Residential status under the Income-tax Act, 1961 plays a central role in determining the scope of taxable income in India. It forms the basis for deciding whether a person is liable to pay tax in respect of income earned both within and outside the country. While all Indian-sourced income is taxable in India irrespective of residential status, foreign income is taxed only if the taxpayer is a resident. This distinction makes residential status critical for assessing tax liability, compliance obligations, and reporting requirements.
We explored the general framework for determining residential status, including key definitions, tests applicable to individuals and other entities, legal provisions, and important principles that govern the classification.
Importance of Determining Residential Status
The relevance of residential status lies in its direct impact on the taxability of income. A person who qualifies as a resident in India is liable to pay tax on their total income, which includes both Indian and foreign income. However, a non-resident is only liable to pay tax on income that is either received in India or accrues or arises in India. Therefore, the residential status of a taxpayer affects the inclusion or exclusion of foreign income in the taxable base.
Determining residential status is not merely a formality. It has substantial implications for individual taxpayers, businesses, multinational companies, returning expatriates, and even those engaged in global freelancing or investments. The classification must be evaluated for each financial year independently, based on criteria laid down in the Income-tax Act.
Key Principles Governing Residential Status
Residential status is governed by a set of guiding rules applicable to different types of taxpayers. It is assessed separately for every previous year and has implications for the assessment year that follows.
Classification of Taxable Entities
The Income-tax Act classifies taxpayers into various categories such as individuals, Hindu Undivided Families (HUFs), partnership firms, companies, associations of persons, and others. The rules for determining residential status vary for each category.
For individuals, the determination is based on the duration of physical presence in India during a financial year and preceding years. For HUFs, firms, and companies, it is based on the location of control and management of their affairs. This classification is essential because the taxability of foreign income depends largely on the specific status attributed to each entity.
Types of Residential Status
For individuals and HUFs, residential status is further divided into three types:
- Resident and ordinarily resident
- Resident but not ordinarily resident
- Non-resident
Other entities such as firms, companies, and associations of persons are classified as either resident or non-resident.
The classification plays a significant role in determining whether income from a foreign source would be brought under the Indian tax net. While a resident and ordinarily resident is taxed on global income, a resident but not ordinarily resident and a non-resident are taxed only on income arising in India or deemed to arise in India.
Same Status Throughout the Previous Year
Once a residential status is determined for a previous year, it applies uniformly to that year. It is not permissible to have multiple residential statuses within the same financial year. Even if an individual travels in and out of the country several times during the year, the overall duration of stay is considered to determine the residential status, and the classification once made is consistent for that entire period.
Change in Status Across Financial Years
The residential status is not permanent and may change from one financial year to another depending on the facts of that year. For instance, a person may be a non-resident for the current financial year and become a resident in the next year depending on their presence in India or changes in business operations.
This dynamic nature means that residential status must be assessed separately for each year, and tax planning must be done accordingly to ensure compliance and accurate reporting of income.
Dual Residency and Tie-Breaker Rules
It is possible for an individual to qualify as a resident under the domestic laws of more than one country. Such dual residency situations are common among individuals who have business interests or family ties in more than one jurisdiction.
In such cases, tax treaties or Double Taxation Avoidance Agreements usually provide tie-breaker rules to determine which country will have the primary right to tax. These treaties help avoid double taxation and allocate taxing rights between the contracting states based on criteria such as place of permanent home, center of vital interests, habitual abode, and nationality.
Burden of Proof on the Assessee
The responsibility for establishing residential status lies with the taxpayer. The tax authorities are not required to prove it on behalf of the assessee. This means that the individual or entity must maintain proper documentation such as travel records, visa details, flight tickets, or documents demonstrating control and management of operations in order to substantiate their claim.
Failure to maintain adequate evidence may lead to disputes or denial of benefits such as treaty relief or exemption of foreign income from Indian taxation.
Residential Status of an Individual under Section 6
Section 6 of the Income-tax Act provides specific criteria for determining the residential status of individuals. These criteria are based on the number of days an individual stays in India during the relevant financial year and the years immediately preceding it.
Basic Conditions to Determine Residency
An individual is considered a resident in India for a financial year if they meet either of the following conditions:
- They are present in India for a total of 182 days or more during the relevant financial year, or
- They are present in India for at least 60 days in the relevant year and for a total of 365 days or more in the four years immediately preceding that year.
If either of the two conditions is satisfied, the individual is treated as a resident for that financial year. If none of the conditions are met, the individual is treated as a non-resident.
Relaxation for Certain Individuals
There are certain exceptions to the above rule. In the case of an Indian citizen or a person of Indian origin who comes to India on a visit, the threshold of 60 days is extended to 182 days. This relaxation ensures that casual or short-term visits do not result in unintended residency status.
In addition, individuals who are Indian citizens leaving India for employment abroad or as a crew member of an Indian ship are also allowed the 182-day threshold instead of 60 days. These exceptions recognize the global mobility of Indian citizens and provide tax relief in genuine cases.
Additional Conditions for Ordinarily Resident Status
Once a person qualifies as a resident, a further distinction is made between ordinarily resident and not ordinarily resident based on two additional conditions:
- The individual has been a resident in India for at least 2 out of the 10 preceding years immediately prior to the relevant year, and
- The individual has stayed in India for at least 730 days during the 7 years immediately preceding the relevant year.
If both conditions are met, the individual is considered a resident and ordinarily resident. If either condition is not met, the person is treated as a resident but not ordinarily resident.
Implications of Residential Subcategories
A resident and ordinary resident is taxed on their entire global income. This includes all income earned or received in India and all income earned abroad, regardless of whether it is brought to India or not.
A resident but not ordinarily resident, on the other hand, is taxed only on:
- Income received or deemed to be received in India
- Income accruing or arising in India
- Income accruing or arising outside India if it is derived from a business controlled in or a profession set up in India
A non-resident is taxed only on income received in India, income deemed to be received in India, or income that accrues or arises or is deemed to accrue or arise in India.
Practical Examples
To better understand the application of these rules, consider a few illustrations:
- A person who stayed in India for 185 days during the financial year and was also present in India for three of the previous four years would be treated as a resident. If they also satisfy the additional conditions regarding prior residency and physical presence, they would be a resident and ordinarily resident.
- A person who stays in India for 150 days during the financial year and has stayed for 370 days in the last four years will also be treated as a resident. However, if they fail to meet the additional conditions, they will be classified as a resident but not ordinarily resident.
- A business executive who comes to India for 100 days in a year but had never been in India before would not qualify as a resident since neither of the basic conditions is satisfied. Hence, they will be treated as a non-resident.
Special Clarifications Issued by the Board
In light of extraordinary situations such as the suspension of international flights during the COVID-19 pandemic, the Central Board of Direct Taxes issued Circular No. 11/2020 to provide relief for determining residential status for the financial year 2019-20.
According to this circular, for individuals who came to India before March 22, 2020, and were unable to leave due to travel restrictions, their period of stay after that date could be excluded for the purpose of calculating residential status. Such administrative reliefs are issued from time to time to ensure that genuine hardships are mitigated and unintended tax liabilities do not arise.
Residential Status of a Hindu Undivided Family
A Hindu Undivided Family is a unique legal entity under Indian personal and tax laws. It consists of persons lineally descended from a common ancestor, including their wives and unmarried daughters, and operates as a unit. Its income is assessed separately from the individual incomes of its members.
Under the Income-tax Act, the residential status of a HUF is governed by Section 6(2). A HUF can either be a resident or a non-resident for a given financial year, and if it is a resident, it is further classified into ordinarily resident or not ordinarily resident.
When a HUF is Treated as Resident or Non-Resident
A HUF is treated as a resident in India if the control and management of its affairs is wholly or partly situated in India during the relevant previous year. If the control and management is entirely outside India for the whole year, the HUF will be considered a non-resident.
It is important to note that unlike individuals, the physical presence of members or the Karta does not determine the residential status. Instead, the primary consideration is the location from where decisions are made and the extent to which those decisions are implemented in India.
Understanding Control and Management
Control and management refers to the decision-making process regarding the affairs of the entity. It includes strategic and policy-level decisions, not routine day-to-day administrative tasks. Control and management is considered to be situated at the place where the head office or seat of the governing body is located.
For instance, if the Karta of the HUF lives in India and makes key financial and operational decisions from India, then the control and management would be considered to be located in India, making the HUF a resident.
Resident HUF: Ordinarily Resident or Not Ordinarily Resident
If a HUF is classified as a resident, a further categorization is made to determine whether it is an ordinarily resident or not ordinarily resident. This is done by applying tests that are similar to those used for individuals, but the focus is on the Karta of the HUF.
A resident HUF is considered to be ordinarily resident in India if the Karta satisfies both of the following conditions:
- He has been resident in India in at least two out of the ten previous years immediately preceding the relevant financial year, and
- He has been present in India for at least 730 days in total during the seven years immediately preceding the relevant financial year.
If the Karta fails to satisfy even one of these conditions, the HUF is classified as a resident but not ordinarily resident.
Practical Implications for HUFs
The classification of the HUF impacts the taxability of its income. A resident and ordinarily resident HUF is liable to pay tax on its global income, just like an individual. A resident but not ordinarily resident HUF is taxed only on Indian income and income arising abroad from a business controlled from India.
A non-resident HUF is liable to pay tax only on Indian income or income that is deemed to arise in India. The distinction between resident and non-resident HUFs becomes critical when the HUF has business or property interests located outside India.
Residential Status of Partnership Firms and Associations of Persons
Firms and AOPs are other significant entities whose tax obligations depend on their residential classification. Section 6(2) of the Income-tax Act provides the rules for determining their residential status. Similar to HUFs, the status depends on the location of control and management of their affairs.
A partnership firm or an AOP is considered to be resident in India if the control and management of its affairs is wholly or partly situated in India during the relevant previous year. If the control and management is situated entirely outside India, then the entity is considered to be a non-resident.
Nature of Control and Management in Firms and AOPs
In a partnership firm, control and management is generally exercised by the partners collectively. For an AOP, control may rest with the managing members or a principal officer designated for decision-making.
Control and management is not determined by merely having the legal right to control or manage. The real test is whether in practice, important decisions are taken in India or outside. It must be proven that the directing power lies in India to be classified as a resident.
If the primary decision-making occurs outside India and no strategic policies are framed or executed within India, then the firm or AOP may be considered a non-resident. The place where resolutions are passed, agreements signed, or board meetings conducted often plays a role in determining this.
Rebuttable Presumption of Residency
In cases where all or most of the partners of a firm are residents of India, there is a natural presumption that the firm is also resident. However, this is not conclusive. The presumption can be rebutted by providing adequate evidence to show that the actual control and management of the firm’s affairs takes place outside India.
This means the burden of proof rests on the assessee to demonstrate with factual material that even though the partners may reside in India, the firm itself is non-resident due to its central management being outside the country.
Importance of Evidence and Documentation
To determine and establish the correct residential status, it is essential for firms and AOPs to maintain proper records of where decisions are taken. This may include:
- Minutes of meetings
- Location of key personnel
- Communications or correspondence with clients or vendors
- Documentation of strategic business decisions
Such records may be called upon during assessments or litigation to determine whether the control and management lies within or outside India.
Impact on Taxable Income
The implications of being classified as resident or non-resident are significant. A resident firm or AOP is taxed on its global income, just like any resident individual or HUF. This includes income received abroad and income accruing outside India.
However, a non-resident firm or AOP is taxed only on the income that arises in India or is deemed to arise in India. This limited tax base can offer relief in situations where the business operations are primarily international, provided the control and management is also situated outside India.
Examples to Illustrate Residential Status
To illustrate, consider a partnership firm formed by three partners who reside in India. The firm conducts all its operations in Dubai, and strategic decisions are made by the partners during their meetings held in Dubai. There is no office or staff in India. In this case, even though the partners are residents of India, the firm may be classified as non-resident, provided sufficient evidence is maintained.
In contrast, if a firm claims to operate from abroad but has all meetings, operations, and contracts executed in India, then it will be treated as a resident irrespective of its foreign incorporation or registrations.
Practical Considerations and Compliance
Firms and AOPs operating internationally must be particularly cautious about their residential status as it affects not only their tax liability but also their obligations to file returns, maintain accounts, and adhere to transfer pricing rules if applicable.
It is advisable for such entities to evaluate their governance structures and operating models to avoid unintended tax consequences. A careful review of the place where board meetings, strategic decisions, and central operations take place is often necessary to determine their true residential character.
Role of Judicial Interpretation
Several judicial decisions have clarified the meaning of control and management. Courts have emphasized that the real test is the seat of the decision-making process, not the formal place of registration or nominal office address.
The Supreme Court and various High Courts have laid down guiding principles that help in assessing the true nature of control. In particular, they have looked into the substance-over-form principle and considered where the key business strategies are developed and implemented.
Differences with Individual Assessment
Unlike individuals, where day count and physical presence form the basis for residency, for firms and AOPs, the test is more qualitative. It is based on where the mind and will of the business reside. This makes the analysis subjective and dependent on facts and circumstances rather than a fixed threshold.
International Implications
Firms and AOPs that have cross-border operations must also consider how their residential status affects their obligations under other jurisdictions’ laws. There can be instances of dual residency, and in such cases, tax treaties may offer relief through provisions relating to tie-breaker rules or foreign tax credits.
It is also important to consider permanent establishment risks, withholding tax exposure, and compliance with international reporting obligations such as those under transfer pricing regulations or country-by-country reporting.
Residential Status of Companies and Administrative Clarifications
The residential status of a company under the Income-tax Act plays a pivotal role in determining whether its global income will be subjected to Indian taxation. While the residential status of individuals, Hindu Undivided Families (HUFs), firms, and associations of persons (AOPs) is decided based on physical presence or control and management of affairs, companies follow a more nuanced approach.
The concept of “place of effective management” has been introduced to handle complex cross-border corporate structures, especially those involving foreign subsidiaries and holding companies. We examine the residential status of companies, the legal provisions governing them, the role of place of effective management (POEM), and administrative clarifications issued from time to time.
Residential Status of Companies under Section 6
Section 6(3) of the Income-tax Act lays down the conditions to determine the residential status of companies. According to this section, a company is said to be resident in India if:
- It is an Indian company, or
- Its place of effective management during the relevant financial year is in India.
If neither of the above conditions is satisfied, the company is considered a non-resident.
This definition ensures that both domestic companies and certain foreign companies that are effectively managed from India fall within the Indian tax net for their global income.
Indian Company and Its Residency
An Indian company, as defined in the Act, includes a company formed and registered under the Companies Act. By default, any such company is always treated as a resident in India, regardless of where it conducts its operations or from where it is managed.
Therefore, even if an Indian company’s operations are entirely based overseas and decisions are made abroad, its status as a resident does not change. This ensures that Indian companies are taxed on their global income.
Foreign Company and the Concept of POEM
For companies that are not incorporated in India, the determination of residency depends on their place of effective management. This concept was introduced to curb tax avoidance strategies where companies are incorporated in low-tax jurisdictions but are effectively controlled from India.
A foreign company will be considered a resident in India if its place of effective management in a financial year is situated in India.
Place of Effective Management Explained
Place of effective management is defined as the place where key management and commercial decisions that are necessary for the conduct of the business as a whole are, in substance, made.
This concept focuses not on legal or formal control, but on the actual place where the mind and will of the company operate. The central theme is to identify where the vital decisions of the company are taken in a meaningful and effective way.
CBDT Guidelines on POEM
To bring clarity to the concept, the Central Board of Direct Taxes issued a circular providing comprehensive guidelines on the determination of POEM. The guidelines are applicable to companies with gross turnover or receipts exceeding a specified threshold in a financial year.
The guidelines emphasize a two-step process:
- Identifying the persons who actually make key management and commercial decisions for the company
- Determining the location where those decisions are made on a regular and effective basis
Active Business Outside India
If a foreign company is engaged in active business outside India, it is presumed that its POEM is outside India unless there is evidence to the contrary.
A company is said to be engaged in active business outside India if:
- The passive income is not more than fifty percent of its total income
- Less than fifty percent of total assets are situated in India
- Less than fifty percent of total employees are situated in India
- The payroll expenses incurred on Indian employees are less than fifty percent of the total payroll expenses
If all these conditions are met, the company is presumed to have its POEM outside India. However, if any of these conditions fail, a deeper analysis is required to determine the POEM.
Factors Determining POEM
Several factors are considered in determining whether POEM is in India, especially when the presumption of foreign POEM is not applicable:
- Location of the company’s board meetings
- Who is taking strategic decisions regarding expansion, mergers, product launch, or financial policies
- Place where senior management resides and functions
- Delegation of authority and autonomy granted to local offices
- Location where consolidated accounts are prepared and approved
No single factor is conclusive. A holistic approach is adopted by examining the pattern of decision-making and the actual place from where such decisions are made.
Management Power Exercised in India
A foreign company may still be considered a resident of India if the central decisions relating to the company’s commercial affairs are made in India, even if its incorporation and physical operations are located abroad.
Instances where Indian shareholders or directors exercise real control over strategic matters, approve budgets, review performance, and take key financial decisions may lead to a finding that the POEM is in India. This is especially important for companies that have nominee directors or virtual control structures that obscure the actual place of management.
Documentation for POEM Determination
Companies that are exposed to the risk of being considered Indian residents due to POEM must maintain comprehensive documentation to substantiate their claims. This includes:
- Minutes of board meetings showing decision locations
- Communication trail of decision-makers
- Travel logs of key personnel
- Organizational charts
- Delegation matrices
Having clear records showing that the vital decisions are made abroad helps mitigate the risk of unintended residential classification in India.
Prior Approval Requirement
To avoid unnecessary litigation and confusion, certain cases involving POEM may require the prior approval of the Principal Commissioner or Commissioner of Income-tax. This requirement serves as an administrative check and allows companies to seek clarity from the authorities in advance.
It also ensures that companies are not subjected to retrospective tax demands on account of ambiguous interpretations regarding their place of effective management.
Impact of Residency on Taxability
A company that qualifies as a resident in India is liable to pay tax on its global income. This includes income earned from operations in other countries, interest, dividends, capital gains, and other sources.
On the other hand, a non-resident company is taxed only on the income received in India or deemed to arise or accrue in India. This includes business income arising through a permanent establishment, royalty, fees for technical services, and income from the transfer of capital assets located in India.
Therefore, a change in residential status has a profound impact on the overall tax liability and reporting requirements.
Treaty Benefits and Foreign Companies
Many foreign companies that operate in India are eligible to claim benefits under tax treaties. These treaties often contain specific provisions to determine residency and prevent double taxation.
The treaties generally provide tie-breaker rules to resolve dual residency conflicts. These rules prioritize the place of incorporation, effective management, or other tests as mutually agreed between the countries.
In such cases, the treaty provisions override the domestic law, offering relief to companies that may be taxed in two jurisdictions. However, access to treaty benefits is not automatic. Companies must comply with procedural requirements, including obtaining a tax residency certificate from the home country.
Recent Developments and Trends
In recent years, there has been an increased global focus on substance-over-form, driven by international tax reforms under the base erosion and profit shifting initiative. Indian authorities are also applying the POEM provisions more stringently in light of evolving global standards.
Companies with complex international structures are advised to periodically review their governance models to ensure that management and control are aligned with their legal and tax obligations. Decisions involving group strategy, investment, and control must be adequately documented.
Examples to Illustrate POEM Application
Consider a foreign holding company incorporated in a jurisdiction with minimal tax liability. Its entire board of directors resides in India, and all business strategy decisions are made through virtual meetings held from India. In this case, despite foreign incorporation, the company is likely to be treated as a resident of India under the POEM test.
Conversely, if the company has a full-fledged board that meets regularly outside India and exercises genuine decision-making powers independently, then the POEM may be deemed to be outside India.
Practical Guidance for Companies
Companies that are susceptible to POEM-based residency must:
- Avoid informal decision-making channels
- Maintain transparent documentation of governance and decision flow
- Clearly define roles and responsibilities of overseas and Indian offices
- Ensure that Indian directors do not function as proxy controllers
- Seek expert opinion and prior clarification from authorities if necessary
These measures not only reduce the risk of adverse classification but also enhance compliance with international best practices.
Administrative Circulars and Relief Measures
To ensure that companies are not unduly affected by temporary or exceptional situations, the authorities may issue circulars granting relief. For example, in the wake of global disruptions such as pandemics or travel restrictions, clarifications may be issued to address unintended residency consequences.
Such administrative relief helps ensure that companies are not penalized for circumstances beyond their control and that the application of POEM is based on substance rather than formality.
Role of Judicial Pronouncements
Judicial interpretation plays a significant role in the application of POEM. Courts have consistently stressed that residency should be determined on the basis of actual facts and control, not merely on incorporation or registration details.
Cases where companies had formal foreign incorporation but actual control exercised from India have resulted in courts treating such companies as residents. Similarly, genuine foreign companies have been protected from adverse taxation when supported by clear evidence. These judgments provide valuable guidance to companies and tax authorities in interpreting the legal provisions correctly.
Conclusion
Understanding and correctly determining the residential status of a taxpayer is crucial under the Income-tax Act, 1961. It not only defines the scope of income that will be taxed in India but also shapes the compliance obligations, reporting responsibilities, and eligibility for reliefs under tax treaties or administrative provisions.
For individuals, the residential status depends primarily on the duration of their physical presence in India. The classification into resident and ordinarily resident, resident but not ordinarily resident, and non-resident affects the taxation of global income versus only Indian-sourced income. Special relaxations and rules apply to visiting Indian citizens, persons of Indian origin, and employees working abroad. The taxability changes substantially with each classification, requiring taxpayers to assess their status each year carefully.
For Hindu Undivided Families (HUFs), partnership firms, and associations of persons (AOPs), the test is not based on physical presence but on the location of control and management of their affairs. If such control is wholly or partly in India, the entity is treated as resident. Further classification for resident HUFs depends on the residency of the Karta. In all such cases, the place where key decisions are made determines the tax treatment of the income.
When it comes to companies, the rules are more nuanced. While Indian companies are always considered residents, the residential status of foreign companies is decided by the Place of Effective Management (POEM) test. If the company’s central decision-making is effectively located in India, it becomes a resident and is liable to Indian taxation on its worldwide income. The POEM test ensures that shell companies incorporated in low-tax jurisdictions but controlled from India do not escape taxation.
The Income-tax Department has issued detailed guidelines, circulars, and clarifications to bring consistency in the application of these rules, especially in complex or international scenarios. Judicial decisions also play a pivotal role in interpreting these provisions, often emphasizing substance over form and real control over legal structures.
Taxpayers, individuals or entities, must maintain accurate records and remain vigilant about their residential classification every financial year. Inaccurate classification can lead to substantial tax liabilities, penalties, or denial of treaty benefits. Those with cross-border operations or global mobility should regularly review their circumstances to avoid unintended tax consequences.
In conclusion, residential status is not a static label but a dynamic condition determined by law and practice. It is the gateway through which the Indian tax system determines its jurisdiction over income. A careful and informed approach is essential to ensure compliance, optimize tax planning, and avoid disputes.