27 January 2022 - Article
When India’s 2020 Budget was announced on February 1, the proposed changes to the tax residency rules caused jitters among wealthy non-resident Indians (NRI) and persons of Indian origin (PIO). With effect from April 1, 2020 the threshold for residence was supposed to go down to 120 days (from 182 days) and Indian citizens living in zero tax countries risked being deemed residents of India.
Significant changes have been made to the new residency tests in the final bill which was approved by Parliament on March 23. We have summarized the key changes and some planning considerations for wealthy families and entrepreneurs.
New residency test for individuals
Residents of India are subject to worldwide income tax and reporting obligations. NRIs and PIOs will continue to be treated as residents if they spend at least 182 days of the year in India. They may also become residents if their income from sources in India exceeds INR 1.5 million in any year and their time spent in India is at least 120 days in the relevant year and 365 days in the last 4 years.
An NRI having income from sources in India exceeding INR 1.5 million in a year would be a deemed resident if he lives in a zero tax country.
The new rules retain the existing criteria for ‘resident who is not ordinarily resident’ (RNOR), but with two additions. NRIs or PIOs whose income from sources in India exceeds INR 1.5 million in any year may be considered as RNOR if they spend between 120 to 182 days of the year in India. NRIs who are deemed to be resident because they live in a zero tax country would also be treated as RNORs.
Unlike ordinary residents, RNORs are taxed on income sourced in India or foreign source income derived from a business controlled in India. RNORs are also not required to disclose overseas trusts, bank accounts or financial interests.
While it may seem that RNORs are broadly taxed like non-residents, there are specific risks that an RNOR has to consider. An RNOR may still be viewed as a resident for the purpose of automatic information exchange with India under common reporting standards. An RNOR who exercises control over companies and trusts outside India may create Indian tax residency risks for the overseas entities. There is also a risk that foreign source income of an RNOR may be taxed on the basis that he controls the overseas entities that distribute the income.
Planning considerations for wealthy families and entrepreneurs
The 43% tax rate in India for individuals has pushed several wealthy families and entrepreneurs to become non-residents and consolidate investment holdings outside India. The COVID-19 lockdowns remind us of the reality that we may be grounded in a specific country and risk becoming a tax resident for reasons that we cannot control. Some families and entrepreneurs are using this time to analyze their cross-border corporate and trust structures and explore options to mitigate potential risks going forward.
- Managing income from sources in India: The new residency thresholds (ie 120 to 182 days) for being considered an RNOR apply to individuals whose income from sources in India exceeds INR 1.5 million. However, this risk may not arise if the Indian assets generating the income are held through an appropriate structure, whether in India or overseas.
- Citizenship and residency planning: To address deemed residency risks, wealthy NRIs and PIOs are likely to consider shifting residence from zero tax countries to countries like Singapore or UK. More Indians are also likely to consider getting alternative passports through various citizenship by investment programs in the EU and Caribbean.
- ‘Tie breaker’ relief: NRIs and PIOs who risk becoming an Indian resident or RNOR can claim relief under the ‘tie-breaker’ test of the applicable tax treaty in order to justify residence in the relevant country outside India.
- Expatriation of wealth: Wealthy families often use a number of avenues permitted by Indian forex control rules to take wealth out of India over a period of time. The overhaul of India’s dividend tax regime in the 2020 Budget may prompt business owners to take out significant cash trapped in their Indian companies. Multiple layers of holding companies will also not result in tax leakages at each level. While a resident individual may subject to a 43% tax on dividends, non-residents can significant reduce this tax while relying on an appropriate tax treaty (where rates range between 5-15%).
- Overseas trusts: Indian families are becoming increasingly comfortable with using various types of trust structures for purposes of succession planning, asset protection and confidentiality. In several cases, trusts are also useful vehicles to consolidate income generating assets (both liquid and business holdings) overseas. Certain trusts can also become tax blockers from an Indian perspective even in a scenario where the relevant individuals become Indian residents.
- Overseas investment and business structures: Several entrepreneurs have been exploring options to invert their business holdings outside India or create parallel structures to capture value overseas. Wealth generated from these businesses are also invested through overseas structures. To manage tax risks, decision makers connected to the overseas structures have to retain their non-resident status. Using an overseas family office in the structure also enhances governance, economic substance and effective control outside India. The family office regime in Singapore has become particularly attractive for Indian families due to its reputation and tax incentives available for investment management activities.
If you have any queries, please contact Mahesh Kumar.