The global economy has made it easier than ever for people to work and invest across borders. However, it also poses unique challenges, especially when it comes to taxation. If you’re a tax resident in one country but have income streams in another, you could be subject to double taxation. This article delves into how countries like those following Residence-Based or Citizen-Based Tax Systems handle this issue and offers solutions for mitigating double taxation.
In countries following a Residence-Based Tax System or a Citizen-based Taxed System, individuals are subject to taxation on their global income by their respective country of residence or citizenship.
What is “Global Income”?
Global income encompasses all income earned by a taxpayer in the country where they qualify as a tax resident due to their residential status. This includes income earned within the country as well as income generated from financial assets or investments in other countries, such as interest, dividends, rental income, or capital gains.
Let’s illustrate this concept with a couple of examples:
Example 1: Mr. Rahul, an individual of Indian origin, has settled in the UK. He works as a software engineer in a UK-based software company, earning his salary in British Pounds (GBP). Additionally, Mr. Rahul owns a property in India, which he has rented out, generating rental income.
Answer: Mr. Rahul is considered a tax resident of the UK, and he is obligated to pay taxes on his global income, which includes both his salary earned in GBP and the rental income from India when filing his tax return in the UK.
Example 2: Mr. Sam, originally from Germany, has settled in India and works as a doctor. Additionally, he has investments in Germany that generate income.
Answer: Mr. Sam is regarded as a tax resident of India, subject to Indian taxation on his global income. This includes income earned from his medical practice in India and income generated from investments in Germany.
In such scenarios, taxpayers being taxed in two countries on the same income (i.e interest, Rental capital gain etc) as a resident on global income and simultaneously as a non-resident in another Country Where his investment sourced.
This double taxation can be alleviated through Double Taxation Avoidance Agreements (DTAA) between the individual’s resident country and the source country. These agreements provide provisions for Foreign Tax Credit (FTC), allowing taxpayers to offset double taxation when filing tax returns in their resident country.
Foreign Tax Credit (FTC) rules in each country outline the procedure for claiming credits for taxes paid in another country. The key provisions typically include:
- Taxpayers can claim credit and exemption in their resident country for taxes paid as non-residents in another country.
- FTC is allowed in the year when the corresponding income is taxed as global income in the resident country.
- FTC is restricted to the amount of tax payable in the resident country on the corresponding income.
- Any excess foreign tax paid beyond the resident country’s tax liability will not be credited.
- FTC can only offset tax, surcharge, and cess payable on the corresponding income in the resident country.
- FTC cannot be used against interest or penalty payable under resident country’s income tax law.
- In cases where a taxpayer qualifies as a tax resident in both the source and residence countries, tax residency is determined by DTAA tie-breaker rules or by competent authorities as specified in the DTAA.
So, what is Tie-breaker concept, and what are the rules per the India – USA treaty Agreement?
Suppose a U.S. citizen or Green Card holder lives and works in India for an entire year. In such a case, due to U.S. citizenship, they become a tax resident of the U.S. because of citizenship-based taxation. Additionally, they become a tax resident of India because of residence-based taxation, as they have lived in India for more than 182 days in the tax year. Therefore, they are considered residents in both countries. In this situation, tax residency is determined by DTAA tie-breaker rules or competent authorities to provide tax benefits.
In the context of the India-USA DTAA, the tie-breaker rule for determining an individual’s tax residency typically follows the “permanent home” and “center of vital interests” criteria.
Here’s the step to determine the Tax residency.
Permanent Home: An individual will be considered a resident of the country where they have a permanent home available to them. If they have a permanent home in both India and the USA, the tie-breaker rule proceeds to the next criterion.
Center of Vital Interests: If the individual has a permanent home in both countries or none, they will be considered a resident of the country where they have their center of vital interests. This determination considers factors such as their personal and economic ties, family, social and professional activities, and other significant connections. The country where the individual has stronger connections will be considered their tax residency.
Habitual Abode: If it is still not possible to determine tax residency based on the above criteria, or if the individual has a habitual abode in both countries or none, the authorities of both countries will negotiate and resolve the residency issue by mutual agreement.
Let’s understand now whole concept with the below examples:
Example 1: Mr. Rahul, an individual of Indian origin, has settled in the UK. He works as a software engineer in a UK-based software company, earning his salary in British Pounds (GBP). Additionally, Mr. Rahul owns a property in India, which he has rented out, generating rental income.
Answer: Mr. Rahul is considered a tax resident of the UK, and he is obligated to pay taxes on his global income, which includes both his salary earned in GBP and the rental income from India when filing his tax return in the UK.
Furthermore, Mr. Rahul must also file an Income Tax Return (ITR) in India as a Non-Resident. Since Mr. Rahul is a tax resident of the UK, he is eligible to benefit from the Double Taxation Avoidance Agreement (DTAA) in the UK, based on the taxes paid and ITR filed in India as a non-resident.
Example 2: Mr. Sam, originally from Germany, has settled in India and works as a doctor. Additionally, he has investments in Germany that generate income.
Answer: Mr. Sam is regarded as a tax resident of India, and he would typically be subject to Indian taxation on his global income. This includes income earned from his medical practice in India and any income generated from investments in Germany.
Mr. Sam also has tax obligations in Germany on the income generated from his investments there, and he needs to report this income to the German tax authorities and file their tax submissions as a Non-Resident.
As Mr. Sam is a tax resident of India, he is eligible for benefits in India and must file Form 67 online, accompanied by proof of foreign tax payment.
Example 3:
Alex who is a citizen of India and a permanent resident (Green Card holder) of the United States. He has permanent House in both countries However Alex spends 8 months in India and 4 months in California USA throughout the year and has financial and personal ties to both India and the USA. we need to determine Alex’s tax residency according to the tie-breaker rule in the India-USA DTAA.
Answer:
Permanent Home: First, we check if Alex has a permanent home in both India and the USA.
Alex owns a house in India, and has a residence in California, USA. Therefore, he has a permanent home in both countries.
Center of Vital Interests: Since Alex has a permanent home in both countries, we move to the next criterion – the center of vital interests.
In India, Alex’s family, including his spouse and children, resides. He also maintains a bank account, investments, and owns a business in India.
In the USA, Alex works full-time, owns a house, and pays taxes. He has a bank account, investments, and significant social ties, including close friends, in the USA.
Based on the “center of vital interests” criterion, it appears that Alex has significant ties and interests in both India and the USA.
Now, let’s proceed with the habitual abode criterion.
Habitual Abode: This criterion considers where Alex habitually resides, meaning the place where he spends more time throughout the year, even if it’s not his permanent home.
After further analysis, it’s determined that Alex spends 8 months of the year in India, primarily due to his job, and 4 months of the year in California USA.
Based on the habitual abode criterion, it’s evident that Alex spends more time in India (8 months) than in USA (4 months) throughout the year. Therefore, according to the tie-breaker rule, Alex would be considered a tax resident of the India under the India-USA DTAA.
Conclusion:
When liable to taxed in two countries, follow these steps to avoid double taxation and maximize benefit in your Resident country.
1. Determine Your Eligible Resident Country for FTC (Foreign Tax Credit): First identify your resident country, which is eligible for foreign tax credit relief Either with Normal rule or Tie- breaker rule prescribe in DTAA
2. Timely submission of Required form: Ensure that you submit the necessary forms promptly to claim the benefits of foreign tax credits within prescribed timeline (for claiming FTC in India, Form 67 need to be dully filed verified and certified by a Chartered Accountant on or before furnishing the Return of income under section 139(1)).
3. Maintain Proof of Foreign Tax Payment: Keep records of the foreign taxes you’ve paid. These records serve as evidence when you seek relief in your resident country for taxes paid abroad. Proper documentation is essential to support your claim.
4. Comply with Foreign Country’s Tax Laws: In the foreign country where you’ve earned income and paid taxes as a non-resident, adhere to their tax laws and regulations. This may involve filing income tax returns in that country, following the specific guidelines for non-resident taxpayers.
5. Include Global Income in Resident Country’s Tax Returns: When filing your income tax returns in your resident country, make sure to include your global income. This means reporting all income, including that which you’ve earned abroad and for which you’ve already paid taxes in another country.
6. Claim Relief for Taxes Paid Abroad: In your resident country’s tax return, you can claim relief for taxes paid in the foreign country. This relief can come in various forms, such as exemptions, deductions, or foreign tax credits, depending on your resident country’s tax laws and any existing tax treaties or agreements between the two countries.
*****
Disclaimer: The views expressed in this article are the personal views of the author. Neither the views nor the analysis constitute a legal opinion and are not intended to be advice.
Author Bio
