The Indian Income-tax Act provides for levy of income-tax on the income of foreign companies and non-residents, but only to the extent of their income sourced from India. Under section 5 of the Act, a foreign company or any other non-resident person is liable to tax on income which is received or is deemed to be received in India by or on behalf of such person, or income which accrues or arises or is deemed to accrue or arise to it in India. Section 9 thereafter specifies certain types of income that are deemed to accrue or arise in India in certain circumstances. These two sections embody the source rule of income taxation in the domestic law. No income of a non-resident can be taxed in India unless it falls within the four corners of section 5 read with section 9 of the Income-tax Act.

Broadly speaking, business income of a foreign company or other non-resident person is chargeable to tax to the extent it accrues or arises through a business connection in India or from any asset or source of income located in India, and to the extent such income is attributable to the operations carried out in India. Income in the nature of salary is taxable in India if it is earned for services rendered in India. Income in the nature of interest, royalty and fees for technical services is taxable in India, if such income is received from the Government; or from a person resident in India except where such income is connected with a business or profession carried on outside India or with any other source of income outside India. Income in the nature of interest, royalty and fees for technical services received from a non-resident is also taxable in India if it is connected with a business or profession carried on in India or with any other source of income in India.

The Income-tax Act contains a number of special provisions relating to income of non-residents, including provisions under section 10 of the Act exempting certain categories of income. It also contains provisions prescribing a presumptive basis of taxation of certain types of income, so as to simplify the computation of income and tax in cases where the nature of activity makes such computation difficult. The Act also requires deduction of tax at source from certain types of income, and for withholding tax on all chargeable income remitted outside India.

This source-based taxation often gives rise to the problem of double taxation, where the same income could be taxed twice - in India, and also in the country of residence of the taxpayer. India has entered into Double Tax Avoidance Agreements (DTAAs) with a large number of countries, to resolve this problem. Essentially, these DTAAs lay down the extent to which one country has a right to tax income of a resident of the other country that is sourced from the first-mentioned country. The Governments of the two countries, having regard to the source rules contained in their respective domestic laws, have negotiated this extent. The Income-tax Act provides that the provisions of such a DTAA, if they are more favourable to a taxpayer, will override the provisions of the domestic tax law.

With a view to impart certainty of taxation in the cases of non-residents, a mechanism for obtaining timely advance rulings on the tax implications of transactions undertaken or proposed to be undertaken by them, is available. Applications for obtaining such rulings, which are binding on the tax department as well as the taxpayer, can be made to an independent judicial body, namely, the Authority for Advance Rulings.