The residential status of a person, especially of an NRI, plays a significant role in determining how their income will be taxed in India. Non-resident Indians (NRIs) and persons of Indian origin (PIOs) are usually meticulous in planning their stay in India in a given year so that their foreign income is not subjected to taxation in India. Many NRIs and PIOs were compelled to stay longer in India since March 2020 due to the Covid-19 pandemic restrictions worldwide. This can potentially lead to a change in their residential status in India for tax purposes. You must be wondering how to avoid double taxation in India!
How Residential Status Impacts Taxation
A person’s tax liability under the Indian Income Tax law is based on an individual’s residential status during a relevant financial year. Their residential status is based on the number of days s/he spends in India during the relevant year and the last ten years. There are three categories- resident, non-resident and resident but not ordinarily resident (RNOR).
As the scope of income taxable in India differs based on residential status, non-residents are not subjected to pay taxes against their overseas income in India. RNORs have to even pay taxes for a business controlled in India or a profession set up in India.
Subsequently, if an NRI or PIO becomes a resident or RNOR because of their spent days in India, then their overseas income may become taxable in India.
DTAA Benefits
India has joined Double Taxation Avoidance Agreements (DTAAs) or bilateral tax treaties with major countries. The basic purpose of DTAA 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 individual is a tax resident and provide limited taxation rights to the country where the source of income lies. Double taxation is usually eliminated by providing foreign tax credit (FTC) in the residence country.
DTAA provides residential status is to be determined based on the domestic laws of each country. In case you, as an NRI/PIO, qualify as tax residents of both countries, the treaty may provide for a tiebreaker rule. For example, you may qualify as a tax resident of India due to your stay in India exceeding a certain threshold. At the same time, you may also qualify as a tax resident of the US under your citizenship. In such a situation, the tiebreaker rule under India-USA DTAA will come into the picture, and you may qualify to be a tax resident of the US.
Suppose you are a tax resident of a country with which India has a DTAA. In that case, you can claim benefits under the treaty. Your liability to taxation in India will be limited to the extent of taxing rights to the source country under the treaty. Under the Indian income law, you can take benefit of the treaty under Section 90 of the Indian IT Tax Act, 1961, subject to procedural compliances such as submission of Tax Residency Certificate of your host country.
In case if you qualify as a tax resident of India, then India will have residential powers of taxation, subject to limited rights granted to the other country under the treaty.
