Section 5(2) of the Income Tax Act – Taxability of Non-Resident Income

Every country taxes income that has a connection to its economy. India follows the same principle, but the link depends on whether the person earning that income is a resident or a non-resident.
Section 5 of the Income Tax Act lays down this foundation, and its subsection (2) specifically explains how income of non-residents (NRIs or foreign citizens) is treated.

Unlike Indian residents, who pay tax on global income, non-residents are taxed only on income that is earned, received, or deemed to arise in India. This creates a fair system where only income linked to India falls within the tax net.

Why Section 5(2) Exists

Section 5(2) ensures that India taxes only what is genuinely connected to its territory. It sets clear boundaries — so that NRIs aren’t taxed twice & the government rightfully collects tax where economic activity happens.

Put simply, this section determines which part of a non-resident’s income is taxable in India, depending on where it was earned and where it was received.

What Constitutes Total Income for a Non-Resident

Section 5(2) states that the total income of any previous year of a person who is a non-resident includes:

1. Income received or deemed to be received in India during the previous year, and
2. Income accruing or arising or deemed to accrue or arise in India during that year."

That means if money is received directly in India, or if the income originates from Indian sources, it is taxable in India.

Example:
An NRI working in London receives professional fees directly in an Indian bank account. Since the receipt happened in India, the income becomes taxable in India under Section 5(2).

Also Read: Income Deemed to Accrue or Arise

Section 5(1) vs Section 5(2): Resident vs Non-Resident

Here’s a quick look at how the rule differs for residents & non-residents:

So, Section 5(2) acts like a filter, ensuring that income unrelated to India doesn’t attract Indian tax.

Connection with Section 6 – Residential Status Matters

Before you can apply Section 5(2), you must determine whether the person is resident or non-resident under Section 6.
A person becomes a non-resident if they stay in India for less than 182 days in a year (or don’t meet the cumulative 365 days over 4 years 60 days in the current year rule).

This residential test is crucial, because a single change in status can alter the tax treatment entirely. A person can be resident one year & non-resident the next — depending on the number of days spent in India.

When is Income “Deemed” to Arise in India

Even if an income is earned abroad, it can still be deemed to accrue or arise in India under certain conditions listed in Section 9.
Common examples include:

• Salary for services rendered in India
• Business operations connected to India
• Royalties or technical fees paid by an Indian company
• Transfer of a capital asset situated in India

Example:
If a U.K. consultant completes a project for a Mumbai client, the consultancy fee is deemed to accrue in India — even if the payment goes abroad.

Understanding “Receipt of Income”

One of the most debated lines in Indian tax law is that the receipt of income is at place where services are rendered.
If work is done in India, the income is taxable here — regardless of where the payment lands. But if the work or service is performed outside India, that income generally escapes Indian taxation."

Example:
A software engineer working from Canada for an Indian company is paid in an NRE account. Because services are rendered outside India, it isn’t taxable in India.

Also Read: Taxation Rules for Non-Residents on Dividends, Interest, Royalties & Fees

Salary Credited to NRE Account — When It’s Exempt

You might often hear that “salary received by NRI through NRE Account is exempted from Income Tax”.
That’s partly true. If the salary relates to services performed outside India, and the individual qualifies as a non-resident, then it is not taxable in India — even if credited to an NRE account in India.

However, if the same salary is for work done within India, tax applies, regardless of the account type.

Example:
An NRI pilot employed by a foreign airline & paid in NRE account for international routes won’t be taxed in India. But if he flies Indian routes, that portion becomes taxable.

Key Principles of Section 5(2)

Here’s how to decode this section practically:

This clarity helps NRIs avoid confusion about remittances or double taxation.

Common Real-Life Scenarios

1. Consultants & Freelancers
   NRIs working remotely for Indian companies are taxed only if services are performed in India.
2. Investment Income
   Dividends, interest, & capital gains from Indian assets are taxable.
3. Employment Income
   When part of the job is performed in India, that portion of salary becomes taxable.
4. Foreign Gifts
   Gifts received abroad by an NRI are not taxable in India unless they are income in nature or deposited into an Indian account as income.

The Role of DTAA – Avoiding Double Taxation

Many NRIs live in countries where income is also taxed locally. That’s where the Double Taxation Avoidance Agreement (DTAA) steps in.
DTAA ensures you don’t pay tax twice on the same income — it either exempts the income in one country or provides tax credit for taxes already paid abroad.

Example:
An Indian citizen working in the U.K. who pays U.K. income tax on salary can claim relief in India under the India–U.K. DTAA.

What Courts Have Said

Judicial interpretations have shaped how Section 5(2) is applied:

• In CIT v. Toshoku Ltd. (1980), commission earned abroad by a non-resident was held not taxable since services were rendered outside India.
• In Performing Right Society Ltd. v. CIT (1977), the Supreme Court clarified that income accrues where the right to receive arises, not merely where payment is made.

Together, these cases confirm that the location of service & source of income determine taxation, not the location of the account.

Also Read: TDS on Payments to Non-Residents

Exemptions Commonly Claimed by NRIs

Some forms of income are explicitly exempt under the Act:

• Interest on NRE accounts (Section 10(4)(ii))
• Interest on FCNR deposits
• Dividends from foreign companies (if source is outside India)

These exemptions are intended to promote legitimate foreign earnings and investment inflows through proper banking channels.

Compliance Requirements for NRIs

Even though the taxable scope is limited, non-residents still have to comply with Indian filing rules:

• File ITR-2 (for salary, capital gains, or investment income) or ITR-3 (for business income).
• Provide PAN & maintain FEMA-compliant NRE/NRO accounts.
• Report any Indian-source income correctly.
• Claim DTAA benefits under Section 90 or 91, where applicable.

Timely compliance helps avoid penalties under Sections 234A, 234F, and 271F.

Summary of Section 5(2) Application

Final Thoughts

Section 5(2) is one of the simplest yet most powerful provisions for NRIs. It clearly separates Indian income from global income & provides a fair taxation framework.
For every NRI, understanding this rule is essential for compliance — and for avoiding unnecessary tax deductions on income that doesn’t truly belong to India.

If you’re earning abroad but receiving funds in India, remember: what matters is where the services are performed & where the income originates, not just where it’s deposited.

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