Earned income outside India? DTAA will save you from double taxation

On top of it, if he is a resident of the other country, that country may also tax his global income (i.e. the income earned outside the country of residence).

Few countries like USA, tax its citizens based on the citizenship, implying that irrespective of the fact that the US citizen was outside the USA for the entire tax year, he may still have to pay taxes on his global income in the USA. Fortunately, India does not have citizenship based taxation and it follows residency based taxation system.

If the taxpayer qualifies as a resident as per the residency rules listed in section 6, then he will have to pay taxes on his global income. Further, if a taxpayer is becoming a resident of both the countries by applying the local tax laws, then his residential status is determined by applying the tie-breaker rule in the respective DTAA.

All this can result in serious double taxation of the same income. In such situation “Double Tax Avoidance Agreement – DTAA” can come to the rescue of such taxpayer. Currently, India has comprehensive DTAAs with 88 countries, out of which 85 have are in force.

What is DTAA? It is a bilateral or multilateral agreement between two or more countries to resolve the issues of taxation of income, bring the transparency and to plug the tax evasion. DTAA helps in:

• Allocation of taxpayer’s income and related taxing rights of two countries.
• Avoiding double taxation of income.
• For smoother recovery of Income Tax in both the countries.

How DTAA works: Primary purpose of the DTAA is to eliminate or avoid double taxation of income. This is achieved by adopting various methods listed below

• Deduction Method: Under this method, the country in which the taxpayer is resident, allows him a deduction from the taxable income, on account of the taxes paid in another country on his foreign source. This method is not very common as it does not eliminate the double taxation completely.

• Exemption Method: Under this method, the taxpayer can claim his foreign source income as exempt from tax. This would imply that the income is not included in taxable income at all. Hence there would be no question of double taxation. India has a tax treaty with many countries; many treaties provide for exemption of certain income from double taxation. Eg. As per IND-US DTAA social security benefits and other public pensions paid by US to a taxpayer resident in India will be taxable in US only, and it will be exempt from double taxation in India. Further any US Government pension, paid in respect of services rendered in US and received by a US national resident in India shall be taxable only in US.

• Credit Method: Under this method, the taxpayer first includes his foreign source income in his total taxable income in the country of residence (i.e. India) and calculates the taxes as per the normal provisions of the tax laws of that country. Then he will be eligible to claim the credit for the foreign taxes (in respect of the doubly taxed income) against the respective tax liability in the country of residence. The taxpayer will be able to claim the credit at a rate lower of the taxes paid in the foreign country and the taxes payable in the home country as applicable on the doubly taxed income. This is the most commonly used method of providing relief from double taxation and finds place in almost all the tax treaties.

In simple words, if the tax rate in the resident country is higher than the foreign country, then the taxpayer will have to pay the differential (additional) taxes in the home country. If the tax rate in the resident country is lower than the foreign country, then he will be able to claim only to the extent of the rate at which the income is taxable in resident country.

Do remember that each DTAA has some or other beneficial provision which can help in avoiding double taxation. Hence if someone has worked outside India for part of the year and qualifies as an ordinary resident of India for the respective tax year, then it is in his interest to carefully analyse whether he is eligible for any special benefits under respective DTAA.

If not he can at least claim the credit for the taxes paid on such income in the foreign country. Remember that the tax treaty provision will apply only to the extent beneficial to the taxpayer. Therefore, if India does not have a tax treaty with the other country from which you are earning income, then you can still claim the foreign tax credit under section 90A of the IT Act.

The writer is Head of Tax Research at H&R Block India.