TAXATION OF GIFTS MADE TO NON-RESIDENTS

The Finance (No. 2) Act, 2019 has inserted
section 9(1)(viii) in the Income-tax Act, 1961 (the Act) regarding deemed
accrual in India of gift of money by a person resident in India to a
non-resident. In this article we discuss and explain the said provision in
detail.

INTRODUCTION

Taxation of gifts in India has a very long
and chequered history. Ideally, taxes are levied on income, either on its
accrual or receipt. However, with the object of expanding the tax base, the
Indian tax laws have evolved the concept of ‘deemed income’. Deemed income is a
taxable income where the law deems certain kinds of incomes to have accrued to
an assessee in India.

Similarly, the legislation in India uses the
concept of deemed income to tax gifts. The Gift Tax Act, 1958 was introduced
with effect from 1^st April, 1958 and subsequently amended in the
year 1987. It was repealed w.e.f. 1^st October, 1998. Till that date
(1^st October, 1998), all gifts (including gifts to relatives)
barring a few exceptions were chargeable to gift tax in the hands of the donor.
The gifts were taxed at a flat rate of about 30% then, with a basic exemption limit
of Rs. 30,000.

With the
abolition of the Gift Tax Act, 1958 w.e.f. 1^st October, 1998, gifts
were not only used for wealth and income distribution amongst family members /
HUFs, but also for conversion of money. With no gift tax and exemption from chargeability
under the Income-tax Act, gifts virtually remained untaxed until a donee-based
tax was introduced by inserting a deeming provision in clause (v) of section
56(2) by the Finance Act, 2004 w.e.f. 1^st April, 2005 to provide
that any sum of money received by an assessee, being an individual or HUF,
exceeding Rs. 25,000 would be deemed to be income under the head ‘Income from
other sources’. Certain exceptions, like receipt of a gift from a relative or
on the occasion of marriage, etc., were provided.

The Act was amended w.e.f. 1^st
April, 2007 and a new clause (vi) was inserted with an enhanced limit of Rs.
50,000. Another new clause (vii) was inserted by the Finance (No. 2) Act, 2009
w.e.f. 1^st October, 2009 to further include under the deeming provision
regarding receipt of immovable property without consideration.

When the Act was amended vide Finance Act,
2010 w.e.f. 1^st June, 2010, a new clause (viia) was inserted to also
tax (under the deeming provision) a receipt by a firm or company (not being a
company in which public are substantially interested) of shares of a company
(not being a company in which public are substantially interested) without
consideration or at less than fair market value.

Via the Finance Act, 2013, and w.e.f. 1^st
April, 2013, another new clause (viib) was inserted for taxing premium on the
issue of shares in excess of the fair market value of such shares.

Yet another important amendment was made
vide the Finance Act, 2017 w.e.f. 1^st April, 2017 suppressing all the
deeming provisions except clause (viib) and a new clause (x) was inserted.

At present, clause (viib) and clause (x) of
section 56(2) are in force and deem certain issue of shares or receipt of money
or property as income.

SECTION 56(2)(X) AND OTHER RELATED PROVISIONS

Section 56(2) provides that the incomes
specified therein shall be chargeable to income tax under the head ‘Income from
other sources’.

Section 56(2)(x) provides that w.e.f. 1^st
April, 2017, subject to certain exemptions mentioned in the proviso thereto,
the following receipts by any person are taxable:

(a) any sum of money without consideration,
the aggregate value of which exceeds Rs. 50,000;

(b) any immovable property received without
consideration or for inadequate consideration as specified therein; and

(c) any specified property other than
immovable property (i.e., shares and securities, jewellery, archaeological
collections, drawings, paintings, sculptures, any work of art or bullion)
without consideration or for inadequate consideration, as specified therein.

It is important to note that the term
‘consideration’ is not defined under the Act and therefore it must have the
meaning assigned to it in section 2(d) of the Indian Contract Act, 1872.

The proviso to
section 56(2)(x) provides for exemption in certain genuine circumstances such
as receipt of any sum of money or any property from any relative, or on the
occasion of a marriage, or under a Will or inheritance, or in contemplation of
death, or between a holding company and its wholly-owned Indian subsidiary, or
between a subsidiary and its 100% Indian holding company, etc.

Section
2(24)(xviia) provides that any sum of money or value of property referred to in
section 56(2)(x) is regarded as income.

Section 5(2) provides that non-residents are
taxable in India in respect of income which accrues or arises in India, or is
deemed to accrue or arise in India, or is received in India, or is deemed to be
received in India.

SECTION 9(1)(VIII)

The Finance (No. 2) Act, 2019 inserted
section 9(1)(viii) w.e.f. A.Y. 2020-21 to provide that any sum of money
referred to in section 2(24)(xviia) arising outside India [which in turn refers
to section 56(2)(x)], paid on or after 5^th July, 2019 by a person
resident in India to a non-resident, not being a company, or to a foreign
company, shall be deemed to accrue or arise in India.

Section 9(1)(viii) creates a deeming fiction
whereby ‘income arising outside India’ is deemed to ‘accrue or arise in India’.

Prior to the insertion of section
9(1)(viii), there was no provision in the Act which covered the gift of a sum
of money given to a non-resident outside India by a person resident in India if
it did not accrue or arise in India. Such gifts therefore escaped tax in India.
In order to avoid such non-taxation, section 9(1)(viii) was inserted.

Section 9
provides that certain incomes shall be deemed to accrue or arise in India. The
fiction embodied in the section operates only to shift the locale of accrual of
income.

The Hon’ble Supreme Court in GVK
Industries vs. Income Tax Officer (2015) 231 Taxman 18 (SC) while
adjudicating the issue pertaining to section 9(1)(vii) explored the ‘Source
Rule’ principle and laid down in the context of the situs of taxation,
that the Source State Taxation (SST) confers primacy and precedence to tax a
particular income on the foothold that the source of such receipt / income is
located therein and such principle is widely accepted in international tax
laws. The guiding principle emanating therefrom is that the country where the
source of income is situated possesses legitimate right to tax such source, as
inherently wealth is physically or economically generated from the country
possessing such an attribute.

Section 9(1)(viii) deems income arising
outside India to accrue or arise in India on fulfilment of certain conditions
embedded therein, i.e. (a) there is a sum of money (not any property) which is
paid on or after 5^th July, 2019; (b) by a person resident in India
to a non-resident, not being a company or to a foreign company; and (c) such
payment of sum of money is referred to as income in section 2(24)(xviia) [which
in turn refers to section 56(2)(x)].

Section 9(1)(viii) being a deeming
provision, it has to be construed strictly and its scope cannot be expanded by
giving purposive interpretation beyond its language. The section will not
apply to payment by a non-resident to another non-resident.

It is to be noted that any sum of money paid
as gift by a person resident in India to a non-resident during the period 1^st
April, 2019 to 4^th July, 2019 shall not be treated as income deemed
to accrue or arise in India.

Exclusion of gift of property situated
in India:

Section 9(1)(viii) as proposed in the
Finance (No. 2) Bill, 2019 had covered income ‘…arising any sum of money
paid, or any property situate in India transferred…’

However, section 9(1)(viii) as enacted reads
as ‘income arising outside India, being any sum of money referred to in
sub-clause (xviia) of clause (24) of section 2, paid…’

For example, if a non-resident receives a
gift of a work of art situated outside India from a person resident in India,
then such gift is not covered within the ambit of section 9(1)(viii).

Thus, as compared to the proposed
section, the finally enacted section refers to only ‘sum of money’ and
therefore gift of property situated in India is not covered by section
9(1)(viii). It appears that the exclusion of the
property situated in India from the finally enacted section 9(1)(viii) could be
for the reason that such gift of property could be subjected to tax in India
under the existing provisions of section 5(2) where any income received or
deemed to be received in India by a non-resident or on his behalf is subject to
tax in India.

Non-application to receipts of gifts
by relatives and other items mentioned in proviso to section 56(2)(x):

As mentioned above, section 9(1)(viii) deems
any sum of money referred to in section 2(24)(xviia) to be income accruing or
arising in India, subject to fulfilment of conditions mentioned therein.

Section 2(24)(xviia) in turn refers to sum
of money referred in section 56(2)(x) and regards as income only final
computation u/s 56(2)(x) after considering exclusion of certain transactions
like gifts given to relatives or gift given on the occasion of marriage of the
individual, etc., as mentioned in the proviso to section 56(2)(x).

Thus, for example, if there is a gift of US$
10,000 from A who is a person resident in India, to his son S who is a resident
of USA, as per the provision of section 56(2)(x) read with Explanation
(e)(i)(E) of section 56(2)(vii), the same will not be treated as income u/s
9(1)(viii).

Therefore,
the insertion of section 9(1)(viii) does not change the position of non-taxability
of receipt of gift from relatives or on the occasion of the marriage of the
individual, etc. Similarly, the threshold limit of Rs. 50,000 mentioned in
section 56(2)(x) would continue to apply and such gift of money up to Rs.
50,000 in a financial year cannot be treated as income u/s 9(1)(viii).

It is important
to keep in mind that section 5 broadly narrates the scope of total income.
Section 9 provides that certain incomes mentioned therein shall be deemed to
accrue or arise in India. However, total income under the provisions of the Act
has to be computed as per the other provisions of the Act, and while doing so
benefits of the exemptions / deduction would have to be taken into account.

In this connection, the relevant portion of
the Explanatory Memorandum provides that ‘However, the existing provisions
for exempting gifts as provided in proviso to clause (x) of sub-section (2) of
section 56 will continue to apply for such gifts deemed to accrue or arise in
India.’

The Explanatory Memorandum, thus, clearly
provides for application of exemptions provided in proviso to section 56(2)(x).

Income arising outside India:

Section
9(1)(viii) uses the expression ‘income arising outside India’ and, keeping in
mind the judicial interpretation of the meaning of the term ‘arise’ or
‘arising’ (which generally means to come into existence), the income has to
come into existence outside India, i.e. the gift of money from a person
resident in India to a non-resident has to be received outside India by the
non-resident.

PERSON RESIDENT IN INDIA AND NON-RESIDENT

Person resident in India:

The expression ‘person resident in India’
has been used in section 9(1)(viii). The term ‘person’ has been defined in
section 2(31) of the Act and it includes individuals, HUFs, companies, firms,
LLPs, Association of Persons, etc.

The term ‘resident in India’ is used in
section 6 which contains the rules regarding determination of residence of
individuals, companies, etc.

It would be very important to minutely
examine the residential status as per the provisions of section 6 to determine
whether a person is resident in India as per the various criteria mentioned
therein, particularly in case of NRIs, expats, foreign companies, overseas
branches of Indian entities, for proper application of section 9(1)(viii).

Non-resident:

Section 2(30) of the Act defines the term
‘non-resident’ and provides that ‘non-resident’ means a person who is not a
‘resident’ and for the purposes of sections 92, 93 and 268 includes a person
who is not ordinarily resident within the meaning of clause (6) of section 6.

Therefore, for the purposes of section
9(1)(viii), a not ordinarily resident is not a ‘non-resident’.

It is to be noted that residential status
has to be determined as per provisions of the Income-tax Act, 1961 and not as
per FEMA.

Obligation to deduct tax at source:

Section 195 of the Act provides that any
person responsible for paying to a non-resident any sum chargeable to tax under
the provisions of the Act is obliged to deduct tax at source at the rates in
force. Accordingly, provisions of section 195 would be applicable in respect of
gift of any sum of money by a person resident in India to a non-resident, which
is chargeable to tax u/s 9(1)(viii) and the resident Indian gifting money to a
non-resident shall be responsible to withhold tax at source and deposit the
same in the government treasury within seven days from the end of the month in
which the tax is withheld.

The person resident in India shall be
required to obtain tax deduction account number (TAN) from the Indian tax
department, file withholding tax e-statements and issue the tax withholding
certificate to the non-resident. In case of a delay in deposit of withholding
tax / file e-statement / issue certificate, the resident would be subject to
interest / penalties / fines as prescribed under the Act.

Applicability of the provisions of
Double Taxation Avoidance Agreement (DTAA):

Section 90(2) of the Act provides that where
the Central Government has entered into a DTAA for granting relief of tax or,
as the case may be, avoidance of double taxation, then, in relation to the
assessee to whom such DTAA applies, the provisions of the Act shall apply to
the extent they are more beneficial to that assessee.

Therefore, the relief, if any, under a DTAA
would be available with respect to income chargeable to tax u/s 56(2)(viii).

The Explanatory Memorandum clarifies that
‘in a treaty situation, the relevant article of applicable DTAA shall continue
to apply for such gifts as well.’

A DTAA distributes taxing rights between the
two contracting states in respect of various specific categories of income
dealt therein. ‘Article 21, Other Income’, of both the OECD Model Convention
and the UN Model Convention, deals with those items of income the taxing rights
in respect of which are not distributed by the other Articles of a DTAA.

Therefore, if the recipient of the gift
is a resident of a country with which India has entered into a DTAA, then the
beneficial provisions of the relevant DTAA will govern the taxability of the
income referred to in section 9(1)(viii).

Article 21 of the OECD Model Convention,
2017 reads as follows:

Article 21, Other Income:

(i)   Items of income of a resident of a contracting
state, wherever arising, not dealt with in the foregoing Articles of this
Convention, shall be taxable only in that state;

(ii)   The provisions of paragraph 1 shall not apply
to income, other than income from immovable property as defined in paragraph 2
of Article 6, if the recipient of such income, being a resident of a
contracting state, carries on business in the other contracting state through a
permanent establishment situated therein and the right or property in
respect of which the income is paid is effectively connected with such permanent
establishment. In such case, the provisions of Article 7 shall apply.

Similarly, Article
21 of the UN Model Convention, 2017 reads as follows:

Article 21,
Other Income:

(1) Items of income
of a resident of a contracting state, wherever arising, not dealt with in the
foregoing Articles of this Convention shall be taxable only in that State;

(2) The provisions
of paragraph 1 shall not apply to income, other than income from immovable
property as defined in paragraph 2 of Article 6, if the recipient of such
income, being a resident of a contracting state, carries on business in the
other contracting state through a permanent establishment situated therein, or
performs in that other state independent personal services from a fixed base
situated therein, and the right or property in respect of which the income is
paid is effectively connected with such permanent establishment or fixed base.
In such a case the provisions of Article 7 or Article 14, as the case may be,
shall apply;

(3) Notwithstanding
the provisions of paragraphs 1 and 2, items of income of a resident of a
contracting state not dealt with in the foregoing Articles of this Convention
and arising in the other contracting
state may also be taxed in that other state.

On a comparison of the abovementioned Article 21 of the OECD and UN
Model Conventions, it is observed that Article 21(1) of the OECD Model
Convention provides taxing rights of other income to only a country of
residence.

However, Article 21
of the UN Model contains an additional para 3 which gives taxing rights of
other income to the source country also, if the relevant income ‘arises’ in a
contracting state.

DTAAs do not define
the term ‘arise’ or ‘arising’ and therefore in view of Article 3(2) of the
Model Conventions, the term not defined in a DTAA shall have the meaning that
it has at that time under the law of the state applying the DTAA.

India has currently
signed DTAAs with 94 countries. India’s DTAAs are based on both the OECD as
well as the UN Models. The distribution of taxation rights of other income /
income not expressly mentioned under Articles, corresponding to Article 21 of
the Model Conventions, in the Indian DTAAs can be categorised as under:

Interestingly, in some of the DTAAs that
India has signed with countries where a large Indian diaspora is present, like
the US, Canada, UK, Australia, Singapore, New Zealand, etc., the taxation right
vests with India (as a source country). It is important that provisions of the
article relating to other income is analysed in detail to evaluate if any tax
is to be paid in the context of such gifts under the applicable DTAA.

In cases of countries covered in Sr. Nos.
1 and 2, due to exemption under the respective DTAAs, India would still not be
able to tax income u/s 9(1)(viii) arising to the residents of those countries.

IMPLICATIONS UNDER FEMA

Besides tax
laws, one should also evaluate the implications, if any, under the FEMA
regulations for gifts from a person resident in India to a non-resident. Thus,
one must act with caution to ensure compliance with law and mitigate
unnecessary disputes and litigation at a later date.

CONCLUDING REMARKS

The stated objective of section 9(1)(viii)
has been to plug the loophole for taxation of gifts of money from a person
resident in India to a non-resident. As the taxability is in the hands of the
non-resident donee, there would be a need for the donee / recipient to obtain
PAN and file an income tax return in India where there is a taxable income
(along with the gift amount that exceeds Rs. 2,50,000 in case of an
individual).

In conclusion, this is a welcome provision
providing certainty in the taxability of gifts to non-residents by a person
resident in India.