In an era of global financial mobility, investors often look beyond borders for promising growth opportunities. India, with its progressive reforms and vibrant economy, is an attractive destination for investment for non-resident Indians (NRIs) who are keen on smart investments6.
However, when NRIs want to invest in India7, understanding the tax implications become a major factor. For NRIs, the taxation rules in India are based on their residential status. If an NRI earns any income in India, such as capital gains from investments, rental income from house property, or interest income, they are generally chargeable to tax in India.1 To avoid such double taxation on the already taxed income, NRIs can benefit from the provisions of the DTAA agreements, if their country of residence has a tax agreement with India. Let us understand what is DTAA in income and how it works for the benefit of NRIs.
What is DTAA?
DTAA stands for Double Taxation Avoidance Agreement (DTAA). It is a bilateral agreement entered by the central government with the government of another country outside India or a specified territory outside India to eliminate double tax on the same income in both countries.3
Under the Income Tax Act, of 1961, the income of a non-resident individual or entity is taxed in the country where the income is accrued or earned2. However, for resident Indians, all income would be under the purview of taxation, irrespective of where it has been earned.
So, NRIs are liable to pay taxes on income they receive or earn in India only. Taxation is based on the individual’s residential status and their source of income. It applies to both domestic and foreign income of the taxpayer, depending on the applicable provisions of the Income Tax Act.
When an entity or an individual resides in one country but has earnings in another country, they may be subjected to pay taxes on the same income in both their home country (where they reside) and the source country (from where the income is accrued or earned). Such a situation results in double taxation of the same income, creating financial burdens and hindering foreign investment and trade.5
How does DTAA in Income Tax work?
NRIs can benefit from DTAA if their country of residence has a tax treaty/agreement with India. The treaty offers an exemption on being taxed twice and helps in determining the taxing rights of each country on different types of income earned by the NRI.5
Let’s say, an NRI is residing in the United States and invests in India by purchasing shares in an Indian company. The NRI receives capital gains and dividends from his/her investments in India.
1. Taxation without DTAA in income tax:
Without the provisions of DTAA, the income of the NRI would be liable to pay tax, both in the United States (their country of residence) and in India (where the income has accrued). The NRI would have to pay tax at the applicable rate in India on the dividend and capital gains from the investment and also report this income in the United States where their tax liability would be considered and paid on worldwide income. 5
2. Taxation with DTAA in income tax:
There are two types of benefit available under DTAA. Let’s consider the same case but with the benefits of DTAA.
a. Tax credit for tax paid in other country
If India has entered into a DTAA agreement with the U.S. and the NRI is eligible to claim the benefits under the terms of the DTAA between India and the U.S., he/she can get a reduced withholding tax rate according to the provisions stipulated in the DTAA. If the NRI pays tax in India at the applicable rate on the dividend income and capital gains, the NRI can claim a foreign tax credit in the U.S. for the taxes paid to India, reducing the U.S. tax liability, subject to the provisions of the DTAA between India and the U.S.5
b. Tax exemption in either country
If India has entered into a DTAA agreement with the U.S. and the NRI is eligible to claim the benefits under the terms of the DTAA between India and the U.S., he/she needs to pay tax only in India or in U.S. For example, if income is subject to be taxed in India, he/she need not pay tax in U.S on the income earned and accrued in India.
What Is The Objective Behind DTAA?
The general aim of DTAA is to avoid situations where an entity or an individual is taxed twice one income in both countries. Apart from avoiding double taxation of income, the central government also has other motives behind entering into such agreements with the Governments of foreign countries or specified territories outside India. DTAA facilitates: 3
- Grant of relief from the income-tax liability under the Income Tax Act, 1961 and the corresponding law in the foreign country or specified territory for promoting trade, investment and mutual economic relations.
- recovery of income tax under this Act and the corresponding law in force in the foreign country or specified territory, as the case may be
- an exchange of information for the avoidance of double taxation or prevention of evasion. DTAA also facilitates the investigation of cases of such avoidance or evasion, if any.3
Features Of DTAA In Income Tax:
DTAA acts as a cornerstone for NRIs, offering them a transparent and streamlined taxation framework. Here are some common features found in many DTAA agreements:
- DTAA defines the residential status of an entity or individual. These agreements state that the taxpayer is a resident of one of the contracting countries and is then taxed in that country based on their global income.4
- The income arising in the country of source is taxed in that country. The DTAA outlines specific types of income (such as dividends, business income, royalties and interest) and the source country has the right to tax such types of income.4
- The taxpayers are allowed to claim an exemption or a credit in their resident country for the taxes paid in the source country, preventing the same income from being taxed twice. 3
A NRI can avail benefits/reliefs under DTAA by timely submission of documents listed below to the payer of income before release of payment: -
1. Tax Residency Certificate (TRC) obtained from Government of Resident country
2.Online 10F Form
Conclusion
With the Double Taxation Avoidance Agreement (DTAA), the NRIs can strategically manage their tax liabilities both in their home countries and in India. By leveraging and understanding the provisions of DTAA in Income Tax, NRIs can explore different investment opportunities in India.
References
1. https://cleartax.in/s/income-tax-for-nri
2. https://incometaxindia.gov.in/pages/i-am/non-resident.aspx#:~:text=In%20case%20of%20resident%20taxpayer,not%20be%20taxable%20in%20India.
3. https://byjus.com/free-ias-prep/dtaa/
4. https://cleartax.in/s/dtaa-between-india-and-usa
5. https://cleartax.in/s/how-nris-can-claim-benefits-under-dtaa
6. https://economictimes.indiatimes.com/nri/invest/how-india-is-luring-back-nris-post-retirement/articleshow/103345313.cms
7. https://economictimes.indiatimes.com/nri/invest/investing-for-nris-a-comprehensive-guide-to-opportunities-and-challenges/articleshow/102828384.cms
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