25. What tests would you apply to determine the residence of : 

Posted on by Raghu Unnam
Law

a) a Hindu undivided family, 

b) a limited company 

c) an Individual 

d) Mention the penalties imposed under the following cases

Understanding the Tax Residency of Different Entities: A Comprehensive Guide

Tax residency is an essential concept under the Income Tax Act of India and other relevant taxation laws globally. The residency status of an individual or an entity determines its tax obligations, including income tax liabilities and the filing of returns. In India, the residency status of various taxpayers, such as Hindu Undivided Families (HUFs), limited companies, and individuals, is assessed differently.

In this article, we will explore the tests that determine the tax residency status for each of these entities under the Indian Income Tax Act and the penalties imposed for non-compliance. Furthermore, we’ll conclude with a mnemonic sentence that helps in remembering the different tests.

1. Tax Residency of a Hindu Undivided Family (HUF)

The Hindu Undivided Family (HUF) is a unique concept in India, primarily consisting of a family living together under a common roof and governed by Hindu Law. The family structure, which is essentially a joint family, can own property, carry out businesses, and generate income. But how does one determine whether an HUF is a resident or non-resident for tax purposes?

Tests to Determine the Residency of HUF:

For tax purposes, the tax residency of a Hindu Undivided Family is determined using the following conditions:

  1. Resident in India: An HUF will be considered a resident in India if the control and management of its affairs are situated in India, or if the Karta (head) of the HUF resides in India for at least 182 days during the previous year.
  2. Non-Resident: An HUF will be considered a non-resident if the control and management of its affairs are situated outside India, and the Karta or any member of the family does not reside in India for the requisite number of days.

Note: The primary test focuses on the “control and management” of the family’s affairs, which means where the family’s financial decisions are being made.

2. Tax Residency of a Limited Company

Limited Companies, whether Indian or foreign, are separate legal entities. Their tax residency status impacts the scope of taxation, particularly in the context of global income and taxation in India.

Tests to Determine the Residency of a Limited Company:

  1. Indian Company: A company is considered an Indian company if it is incorporated under the Companies Act, 2013 or any other Indian law, irrespective of the location of its control and management.
  2. Resident in India: For a company to be classified as a resident of India, it must be “managed and controlled” in India. This means that the company’s decision-making, such as board meetings, must be conducted in India. If the place of effective management (POEM) is located in India, the company will be a resident.
  3. Non-Resident Company: If the company is not incorporated in India and its management and control are situated outside India, it will be considered a non-resident company.

Note: The place of effective management (POEM) is the place where key managerial decisions are made, not just where day-to-day operations are conducted.

3. Tax Residency of an Individual

For individuals, residency status has a direct impact on the income that will be taxed. The Income Tax Act defines a resident and non-resident individual based on their physical presence in India during the relevant financial year.

Tests to Determine the Residency of an Individual:

  1. Resident: An individual will be considered a resident in India if they meet any of the following conditions:
    • Stay in India for at least 182 days during the relevant year.
    • Stay in India for 60 days or more during the relevant year and have been in India for 365 days or more in the four preceding years.
  2. Non-Resident: An individual will be classified as a non-resident if they do not meet either of the above criteria.
  3. Resident but Not Ordinarily Resident (RNOR): A person may be considered “RNOR” if they have been a non-resident in India for 9 out of the last 10 years or if they have stayed for less than 729 days during the preceding 7 years.

Note: The definition of “stay” is critical to determining whether someone qualifies as a resident. The law is designed to capture those who have a substantial presence in India during a given year.

4. Penalties Imposed for Non-Compliance

Failure to comply with tax residency provisions under the Income Tax Act can result in significant penalties. These penalties are levied to encourage taxpayers to accurately declare their income and residence status. Here are some scenarios where penalties may be imposed:

  1. Failure to File Tax Returns:
    • Individuals or entities who do not file their tax returns on time are subject to a penalty ranging from ₹5,000 to ₹10,000, depending on the delay. Additionally, interest under Section 234A, Section 234B, and Section 234C may be imposed on the unpaid tax.
  2. Failure to Pay Taxes:
    • If tax is not paid, an interest of 1% per month is levied on the unpaid amount under Section 234A.
  3. Incorrect Declaration of Tax Residency:
    • If an individual or entity incorrectly declares their tax residency to evade taxes, the Income Tax Department may initiate an inquiry or reassessment. The penalties for such cases can range from 100% to 300% of the taxes due.
  4. Penalty for Underreporting of Income:
    • Under section 270A, if there is an underreporting of income, a penalty of 50% of the tax payable on the underreported income may be imposed.
  5. Failure to Comply with TDS Provisions:
    • If a taxpayer fails to deduct or deposit the required Tax Deducted at Source (TDS), they may face a penalty under Section 234E, along with interest on the amount due.
  6. Tax Avoidance Schemes:
    • If the tax authorities suspect that an individual or entity is using artificial arrangements or evasive schemes to reduce tax liability, they can impose penalties under the General Anti-Avoidance Rule (GAAR).

Summary of Penalties:

  • Failure to file returns: ₹5,000 – ₹10,000
  • Late payment: Interest of 1% per month
  • Incorrect declaration: 100% – 300% of tax due
  • Underreporting: 50% of the tax on underreported income
  • Failure to comply with TDS: Penalties and interest under Section 234E.

Mnemonic :

Mnemonic to Remember the Tests

To help remember the different residency tests for individuals, Hindu Undivided Families (HUFs), and limited companies, here’s a mnemonic:

“HINDI COMPANIES RESIDE IF STAY IN INDIA.”

  1. HINDI: Stands for Hindu Undivided Family — The family’s control and management must be in India.
  2. COMPANIES: Denotes Limited Companies — Managed and controlled in India.
  3. RESIDE: Refers to Residents — Meeting the residency criteria for individuals (182 days or more).
  4. IF: Means Individual — Specific residency test for individuals.
  5. STAY: Refers to physical stay in India as a key test for residency.

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