Residential Status under FEMA and Finance Law

Varun Hariharan

23 Sep, 2020

Determining the period in which an individual stays outside India is crucial for compliance under the respective Foreign Exchange Management Act, 1999 (FEMA) and the Finance Act, 2020. If compliance is not met under the above laws, then the individual would be penalised respectively. Hence it is important to understand the residential status under FEMA and Finance Law. Many times an individual would get confused if he considers the residential status under FEMA and the Income Tax Act, 1961. Therefore, it is crucial to differentiate the residential status under these respective laws. 

Residential Status under FEMA Law

The Reserve Bank of India (RBI) and the Government of India have brought out the foreign exchange management act, 1999 for dealing with foreign exchange transactions. The RBI has various banks authorised under them to carry out respective foreign exchange transactions for individuals. To understand the residential status under FEMA law, it is crucial to interpret different sections under the FEMA.  

For ease of understanding and interpretation, the following have to be considered:

A person who is resident in India (PRII)

The meaning of PRII is interpreted under section 2(v) I of the FEMA Act. It states that if an individual has stayed in India for more than 182 days, then for treatment and residential status, the individual is considered as an Indian Resident. However, section 2(v)i of the FEMA has specific exemptions.

These exemptions do not include the following:

• An individual who has gone outside India for (exemption A)
  • Taking some form of employment with an agency or company.
  • Carrying some form of business or profession.
  • If the individual has an intention of living outside India for a specific period, then the same would be covered under the exemption for section 2(v)i of the FEMA.
• An individual is not considered as a resident Indian who stays or resides in India in typical cases but does not include (exemption B) :
  • Taking up some form of permanent employment in India.
  • Carrying some form of business or profession in India.
  • If a person comes to India and resides in India for an uncertain period, then he would be considered a resident Indian.
• A person who is resident in India would also include an artificial person who has some form of legal status. This will include either a limited liability partnership (LLP), a body corporate which is established in India and any other form of organisation which is established in India.

PROI (person who is resident outside India)

Under section 2(w) of the Foreign Exchange Management Act, 1999 (FEMA) defines a person who is resident outside India. This would include a person who is not resident in India. This would apply to Non-Resident Indians, OCI cardholders and other individuals. Foreigners would also be considered under this definition for determining residential status.

Hence, if we go by the definition under the respective FEMA law, an individual is a resident in India if he or she stays for more than 182 days in the preceding financial year. In India, the residential status is determined by looking at the respective financial year. A financial year in India would begin on April 1 and end on March 31. 

Example for Residential Status under FEMA

As per the above definition, an individual would be considered to be a resident in India if he has stayed in India for more than 182 days in the preceding financial year. For example, consider the financial year 2018-19, if an individual says ‘X’ stays in the preceding financial year, i.e. 2017-18 from the financial year beginning April 1, 2017, to March 31 2018, then this would be considered as the preceding financial year for  2018 -19.

If X stayed more than 182 days in 2017-18, then he would be considered a resident to determine the residential status of ‘X’.  For understanding the residential status under FEMA, we have to consider the number of transactions which occur within the financial year. This interpretation is different from that which is explained under the Income Tax Act, 1961.

For understanding the above example, we can also apply the respective definitions which relate to the definition of a person resident in India under section 2(v)i of the FEMA act 1999. If the person goes outside India for employment or carrying out business, then he will not be considered as a resident.

However, if the individual comes for a specific period, say for a month within the financial year and then goes back abroad for employment. As per the above he will be still treated as a non-resident as per section 2(w) of the FEMA act. In 182 days, if the individual stays 30 days outside India, then he would not be considered as a resident for determining the residential status.

Residential Status under Income Tax Act, 1961

There is always confusion while determining the residential status between FEMA and the Income Tax Act, 1961. To avoid this confusion, it is crucial to understand the meaning of residential status under the Income Tax Act.  To come up with an answer to determine the residential status, we have to look into section 6(1) of the Income Tax Act, 1961.  There are two tests for understanding the status of an individual under the Income-tax Act.

For determining the residential status of an individual, it is important to understand these tests. Here it is necessary to classify the tests as Test 1, Test 2 and Test 3. If an individual or a person falls under one of the above tests, then he will be considered as a resident Indian.

Test 1

This test is used to identify if the individual is a resident of India. To determine the tax status, the Income-tax department would use the below test for understanding the status of the assessee. As per the test, the following has to be satisfied:

• Suppose the individual is present in India in the previous year for a period of more than 182 days. This period can be in separate intervals. Say the individual comes to India after every month, then the whole period has to be taken into consideration for calculating the above; OR
• Suppose the individual was present in India for more than 365 days. This period of 365 days would be applicable for the four previous years. For calculation and computation, the preceding years would be considered; AND
• If the individual has spent more than 60 days or more in the previous year, then he/she would be considered a resident under the Income Tax Act 1961.

An individual who has satisfied the above criteria would be considered as a resident for the tax treatment. Hence an individual who fulfils the criteria would be considered as a resident for tax treatment.

Test 2

This test is used to identify if the individual is considered as an ordinary resident for tax treatment. This test is known as the ROR test or Resident Ordinary Resident Test. So for being considered as a resident, an individual has to satisfy the criteria under Test 1. To fulfil the condition of being considered an ordinary resident in India, there are two other specifications which have to be satisfied by the resident.

Hence to be considered under the ROR, the individual has to fulfil the conditions which are laid down in Test 1 along with the other conditions which are specified below:

• The individual has to be a resident of India in the previous two years out of 10 years. The period of 10 years would be previous years to determine the tax status. This must be immediately before the period of the year in question; and
• The individual must have also stayed in India for more than 730 days in the last seven years.

Test 3

This test is used to identify if the individual is considered a resident but not an ordinary resident. This test is also known as the RNOR test or called as the Resident Not Ordinary Resident test.

To satisfy the criteria and conditions of the RNOR test, the individual must satisfy the requirements of test 1 along with some other conditions.

• The individual can claim some form of status (beneficial status) to not be treated as an RNOR, under section 6(1) of the Income Tax Act, 1961 if the following conditions can be proved:
  • The individual was characterised as a resident in India for nine years out of the previous ten years before the relevant year in question. OR
  • The individual was present in India for a period of lesser than 729 days in the previous seven years of the preceding year. 

Hence, to understand the residential status under the Income Tax Act, 1961, the individual must satisfy the conditions which are laid down in Test 1. If the ROR status wants to be satisfied, then the individual must satisfy the criteria which are set out in Test 1 as well as specific conditions which are laid down in Test 2. Two conditions have to be satisfied in Test 1 along with the other conditions which are laid down in Test 2. Suppose the individual wants to satisfy the criteria for Test 3. In that case, two conditions in Test 1 along with the conditions in Test 3 must be satisfied for residential status under the Income Tax act.  

Difference between FEMA and Income Tax Law for Residential Status

Under the Income Tax law, all the above tests must be satisfied to consider the individual as a resident Indian. However, the conditions which are present under the Income Tax Law are different when compared to the conditions which are present under FEMA.  Both FEMA and Income Tax laws are different. When applying FEMA for treatment of residential status,  the amount of transactions performed is considered for the treatment of tax. The transactions have to be performed between a resident and non-resident.

When it comes to the income tax act, all the tests have to be satisfied. However, the basic test, i.e. test one is similar when interpreting section 2(v) of FEMA and 6(1) of theIncome Tax Act, 1961.

Changes in law and residential status of Non-Resident Indian as per Finance Act 2020

In 2020, the finance bill was promulgated and passed by the parliament. This bill has received royal assent from the president and is considered as law for Income Tax and FEMA regulation in India. The bill has become the law and is considered as the Finance Act, 2020.

There are significant amendments made in the residential status to be classified as a residential Indian and NRI. The following are the amendments:

• Until the financial year 2019-20, an NRI was considered as an individual who has stayed in India for more than 182 days. This would apply to Non-Resident Indian’s as well as Persons of Indian Origin. This period of 182 days has been reduced to 120 days to be considered an NRI. This would be an alarming scenario to different NRI who have income in India.
• This reduced period of 120 days would only apply if the following conditions are met:
  • The individual who is visiting India has some form of Income which is from Indian resources such as dividend income, income from some form of capital gains and other expenditure.
  • Income which is earned in the respective financial year crosses more than INR 15 Lakhs.
  • The individual coming to India would have to keep a check on the finances received in India. If the taxable income received by the Indian individual exceeds 15 lakhs, then the 120 day period would be applicable.
  • Taxable income would include any form of dividend which is distributed by an Indian company.
  • This notification would only be applicable to the relevant financial year, i.e. 2020-21 April 2020 to March 2021.
  • Apart from this, the individual would also need to check, if he has stayed for a period of more than 365 days in the past four years if his amount of taxable income exceeds more than 15 lakhs. In such a circumstance, the Individual would be treated as a resident Indian.
  • The requirement of the RNOR test has been maintained as per relevant authorities.
  • If the individuals are treated as the same status as the RNOR, then foreign income would not be taxable as per applicable financial law.

Therefore from the above, the finance act, 2020 has not repealed the meaning of NRI under respective FEMA and Income Tax Law. Only changes are the taxable income which is earned by an individual under the respective laws.

Conclusion

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