How NRIs can use DTAA to avoid double taxation in India

Since March 2020, many of the NRIs and PIOs have been compelled to stay longer in India due to circumstances beyond their control in the form of travel restrictions due to the pandemic across the globe. This can potentially lead to change in their residential status in India for tax purposes..

The residential status of an individual plays an important role in determining the way his/her income will be taxed during the year in India. Generally, non-resident Indians (NRIs) and Persons of Indian Origin (PIOs) are very meticulous in planning their stay in India in a given year so that their overseas income is not subjected to taxation in India.

However, since March 2020, many of the NRIs and PIOs have been compelled to stay longer in India due to circumstances beyond their control in the form of travel restrictions due to the pandemic across the globe. This can potentially lead to change in their residential status in India for tax purposes.

Residential status for tax purposes

Tax liability of a person under the Indian Income Tax law is based on his residential status during the relevant financial year. Residential status of an individual is primarily based on the number of days of stay in India during the relevant year as well as the past ten years. Broadly, there are three categories: resident, non-resident and resident but not ordinarily resident (RNOR).

Scope of income taxable in India varies based on residential status. It is widest in case of a resident, whose global income is subjected to tax in India, and is narrowest in case of a non-resident, wherein only income received or income accruing or arising in India is taxable in India. Thus, typically, a non-resident is not required to pay taxes on his overseas income in India. For an RNOR, apart from income received or accruing or arising in India, even income from a business controlled in India or profession set up in India is taxable.

As a result, if any NRI or PIO becomes a resident or RNOR due to his stay in India, then, even his overseas income may become taxable in India. Take for instance an NRI running a business outside India. Even if he qualifies as only RNOR for a particular year, his income from that overseas business may be subjected to tax in India on the basis that the business was controlled by him from India during his stay here.

Benefits available under DTAAs

India has entered into Double Taxation Avoidance Agreements (DTAAs) or bilateral tax treaties with all major countries. As the name suggests, the basic purpose of these treaties is to avoid the burden of double taxation on the taxpayers in more than one jurisdiction. By default, the tax treaties provide unlimited taxation rights to the country where the person is tax resident (residence country) and provides limited taxation rights to the country where the source of income lies (source country). Double taxation is usually sought to be eliminated by providing foreign tax credit (FTC) in the residence country.

Normally, these treaties provide that residential status is to be determined based on domestic laws of each country. In case an individual qualifies as tax residents of both the countries, then the treaty may provide for a tiebreaker rule. For instance, a PIO may qualify as tax resident of India due to period of his/her stay in India exceeding a certain threshold. At the same time, he/she may also qualify as a tax resident of the US by virtue of his/hers citizenship. In such a case, the tiebreaker rule under India-USA DTAA will come into play and it may happen that the person qualifies to be a tax resident of the US.

An individual, who is a tax resident of a country with which India has a DTAA, can claim benefit under the treaty and his/her liability to taxation in India will be limited to the extent of taxing rights to source country under the treaty. It may be highlighted that even if the scope of taxation under the Indian income tax law is wider, such individual can take benefit of the treaty by virtue of section 90 of the Indian Income-tax Act, 1961, subject to procedural compliances like submission of Tax Residency Certificate (TRC) of the other country, etc.

On the other hand, if an individual qualifies as a tax resident of India, both in terms of Indian domestic law as well as the relevant treaty, then India will have residual powers of taxation, subject to limited rights granted to the other country under the treaty.

Foreign Tax Credit (FTC) in India

Once an NRI or PIO qualifies as an Indian tax resident, he/she will be eligible to claim credit of taxes paid in other foreign countries in his/her income tax return filed in India, subject to certain conditions and procedural compliances prescribed in rule 128 of the Income Tax Rules. FTC will be allowed in the year in which the corresponding income is offered to tax in India. The individual will be required to submit particulars of FTC claimed in prescribed Form 67 along with documents to support payment or deduction of tax in other countries.

For claiming FTC, an individual needs to have a certificate or statement specifying the nature of income and the amount of tax deducted therefrom or paid by the assessee. It can be obtained from one of the following:

(i) from the tax authority of the country or the specified territory outside India; or

(ii) from the person responsible for deduction of such tax; or

(iii) signed by the assessee (along with an acknowledgement of online payment or bank counter foil or challan for payment of tax where the payment has been made by the assessee or proof of deduction where the tax has been deducted).

It may be noted that FTC is allowed only in respect of taxes paid in other countries in accordance with the applicable DTAA and any excess foreign tax will be ignored. Also, FTC will be limited to the extent of taxes payable in India.

The overall process of FTC in India has been streamlined pursuant to introduction of the rules with effect from April 2017 and taxpayers can avail benefit of such credit to avoid the burden of double taxation to the extent legally possible.