Introduction

The concept of ‘resident of a Contracting State’ has various functions and is of importance for following reasons:

1. in determining a convention’s (treaty) personal scope of application;

2. in solving cases where double taxation arises in consequence of double residence;

3. in solving cases where double taxation arises as a consequence of taxation in the State of residence and in the State of source or situs.

Synopsis of the Article 4 of the Treaty

Article 4 of the OECD model deals with residence of a person, is sub-divided into three paragraphs.

1. The first paragraph lays down the basic conditions to be satisfied to become a resident of one of the contracting states. However, there can be situations where a person will become a resident in both the contracting states. Thus, there will be a tie between the claims of the two states regarding the residence of the same person.

2. To resolve the above situation, second and the third paragraph provide further tests for the claim of residence. These two paragraphs are popularly known to lay down the tie-breaker tests.

3. The second paragraph lays down the tie-breaker tests for persons who are individuals.

4. For persons other than individuals, the tie is resolved by referring to the additional criteria laid down under paragraph 3.

Explanation of paragraphs of the Article 4

1. Paragraph (1) of Article 4

Any person, who is resident of one of the contracting states, as per the domestic laws, by reasons of his domicile, residence, place of effective management / incorporation & criteria of similar nature will be considered as resident under the treaty. UN & the OECD model both use same wordings for Article 4. “Place of incorporation” is an additional criteria specified in paragraph 1 for becoming a resident under the UN model, as compared with OECD model.

The US Model has two additional criteria in paragraph 1; i.e. citizenship and place of Incorporation. Also there is an additional condition for income derived and paid by partnership, estates or trusts.

The second sentence Article 4(1) of the OECD model convention needs to be considered carefully. The sentence reads as “This term, however, does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein.” It is interesting to note that most of the treaties entered by India do not contain the second sentence.

2. Paragraph 2 of Article 4

If an individual is resident of both countries under the respective domestic laws (by applying paragraph 1), resident-resident conflict arises, as both countries would naturally claim “full tax liability” over the person. This situation is avoided by the treaty, by providing that a person would be resident of any one of the countries. This paragraph lay down a number of subsidiary criterions in decreasing order of preference, to determine the attachment of the individual person with only one of the countries. These steps are also popularly referred to as the tie-breaker test.

The tests (to be applied in serial order) laid down under article 4(2) can be summarized as follows:

1. Permanent Home Test: 4 (2) (a)

The Individual will be resident of the state in which he has permanent home available to him. The concept of home, here may mean any form of dwelling place, or apartment belonging to or rented by the individual, rented furnished room. But the permanence of the home is the most essential. Thus the dwelling available to him at all times continuously, and not occasionally for the purpose of a stay or for short duration say for example travel for pleasure, business travel, educational travel, attending a course at a school, etc.

In most cases the permanent home test will resolve the tie of double residence.

2. Centre of Vital Interest Test: 4 (2) (a)

This test is applicable in case where the individual has permanent home in both the states, here just availability of permanent home is to be considered, the size the quality, value of premises does not matter. The person will be resident of the state where his centre of vital interest lies.

The term “Centre of Vital Interest” means the place where personal and economical interests of an individual are concentrated. Personal interest will generally mean his family, social relations, political & cultural activities. Economical interest will generally mean his occupation business or profession i.e. his source of livelihood.

For example, if an individual moves for an employment from one state to another and establishes a home in the other state, but retains the home in the first state where his family still continues to live. In such a case his centre of vital interest will be in the first state.

3. Habitual Abode Test: 4 (2) (b)

This test is applicable in two distinct type of situation, one in case if the individual has permanent home in neither of the states, second while the individual has permanent home in both states and centre of vital interest cannot be determined.

The habitual abode implies the continuous, repeated and persistent stay. While the permanent home is available to a person in both the states, the frequency of his stay in a particular state will become the deciding factor. While considering his stay in a particular state the period for which he stays at the permanent home as well as the period for which he stays in some other place in the same state will also be considered.

The comparison must cover a sufficient length of time for it to be possible to determine whether the residence in each of the two States is habitual and to determine also the intervals at which the stays take place. Neither the Model Conventions nor the commentaries specify the length of time.

4. Nationality: 4 (2) (c)

If the habitual abode test also does not resolve the tie, the individual is considered to be a resident of the state of which he is a national. The term “National” will have the same meaning as given by article 3 (1) (f).

5. Mutual Agreement Procedure: 4 (2) (d)

In case where an individual is national of both states, or national of a third state the competent authorities will have to resolve the situation. In most of the cases, the nationality tests will break the tie of dual residence. However, recently many advanced countries have started accepting the concept of Dual Citizenship. Thus in such cases a Mutual Agreement Procedure under Article 25 will have to be initialled to resolve the difficulty.

3. Paragraph 3 of Article 4

This paragraph lays down the tie-breaker tests for persons other than individuals. Generally for persons other than individuals the question of the dual residence does not arise. It only arises when the two states follow different criteria for residence under domestic tax law For example, one country follows place of incorporation and the other follows place of management. OECD do not consider registration of the entity as an adequate criterion for the purpose of determining the residence under this article. If a non individual is resident of both the states as per Article 4 (1), then it will be considered to be a resident of the state where it has its place of effective management.

“Place of Effective Management” – Place of effective management is said to be at a place where head of the organization is situated, means where key management and commercial decisions that are necessary for the conduct of its business in substance are made. The key factors in determining the place of effective management may be considered as follows:

1. Where the top-level management meets to plan the affairs of the business and policies important for the conduct of the business are decided.

2. Where the business operations are actually conducted.

3. Legal factors such as place of incorporation, location of registered office, etc.

4. Where controlling shareholders make key management and commercial decisions in relation to the company.

5. Where the directors reside.

According to Prof Klaus Vogel, a place of management exists where management directives are given and not where they take effect.

The place of residence of a manager who exercises control would, thus, be relevant.

Indian Case Laws

The definition of “resident” as discussed above has led to controversies regarding its application. Let us take a quick look at some of the Indian case laws on the subject.

1. M.A. Rafiq vs. CIT 213 ITR 317 (AAR)

This was the one of the initial rulings involving the concept of residence under the provisions of the India-UAE treaty. The applicant Mr. Rafiq, was a non-resident of India and was resident of UAE and so claimed the beneficial treatment as per India – UAE Treaty for his Indian sourced income. The department contended that, as there is no tax on individual in UAE, Treaty benefits should not be allowed.

The authority held that a person could be a resident of a State as per Article 4(1) even if there is no actual taxation measure in that state. The consideration will be the existence of some kind of nexus (as mentioned in the article) between the person and the state concerned, to make him liable to be subjected to tax in that state.

2. Rajnikant R. Bhatt (Dr.) 222 ITR 0562 (AAR)

The AAR on the basis of its own decision in MA Rafiq held that a person can claim the treaty benefits although he is not liable to tax in UAE.

3. Cyril Eugene Pereira, In re 239 ITR 0650 (AAR)

The issue involved in this case was the same as discussed in the case Mr. M A Rafiq and Rajnikant R. Bhatt. But the AAR held that UAE Treaty benefits would not be available to individual on the basis of following reasons:

1. Treaties can relieve double tax but cannot encourage tax avoidance.

2. Since individuals are not “liable to tax” in UAE, he could not be treated as resident of UAE and the fact that he was non-resident of India was not in doubt. Thus as he was neither resident of India nor of UAE, he would not be able to access the treaty.

3. Discussing Article 10 (Dividends) AAR noticed that Para 2 of Article 10 uses the word ‘also’ which presupposes that a tax is leviable under para 1 of the Article. Para 1 gives right to the resident state to tax the person whereas para 2 gives right to the source state to tax the person at concessional rate.

4. Thus it was concluded that once resident state does not tax, there is no question of source state taxing it at a concessional rate.

4. Supreme Court judgment in the case of UOI vs. Azadi Bachao Andolan and Another (263 ITR 706)

In this case, for the matter of determination of residence, SC distinguished between “liable to tax” and “payment of tax” which are the terms generally used in the treaty. It stated that:

“In our view, the contention of the respondents proceeds on the fallacious premise that liability to taxation is the same as payment of tax. Liability to taxation is a legal situation; payment of tax is a fiscal fact. For the purpose of application of Article 4 of the DTAC, what is relevant is the legal situation, namely, liability to taxation, and not the fiscal fact of actual payment of tax. If this were not so, the DTAC would not have used the words ‘liable to taxation’, but would have used some appropriate words like ‘pays tax’.

Discussing the issue whether certificate of residence is enough to prove the residential status SC upheld the circular issued by CBDT which directed the assessing authorities to accept the certificate of residence issued by the authority of the other state.

5. In TVM Ltd. vs. Commissioner of Income-tax (102 Taxman 578) it was held that if a company in Mauritius pays NIL tax, then it will not be considered as a resident in Mauritius and therefore not eligible for relief under DTA. However, in view of Supreme Court judgment the ratio of the above decision would not be applicable.
    

6. Emirates Fertilizer Trading Company WLL (AAR No. 628 of 2004)

In this case the applicant was a partnership firm and a resident of UAE. It acquired shares of listed companies and proposed to dispose of the said shares. It was held by the Authority that the capital gains arising from alienation of the shares in Indian companies to the applicant who is a resident of UAE are taxable only in UAE. Under the Act, it cannot be disputed that capital gains arising to a non-resident in India, are taxable in India. Having regard to section 90(2) of the Act, the terms of the treaty have overriding effect over the provisions of the Act in the event of there being conflict between the treaty and the Act. [(Union of India vs. Azadl Bachao Andolan (SC) 263 ITR 706 and RV.A.L Andagan Chettiar 267 ITR 654 (SC)]. It follows that in view of the provisions of para 3 of Article 13 of the treaty, the capital gains arising to the applicant can be taxed only in UAE and not in India and that their taxability under the Act in India does not depend upon whether they are as a fact taxable in UAE. Accordingly, it was held that gains from alienation of shares in Indian companies held by the applicant, a resident of UAE, will not be taxable in India.

7. Green Emirates Shipping & Travel (ITA No. 3784 / Mum / 2002)

In this case the Tribunal took a view that entities can claim the treaty benefit even if they are not liable to pay tax in UAE. In this case the entity was a partnership firm and was allowed the treaty benefit. The term resident as defined in Treaty states that the person should to be liable to tax by reason of his domicile, residence, place of management, place of incorporation or any other criterion of similar nature. As per tribunal the term “liable to tax” has to be read in conjunction with the later part and not in isolation. Reading the full definition in totality it held that UAE was having the right to charge the person with tax due to the different criterion mentioned and hence the person was resident of that country although presently there was no tax levied on that person. The Tribunal also said that they were not pursued by the Order of the AAR where AAR has not given the Treaty benefits to the assessee.