The US federal bifurcates the taxpayers into two prominent heads – Non-resident Aliens (NRA) and Resident Aliens.
Usually, a resident alien is taxed on their worldwide income, the same as a US citizen. Resident aliens have to report all types of income and the amounts earned inside and outside the US. On the contrary, Nonresident aliens (NRA) have to pay federal tax on income earned in the US and/or income connected with US trade or business and are also legally required to file a tax return each year they earned income in US.
How to Test for NRA?
Non-resident Aliens refers to those Non–U.S. citizens who are exempt or haven’t passed the Green Card or substantial presence tests.
1. Green Card Test
If a person has been given the privilege of residing permanently in the US as an immigrant, then he/she will be considered a lawful resident of the US. To get this status, the US citizenship and Immigration Services issue an alien registration card, Form I-551, known as the green card.
2. Substantial Presence Test
The substantial presence test identifies foreign individuals who spend substantial periods of time in the US as resident aliens.
For this test you one has to be physically present in the US on at least:
- 31 days during the current year, and
- 183 days during the 3-year period that includes the current year and the 2 years immediately before that, including:
- All the days you were present in the current year, and
- 1/3rd of the days a person was present in the first year before the current year and
- 1/6th of the days a person was present in the second year before the current year
*However, there are some exceptions to the green card test and substantial presence test.
Taxation of Dividend Income
- For nonresident aliens, US categories the dividend income as Fixed, determinable, annual, and periodic (FDAP) which is subject to a dividend tax rate of 30% (rate can also be lower depending on the treaty) on dividends paid by U.S. companies. However, they are excluded from this tax if the dividends are paid by foreign companies or are interest-related dividends or short-term capital gain dividends.
- Further, the withhold tax is applicable on dividends paid to nonresident aliens by US domiciled ETFs and US stocks.
For individual NRAs, the most common reduced treaty withholding tax rate is for US dividends is 15%. NRAs who are tax residents of treaty countries (e.g., India) need to file Form W8-BEN with the payer of the US dividend to claim the reduced rate of withholding under the relevant treaty.
NRAs deriving only dividend income are not required to file tax return (Form 1040NR) & pay any tax thereon if the applicable amount of tax has been withheld at the applicable rates.
Illustration:
If a US Company pays dividend to an Indian resident shareholder, then the dividend income will be liable to tax in India. Further, the US Company (paying the dividend) also has a right to tax the said dividend in their state. However, if the beneficial shareholder is a resident of India i.e., “a resident of the other contracting state”, then the tax so charged shall not exceed:
1. The beneficial owner is a company which owns at least 10% of the voting stock of the company paying the dividend – 15% of the gross amount of dividend
2. Other Cases – 25% of the gross amount of dividend
Further, If an Indian Resident derives income and the same is taxed in the United States, then India shall allow the amount equal to the income tax paid in the United States, as a deduction. However, such deduction shall not exceed the Indian tax paid on the foreign income earned.
Disclosure Requirement:
For an Indian resident, dividend income earned from foreign stocks shall be taxed under the head ‘Income from Other Sources’. Further, disclosure shall be required to be made in the ITR under –
1. Schedule OS for Dividend income; (ITR 2/3)
2. Schedule FSI and Schedule TR for claiming foreign tax credit in case of double taxation relief
To conclude, dividends are a great way to build the foundation of financial freedom and acts as a motivational tool for investors to stay invested in the company and reap profits but at the same the tax incidence should also be factored in while making such decisions.
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