An individual’s residential status plays a vital role in deciding how their income is taxed in India for a particular financial year. To avoid paying tax on the same income in two different countries, Non-Resident Indians (NRIs) and Persons of Indian Origin (PIOs) often plan the duration of their stay in India carefully.
However, residential status is not always within an individual’s control. Due to unforeseen situations, a person’s residential status may change, resulting in the same income becoming taxable in both India and another country.
To address this issue and strengthen international economic cooperation, countries enter into Double Taxation Avoidance Agreements (DTAAs). In this guide, we will understand how residential status influences taxation and the role of DTAA in preventing double taxation.
Residential Status of an Individual
An individual’s residential status is primarily determined by the number of days they stay in India during the relevant financial year, along with their stay during the preceding years. Broadly, taxpayers are classified into three categories—Resident, Non-Resident (NRI), and Resident but Not Ordinarily Resident (RNOR). The taxability of income in India depends on the category under which an individual falls.
For instance, if an NRI carries on a business outside India but qualifies as an RNOR during a particular year, the income earned from that foreign business may become taxable in India if the business is controlled or managed from India during their stay.
Benefits Available Under DTAA
The Double Taxation Avoidance Agreement (DTAA) offers several tax advantages to NRIs by helping them avoid paying tax on the same income in two countries. Some of the key benefits available under DTAA are explained below.
Exemption of Certain Income in India
Depending on the provisions of the applicable DTAA, certain types of income earned by an NRI in their country of residence may be exempt from taxation in India. These commonly include:
- Salary Income: Salary earned by an NRI in a foreign country may be exempt from tax in India under the relevant DTAA.
- Interest Income: Interest received on eligible deposits held outside India, such as interest on NRE accounts, may qualify for exemption.
- Dividend Income: Certain dividend income may not be taxable in India if covered by the applicable DTAA.
- Pension Income: Pension received from a foreign country may also be exempt from Indian tax, subject to the terms of the DTAA.
Tax Credit for Taxes Paid Abroad
If an NRI has already paid tax on income in their country of residence, they may be eligible to claim a tax credit in India under the DTAA. This helps reduce their overall tax liability.
The tax credit works as follows:
- Taxes paid in the foreign country can be claimed as a credit while calculating tax payable in India.
- The amount of credit available cannot exceed the tax payable in India on the same income.
Example:
Suppose an NRI pays ₹50,000 as tax in a foreign country on a particular income, while the tax payable on that income in India is ₹60,000. In such a case, the NRI can claim a tax credit of ₹50,000 and will only be required to pay the remaining ₹10,000 in India.
Reduced Tax Rates on Certain Income
Many DTAAs prescribe concessional tax rates for specific categories of income. Some common examples include:
- Royalty Income: Often taxed at a lower rate, such as 10%, under the applicable DTAA.
- Interest Income: Interest earned from loans or bonds may be subject to a reduced tax rate if covered under a DTAA.
- Dividend Income: Several DTAAs provide lower tax rates, such as 10% or 15%, compared to the rates prescribed under domestic tax laws.
Example:
Under the India–US DTAA, interest earned on loans is taxable in India at 15%, instead of the standard 30% tax rate.
By taking advantage of these provisions, NRIs can reduce their overall tax liability and avoid double taxation on the same income.
DTAA Rates
A DTAA also specifies the rate at which tax should be deducted from income earned by residents of the treaty country. Therefore, when an NRI earns income in India, TDS is deducted according to the rates prescribed under the relevant DTAA. These rates differ from one country to another and generally range between 7.5% and 15%.
Types of Income Covered Under DTAA
NRIs can avoid paying tax twice on the following types of income:
- Salary earned in India
- Income from house property situated in India
- Capital gains arising in India
- Interest earned on fixed deposits with Indian banks
- Interest earned on savings bank accounts in India
Frequently Asked Questions (FAQs)
Q1. Which types of income can an NRI claim tax credit or exemption for under DTAA?
An NRI can claim tax credit or exemption on eligible income such as salary, interest, dividends, royalties, capital gains, or business income, depending on the provisions of the Double Taxation Avoidance Agreement (DTAA) between India and their country of residence. The eligible income categories differ from one treaty to another.
Q2. What are the methods used to avoid double taxation?
DTAA generally provides relief through the following methods:
- Tax Credit Method: Taxes paid in one country can be claimed as a credit against the tax liability in the other country.
- Exemption Method: Certain income is taxed only in one country and exempted in the other.
- Deduction Method: Taxes paid in a foreign country can be deducted while calculating taxable income, where permitted under the applicable tax laws.
Q3. What are the conditions for claiming DTAA benefits?
To claim DTAA benefits, taxpayers generally need to:
- Be a tax resident of a country that has a DTAA with India.
- Obtain and submit a valid Tax Residency Certificate (TRC).
- Provide the required declarations and supporting documents, such as Form 10F (where applicable).
- Meet the conditions specified under the relevant DTAA.
Q4. Who can benefit from a Double Taxation Avoidance Agreement (DTAA)?
DTAA benefits individuals, NRIs, foreign residents, businesses, and multinational companies that earn income in more than one country. It helps reduce the tax burden by preventing the same income from being taxed twice.
Q5. What is the main purpose of DTAA?
The primary purpose of DTAA is to eliminate or reduce double taxation on the same income, encourage cross-border trade and investment, and provide certainty regarding tax obligations for taxpayers operating internationally.
Q6. Is a Tax Residency Certificate (TRC) mandatory to claim DTAA benefits?
Yes, in most cases, a Tax Residency Certificate (TRC) is required to claim DTAA benefits in India. Tax authorities may also ask for additional documents, such as Form 10F and a self-declaration, depending on the applicable regulations.
Q7. Can NRIs claim a refund if excess tax has been deducted in India?
Yes. If tax has been deducted at a higher rate than the rate prescribed under the applicable DTAA, an NRI can file an income tax return in India and claim a refund of the excess tax paid, subject to eligibility.
Q8. Does India have DTAA agreements with all countries?
No. India has signed Double Taxation Avoidance Agreements with many countries, but not all. DTAA benefits are available only if India has a valid tax treaty with the taxpayer’s country of residence.
Q9. How can an NRI determine whether DTAA applies to their income?
An NRI should review the DTAA between India and their country of residence to understand how a specific type of income is taxed. Since treaty provisions differ, consulting a qualified tax professional can help ensure the correct application of the agreement.
Q10. Can DTAA reduce the TDS deducted on income earned in India?
Yes. If the applicable DTAA prescribes a lower tax rate than the rate under Indian domestic tax laws, eligible taxpayers can claim the treaty benefit and, subject to fulfilling the required documentation, may be able to reduce the Tax Deducted at Source (TDS).