Residential Status & Tax Incidence

Understanding Residential Status & Tax Incidence

Residential status lies at the heart of the Income Tax Act, 1961. It determines the scope of tax liability and identifies what income will be taxed in India. Unlike citizenship—which many students mistakenly confuse with residency—residential status depends entirely on the number of days an individual stays in India, the location of control and management of companies, and the place where business operations occur. The Supreme Court in CIT v. R. Mittal emphasized that the test of residence is strictly statutory and must be applied mechanically without emotional or moral considerations.

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Residential status is not merely a procedural classification. It forms the foundation upon which the entire taxation framework stands. The nature of income that becomes taxable, the exemptions available, and the tax incidence all depend on how a person or entity is categorized under the Act. Therefore, understanding residential status is essential for every law student, tax practitioner, and judiciary aspirant.

Tip: Always remember that residential status ≠ nationality. An Indian citizen can be a non-resident; a foreigner can become a resident. Focus on statutory tests, not assumptions.

Statutory Basis: Sections 6(1), 6(2), 6(3), and 6(4)

Residential status is governed by Section 6 of the Income Tax Act, 1961, which lays down separate rules for individuals, Hindu Undivided Families (HUFs), companies, and other entities. The section provides scientifically crafted criteria so that taxation is based on economic presence rather than mere identity.

Residential Status of Individuals

Individuals can fall into any one of the following three categories:

Resident and Ordinarily Resident (ROR)
Resident but Not Ordinarily Resident (RNOR)
Non-Resident (NR)

Basic Conditions

Under Section 6(1), an individual becomes a resident in India if they satisfy any one of the two basic conditions:

Stay in India for 182 days or more during the relevant previous year, or
Stay in India for 60 days or more during the previous year and 365 days or more during the four preceding previous years

The Supreme Court in CIT v. Suresh Nanda reaffirmed that the day-counting rule must be strictly applied, and even part-day presence counts as a full day unless otherwise specified.

Additional Conditions

To determine whether a resident individual is ROR or RNOR, two additional conditions apply under Section 6(6):

They must be a resident in at least 2 out of the 10 preceding years, and
They must have stayed in India for 730 days or more in the 7 preceding years.

Failure to satisfy these conditions results in RNOR status.

Tip: Individuals who are returning NRIs often fall under RNOR—a transitional category with limited tax liability. Keep this in mind for practical problems.

Special Relaxations and Amendments

The Finance Act, 2020 introduced key changes to prevent tax abuse through residency loopholes. Notable provisions include:

Deemed resident rule for Indian citizens with total income exceeding ₹15 lakh who are not liable to tax in any other country.
Modification of the 182-day rule to 120 days for certain high-income individuals.

These amendments were introduced after global tax mobility concerns grew, and courts have upheld their validity in landmark decisions such as UOI v. Azadi Bachao Andolan, emphasizing the need for sovereign taxation powers.

Residential Status of HUF

Section 6(2) states that the residential status of a Hindu Undivided Family depends on whether the control and management of its affairs is wholly or partly situated in India. The HUF becomes:

Resident, if control and management is wholly or partly in India
Non-resident, if control and management is entirely outside India

Furthermore, the karta’s residency influences whether it falls under ROR or RNOR categories. Courts in CIT v. Nandlal Gandalal clarified that “control and management” refers to central decision-making, not trivial or routine operations.

Residential Status of a Company

Section 6(3) determines company residency using two tests:

A company is resident if it is an Indian company, or
If its Place of Effective Management (POEM) is in India during that year.

The POEM concept was introduced to curb multinational tax avoidance. The Supreme Court in Radha Rani Holdings Pvt. Ltd. v. CIT highlighted that POEM must be determined based on where key management and commercial decisions are made, not where routine activities occur.

Tip: POEM is a qualitative test—focus on decision-making location, not registration or operational branches.

Residential Status of Firms, AOPs, and BOIs

Under Section 6(4), firms and associations of persons (AOPs) are considered resident if control and management is wholly or partly situated in India. If control is entirely outside India, they are non-resident.

This classification ensures that economic nexus, rather than place of formation, drives taxation.

Tax Incidence: What Income Becomes Taxable?

Residential status directly determines tax incidence, meaning the extent to which income becomes taxable in India.

The Act recognizes three types of taxable situations:

Income received or deemed to be received in India
Income accruing or arising in India
Income accruing or arising outside India

The category of residence determines which of these classes is taxable.

Tax Incidence for ROR

An individual who is Resident and Ordinarily Resident is taxed on:

Global income
Income received in India
Income accruing in India
Income accruing outside India

ROR status carries the widest tax base, consistent with OECD international tax principles.

Tax Incidence for RNOR

RNORs are taxed only on:

Income received in India
Income accruing or arising in India
Income from business controlled or profession set up in India, even if it accrues abroad

Foreign income not connected to India remains exempt. Courts in CIT v. P.V.A.L. Kulandagan Chettiar held that double taxation must be avoided where possible through treaty benefits.

Tax Incidence for NR

Non-residents have the narrowest base—they are taxed only on:

Income received or deemed to be received in India
Income accruing or arising in India

Income outside India is not taxed.

Tip: Always draw the tax incidence table in exams—it fetches extra marks and shows conceptual clarity.

Deemed Income and Accrual

The Act contains deeming provisions under Sections 7 to 9. For example:

Section 9 deems certain incomes (e.g., interest, royalties, fees for technical services) to accrue in India even if paid abroad.
The Supreme Court in Ishikawajima-Harima Heavy Industries Ltd. v. DIT highlighted territorial nexus requirements, ensuring fairness in taxing cross-border transactions.

Importance of Residential Status in Practical Taxation

Residential status affects:

TDS applicability
DTAA treaty relief
Taxability of gifts
Foreign asset disclosure (Schedule FA)
GAAR and POEM rules
Applicability of exemptions like Section 10 clauses