The Double Tax Avoidance Agreement (DTAA) is a treaty signed by two countries. It is signed to make a country an attractive destination and to enable NRIs to avoid having to pay taxes multiple times.
DTAA does not mean that the NRI can completely avoid taxes, but it means that the NRI can avoid paying higher taxes in both countries. DTAA allows an NRI to cut down on their tax implications on the income earned in India. DTAA also reduces the instances of tax evasion.
Introduction
Mr X, a resident of India works in the United States. In turn, for the work done, Mr X is given some remuneration in the United States. Now, the US Government levies the Federal Income Tax on the income earned in the US.
However, the Indian Government may also charge income tax on the same sum, i.e., the remuneration earned abroad, as Mr X is a resident of India.
To save innocent taxpayers like Mr X from the harmful effects of double taxation, the Governments of two or more countries may enter into an agreement known as the Double Taxation Avoidance Agreement (DTAA). Thus, Governments enter into Double Taxation Avoidance Agreements with the intent of providing relief to the tax-payers:
- By either exempting the income earned abroad in its entirety, (In our example, the entire income earned by Mr X in the US will be exempt in India);
- By providing credit to the extent of tax already paid in the US (The tax paid by Mr X in the US will be eligible for deduction in India).
The DTAA applies to the residents of the contracting states i.e. India and USA, subject to certain exceptions.
Applicability of the Agreement:
The DTAA applies to the following taxes:
United States:
- Federal Income Tax imposed by the Internal Revenue Code (IRC): The DTAA applies to the Federal Income Tax of the US or in other words, the US income tax. However, the agreement does not apply to the following taxes:
- Accumulated Earnings Tax: This tax is usually levied on companies whose retention ratio of earnings is unreasonable. The main intention of introducing this tax is to encourage companies to declare dividends to shareholders.
- Personal Holding Company Tax: This tax is levied on closely held corporations where earnings are retained with an intent to avoid higher individual tax rates.
- Social Security Taxes: This tax is leviable on salaried individuals and self-employed taxpayers. The amount is used to maintain the nation's social security.
- Exercise taxes imposed on insurance premiums and with respect to private foundations: The DTAA applies to the premium paid to foreign insurers only to the extent the risks are not re-insured with a person who is not entitled to exemption from such taxes.
In India:
- Income Tax including a surcharge (excluding income tax on undistributed income of companies)
- Surtax
Residential Status
Resident: A Resident refers to a person who, as per the relevant laws of the Contracting States, i.e., India and the US, is liable to pay tax by reason of domicile, residence, citizenship, place of management, place of incorporation, etc.
If a person is a resident of both contracting states, then residence will be determined as follows:
General Rule: The individual is deemed to be a resident of the state where his permanent home is available
Situation | Deemed to be a resident of the country in which: |
A permanent home in both states | Personal and economic relations are closer. |
If the above rule is not determinable or no permanent home in either state is there | Habitual abode is present |
Habitual abode in both states | He is a National |
National of both states or neither of them | Competent Authorities shall determine the residential status by mutual agreement. |
Income from Immovable Property
General Rule: Income derived by a resident from immovable property is to be taxed in the state where the immovable property is situated. Eg: If a US Resident derives rental income from immovable property situated in India, then the rental income will be liable to tax in India. Applicability as per the agreement: For instance, the following points will be considered as income from the immovable property:
- Income from agriculture or forestry
- Income derived from the direct use, letting or use in any other form of the immovable property
- Income from immovable property of an enterprise
- Income from Immovable property used for the performance of independent personal services
Dividend
General Rule: Dividend paid by a resident company of a contracting state to a resident of the other contracting state, may be taxed in that other state.
Eg: If a US Company pays a dividend to an Indian Resident shareholder, then the dividend income will be liable to tax in India. Further, USA (The company paying the dividend) also has a right to tax the said dividend in their state. However, if the beneficial shareholder is a resident of India, i.e. a resident of the other contracting state, then the tax so charged shall not exceed:
(a) | The beneficial owner is a company which owns at least 10% of the voting stock of the company paying the dividend | 15% of the gross amount of the dividend |
(b) | Other Cases | 25% of the gross amount of the dividend |
Interest
General Rule: Interest arising in a contracting state and paid to a resident of the other contracting state may be taxed in that other State.
As per the DTAA, if interest income arises in India and the amount belongs to a US Resident, then the said amount shall be taxable in the US. However, such interest may be liable to tax in India as per the Indian Income Tax Act (ie the contracting state where the interest has arisen).
Exception: If the beneficial owner of the interest is a resident of the USA (resident of the other contracting state), then the tax charged in India shall not exceed:
(a) | Interest paid on a bank loan (involved in bonafide banking business) or a similar financial institution (including an insurance company) | 10% of the gross amount of interest |
(b) | In other cases | 15% of the gross amount |
Capital Gains
Every contracting state may tax capital gains as per the applicable domestic law with an exception to shipping and air transport companies. In other words, generally, capital gains are subject to tax based on the domestic laws of the country. For eg: If a US Resident, say, Miss J, sells an Indian Property, then the property is liable to tax as per the Indian Domestic Laws.
Payments Received by Professors, Teachers and Research Scholars
Eg: If Miss K, an Indian Resident moves to the US to serve either as a teacher or as a research scholar at any University or College or Recognised Educational Institution, then Miss K may be exempted from tax on the fulfilment of the following conditions:
- The engagement should be for a period not exceeding two years and
- Immediately before the visit, the individual (Miss K) is a resident of the other contracting state (in our case India)
Note: This exemption shall be available for a maximum period of two years from the date he/she first visits that state for the aforementioned purpose. Additional Condition for Research: This exception shall be applicable only if such research is undertaken by the individual in the public interest and not primarily for the benefit of some private party.
Relief From Double Taxation
In USA: USA shall allow its residents’ credit against the US Tax with respect to:
- Income Tax paid to India by or on behalf of such resident
- If the US Company owns at least 10% of the voting stock of a company which is a resident of India and the US Company receives dividends, then the income tax received by the Indian Government from the Indian company with respect to the profits from which dividends are paid shall be allowed as a credit.
In India: If an Indian Resident derives income and the same is taxed in the United States, then India shall allow the amount equal to the income tax paid in the United States, as a deduction. However, such deduction shall not exceed the Indian tax paid on the foreign income earned. As per the agreement, income shall be deemed to arise as follows:
1 | Income derived by a resident of one contracting state (Eg USA) | Taxed in another contracting state (Eg: India) |
2 | Income derived by a resident of one contracting state (USA) | Income not taxed in the other contracting state |
However, for the purpose of ascertainment of the source of income, the domestic laws of the contracting states shall also apply.
DTAA Between India and USA – Reporting in ITR
Non-residents in India must disclose and pay tax on any income generated outside of India, sometimes known as foreign income.
Foreign income and foreign assets earned by Indian residents should be reported in the Income Tax Return.
Schedule FSI (Foreign Source of Income)
The taxpayer should include information about foreign income, which is revenue obtained outside of India. Enter the following information:
- Country Code - Choose the country where the money is earned.
- Identification Number for Taxpayers
- Income earned outside of India - Enter the amount earned outside of India.
- Outside-of-India taxes - Income tax paid on earnings obtained outside of India
- In India, taxes are levied on income received outside the country.
- Tax relief is given if the tax paid outside India is less than the tax payable in India, whichever is less.
appropriate DTAA Article - Enter the appropriate DTAA article under which the taxpayer claims tax relief.
Schedule TR (Tax Relief)
When a taxpayer enters information about foreign income on Schedule FSI, the information on Schedule TR (Tax Relief) is updated. The relief from double taxation is deducted from the tax calculation.
Schedule FA (Foreign Assets)
If the taxpayer holds any foreign assets outside India, they must report it under Schedule FA i.e. Foreign Assets.
Form 67
To claim the overseas tax credit, the taxpayer must first file Form 67 on theincome tax website before filing Form 1040. Form 67 contains information on foreign income and tax breaks.
