residence

Residency Corporates

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Article 4 - Residence

Test of Residency - Corporates

Ordinarily corporates are resident in the country where they are liable to tax by virtue of their place of incorporation, or place of effective management. In case of a tie break situation Place of effective management relevant The key factors in determining the place of effective management are as follows:

where the head and the brain is situated. where de facto control is exercised and not where ultimate power of control exists. where top level management is situated. where business operations are carried out. where directors reside. where the entity is incorporated. where shareholders make key management & commercial decisions.

According to Klaus Vogel, place of management is where management directives are given and not where they take effect.
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Article 4 - Residence

Peculiar provisions of India UAE treaty as amended by Protocol dated 28-11-2007

Article 4
(a) In the case of India: 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; and (b) in the case of the United Arab Emirates: an individual who is present in the UAE for a period or periods totaling in the aggregate at least 183 days in the calendar year concerned, and a company which is incorporated in the UAE and which is managed and controlled wholly in UAE.

Impact
Amended provision permits UAE registered company to access India-UAE DTAA only if UAE Co incorporated and wholly managed and controlled in UAE . UAE Co not having bonafide business activity or created with the main purpose of obtaining benefits of the treaty not eligible for treaty benefit even assuming above condition satisfied. Where a UAE based company is unable to satisfy the residence test, under the treaty it may be vulnerable to India domestic law provisions - potential challenge of applying any other treaty ?

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Article 4 - Residence

Place of Effective Management

Extracts from the Treatise of Kanga, Palkhivala and Vyas As a rule, the direction, management and control, the head and seat and directing power of a companys affairs is situated at the place where the directors meetings are held and consequently a company would be resident in this country if the meetings of directors who manage and control the business are held here. It is not what the directors have power to do, but what they actually do, that is of importance in determining the question of the place where the control is exercised Supreme Court in the case of Subbayya Chettaiar V/S CIT : Control and management signifies the controlling and directive power, the head and brain; and situated implies the functioning of such power at a particular place with some degree of permanence

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Article 4 - Residence

Place of Effective Management - OECD Article 4(3) Test of place of effective management as tie breaker rule :

The place of effective management is the place where key management and commercial decisions that are necessary for the conduct of the entitys business as a whole are in substance made. All relevant facts and circumstances must be examined to determine the place of effective management. India position on the above.

It is of the view that the place where the main and substantial activity of the entity is carried on is also to be taken into account when determining the place of effective management.

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Article 4 - Residence

Lets understand : Case Study 4

F Co, a company incorporated in Mauritius with the purpose of carrying on business of dealing and making investment in shares and securities etc;

F Co has two individual as shareholders who were US residents; F Co has a valid Tax Residency Certificate (TRC) issued by Mauritius tax authorities F Co has obtained RBI permissions for investment in Indian capital market under Portfolio Investment Scheme

F Co, derived income in the form of short/long term capital gains Power of Attorney issued to Indian residents as authorized representatives to carry on activities on behalf of F Co

Pre condition for India-Mauritius tax treaty benefit : place of effective management in Mauritius

Is F Co entitled to treaty benefit of India-Mauritius tax treaty ?

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Article 4 - Residence

Lets understand : Case Study 5

A Co, a shipping company, wishes to claim the benefit of India Mauritius tax treaty Pre condition for tax treaty benefit : place of effective management in Mauritius. TRC from Mauritius is available Directors meetings and other statutory corporate compliances undertaken in Mauritius. However, actual operations/management of A Co is at the jurisdiction of the ultimate holding company in Singapore

Entire correspondence of Indian agents with Singapore. All staff, officers, captain in Singapore No significant policy/ operational decisions taken at the directors meeting in Mauritius.

Is A Co entitled to treaty benefit of India-Mauritius treaty ?

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Article 4 - Residence

Lets understand : Case Study 6

Shipping Company incorporated in Panama wishes to claim the benefit of India-Greece tax treaty on the basis that the company is wholly managed in Greece.

The company has appointed a Greece company as its agent / general manager There is no staff or facility at Panama; General manager (Greece) has power to appoint staff; dismiss staff; collect and disburse money on behalf of the company; can contract and negotiate on behalf of the company; The general manager has power to negotiate all legal contracts and maintain accounts

Where is the effective place of management ?

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Article 4 - Residence

Test of Residency- Trusts, Partnership Firms etc.

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Article 4 - Residence

Test of Residency- Trusts, Partnership Firms etc

A tax transparent entity refers to that entity which is regarded as a tax exempt entity under a tax law and instead the members / partners/ beneficiaries of the said entity are taxed vis--vis the income earned by such tax transparent entity

Some examples of tax transparent entities - Partnership firms, Trusts, Real Estate Investment Trusts, Collective Investment Vehicles, etc

For instance A UK partnership is tax exempt in UK. Its partners are subject to tax vis--vis the income earned by such partnership firm

Most tax treaties do not treat tax transparent entities as tax resident - Need to carefully consider the specific tax treaty provisions and the domestic laws, wherein such tax transparent entity is being governed

OECD committee on fiscal affairs has considered the difficulty which arises in regard to the treaty entitlement of fiscally transparent entities in its detailed report of August 1999 titled Application of the provisions of the OECD Model Tax Convention to Partnerships

Indias reservations to the OECD A fiscally transparent partnership shall be entitled to the benefits of a tax convention, only if the provisions to that effect are included in the convention entered into with the State where the partnership is situated
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Article 4 - Residence

Peculiarities in Indian Tax Treaties

India-USA Any person who, 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, provided, however, that (a) (b)in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners or beneficiaries. The India-US treaty treats a tax transparent entity as a resident to the extent income derived by such tax transparent entity has been taxed in the US either in the hands of the entity or its partners/ beneficiaries. Most of the treaties that India has signed would be UK patterned and hence it will be a challenge to determine residential status of transparent entities
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Article 4 - Residence

India-UK Any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management or any other criterion of a similar nature

Peculiarities in Indian Tax Treaties India US Tax Treaty

Under the Convention income received by a partnership, estate or trust will be treated as income received by a U.S. resident only to the extent such income is subject to tax in the United States as the Income of a U.S. resident. This rule regarding residence of partnerships, estates or trusts is applied to determine the extent to which that person is entitled to treaty benefits with respect to income which it receives from the other Contracting State and the extent to which a resident of the other Contracting State is entitled to treaty benefits with respect to income paid by such person. Under US tax law, a partnership is never, and an estate or trust is often not, taxed as such (treated as fiscally/ tax transparent entities). To the extent the partners of the partnership firm are subject to US tax, as residents of the United States, the income received by the partnership will be treated as income received by a US resident.

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Article 4 - Residence

Linklaters LLP On eligibility of partnership firms to avail the benefits of the treaty

Linklaters, is a UK based LLP engaged in law practice rendered legal service to clients whose operations extended to India. Legal services were services rendered from UK office, with occasional visits of partners/ staff in India. Linklaters filed Nil tax return in India on the basis that it did not have a permanent establishment in India; Tax Authorities contended a service PE of Linklaters in India Issues as regards eligibility of Linlklaters to avail India-UK tax treaty benefit was raised for the first time before the Tribunal and it was held that Linklaters should be eligible to avail India-UK tax treaty benefits :

In the contextual senses, liable to tax by reason of domiciles refers to a situation in which a person is liable to tax in a jurisdiction by virtue of a locality related attachment which leads to residence type taxation; Tax treaty cannot be strictly interpreted isolating it from the object and purposes for which the provision is made; The event of taxability in the residence country rather than the mode of taxability there, which should be a decisive factor for determining whether the person should be eligible for tax benefit or not; Where, the entire income of partnership is taxed, whether in its own hands or in the hands of the partners, tax treaty benefit should be available; As long as the resident country has the right to tax the entire income of the person, whether or not such a right is exercised, the test of fiscal domicile should be satisfied.
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Liable to tax connotation thereof and controversies

Does the term refers to being actually subject to tax, or whether it refers to a legal liability to pay tax, but which may be inoperative due to a specific exemption, or whether it refers to the right of the State to levy tax on an entity, which may be exercised by such State in future?

The term liable to tax matter of various controversies particularly in the context of India-UAE Tax Treaty prior to its amendment since UAE does not levy any taxes, other than on companies engaged in the oil and banking sector.

The legal liability to tax is considered as distinct (and more relevant for the purposes of being considered as a resident under a Tax Treaty) compared to the fiscal fact of actual payments of tax [Supreme Court in Azadi Bachao Andolan]

Said term refers to the fact of actually being taxed as distinct from merely being governed or subject to the tax laws [GE Pension Trust (AAR)].

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Article 4 - Residence

General Electric Pension Trust (GE) On eligibility of trusts to avail the benefits of the treaty

GE Trust a tax resident of USA , registered with the SEBI as a FII as a sub account of GEAM made regular investments in Indian securities and derived gain from sale of such securities GE did not have any employee, branch, office or place of business in India. In reference to department raising a doubt on the eligibility of GE to claim the benefit under India-US treaty in terms of clause (b) of Para 1 of article 4 of the treaty, AAR held as under:

It is worth pointing out that the phrase liable to tax in Para 1 and the phrase subject to tax in proviso (b) are not synonymous. If both were to be read as synonymous, proviso (b) would become otiose; Para 1 speaks of being in the tax net, proviso is concerned with actual taxation; In the case of a trust, the term resident of USA would apply only to the extent that the income derived by such trust is subject to tax either in the hands of the trust or the beneficiaries; It is an admitted fact that both GE enjoys exemption from payment of USA tax under the relevant code of US and nothing was brought on record to show that the income of securities of Indian companies is being taxed in USA in the hands of the Trust or the beneficiaries; GE is liable to tax by reason of its place of management and place of incorporation and as such is a tax resident yet having regard to the wording in proviso (b), GE being tax exempt in the USA cannot be treated as resident for the purpose of treaty;

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Article 4 - Residence

Tax Residency Certificate

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Article 4 - Residence

Tax Residency Certificate (TRC)

Generally, from a practical perspective, obtaining a tax residency certificate from the tax

office of the particular country is an accepted test of demonstrating ones residential status.

An interesting issue which arises is whether once a foreign entity produces a tax residency certificate of the other contracting state, whether the tax authorities of the source country is bound to accept them, without making any further inquiries.

The Supreme Court in the case of Azadi Bachao Andolan (supra) had held that reproduction of tax residency certificate by the FIIs registered in Mauritius should be considered as evidence of such FIIs being tax residents of Mauritius under the IndiaMauritius Tax Treaty.

Budget 2012-13 has introduced a requirement of obtaining TRC providing the prescribed particulars

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Article 4 - Residence