Tax treaties are agreements between two countries to avoid double taxation of individuals or companies that may have tax obligations in both countries. Non-Resident Indians (NRI) can benefit from tax treaties in several ways. In this response, We will explain what a tax treaty is, how it works, and the various tax treaty benefits available to Non-Resident Indians (NRI).
What is a Tax Treaty?
A tax treaty is an agreement between two or more countries to prevent double taxation of individuals or companies. Double taxation occurs when a taxpayer is required to pay taxes on the same income in two different countries. Tax treaties are intended to promote international trade and investment by eliminating the barriers created by the potential double taxation.
Each tax treaty outlines the specific terms and conditions for the taxation of different types of income earned by individuals or companies that are subject to the agreement. Typically, a tax treaty sets out the tax rates, exemptions, and procedures for the exchange of information between the two countries.
India has signed tax treaties with several countries across the world. Non-Resident Indians (NRI) can benefit from these tax treaties, especially if they have income sources in India and the country where they reside.
How Does a Tax Treaty Work?
When Non-Resident Indians (NRI) have an income source in India and the country of their residence, they are subject to taxation in both countries. Without a tax treaty in place, this could lead to double taxation. However, tax treaties help avoid double taxation by providing relief in various forms.
For example, suppose a Non-Resident Indian (NRI) is living in the United States and has income from a property rental in India. In that case, they will be taxed on this income in India as per Indian laws. However, the United States will also tax this income based on its tax laws. Under the tax treaty between India and the United States, the Non-Resident Indian (NRI) can claim relief for the tax paid in India while filing their tax return in the United States.
Now that we understand what a tax treaty is and how it works, let’s discuss the various tax treaty benefits available to Non-Resident Indians (NRIs).
Reduced Tax Rates:
Tax treaties usually provide reduced tax rates for Non-Resident Indians (NRIs). These rates may vary based on the type of income earned by the Non-Resident Indians (NRIs), such as dividends, interest, royalties, or capital gains. The reduced tax rate could be a fixed rate or a rate lower than the standard tax rate applicable in the country.
For example, the tax treaty between India and the United States reduces the tax rate on interest income from India to 15%, which is significantly lower than the standard tax rate of 30% in India.
Exemption from Taxation:
Tax treaties may also provide for certain types of income to be exempt from taxation in the country where the Non-Resident Indians (NRIs) reside. For instance, most tax treaties provide that a Non-Resident Indians (NRIs) will not be taxed in the country of their residence for income earned from sources in the other country, subject to certain conditions.
For example, the tax treaty between India and the United Kingdom exempts income earned in India by UK residents from being taxed in the UK, provided that it is not connected with a UK permanent establishment. Many tax treaties provide for an exemption from capital gains tax on the sale of certain types of assets, such as shares in a company or real estate. For example, the tax treaty between India and Mauritius exempts capital gains tax on the sale of shares of an Indian company held by a Mauritius resident.
Tax Credits:
Tax treaties often provide for tax credits, which allow Non-Resident Indians (NRI) to claim a credit for the taxes paid in the other country against their tax liability in their country of residence. This helps avoid double taxation and ensures that the Non-Resident Indians (NRI) only pays tax on the income once.
For example, if an Non-Resident Indians (NRI) has already paid taxes on income earned in India under Indian laws, they can claim a tax credit for the same while filing their tax return in their country of residence, such as the United States.
Avoidance of Double Taxation on Capital Gains:
Double taxation of capital gains can occur when a Non-Resident Indians (NRI) earns capital gains in one country and is then taxed on that same income in another country. This can be a significant tax burden for Non-Resident Indians (NRI), as they are already taxed on the same income in their country of residence.
To avoid double taxation of capital gains, Non-Resident Indians (NRI) can take advantage of tax treaties that their home country has entered into with other countries. Most tax treaties include provisions for the avoidance of double taxation of capital gains, and the specific provisions may vary between treaties.
Lower Withholding Tax Rates:
Tax treaties may also provide for lower withholding tax rates on certain types of income, such as interest, dividends, and royalties. For example, the tax treaty between India and the United States provides for a reduced withholding tax rate of 15% on dividends paid by US companies to Indian residents.
Tax Residency Rules:
Tax treaties also provide rules for determining tax residency, which is important for determining which country has the right to tax certain types of income. This can be particularly important for Non-Resident Indians (NRI) who may have ties to multiple countries.
Relief for Short-term Assignments:
Some tax treaties provide for relief from taxation in the country where the individual is working for short-term assignments, such as less than 183 days. This can be beneficial for NRIs who may be working in a foreign country for a short period of time.
In conclusion, NRIs can benefit from tax treaties in various ways, including avoiding double taxation, reducing withholding tax rates, exempting capital gains tax, determining tax residency, and receiving relief for short-term assignments. However, it is important for NRIs to consult with a chartered accountants to ensure they are taking advantage of all the available tax treaty benefits.
