A Comprehensive Guide on the DTAA between India and the USA?

Generally, if a person earns income in a foreign country, it is taxed in both the country in which it arises and the country in which the person resides, resulting in paying tax twice on the same income. To prevent NRIs from this situation, the Government of India has entered into a DTAA (Double Taxation Avoidance Agreement) with several countries. India has signed a total of 85 DTAAs with various countries, of which one is with the USA. In this blog, we will discuss everything about the DTAA between India and the USA.

What is DTAA?

The DTAA (Double Tax Avoidance Agreement) is a treaty signed by two or more countries to avoid charging tax on the same income twice. It is signed to help NRIs prevent paying taxes multiple times. This agreement ensures that taxpayers can avoid international tax burdens and pay taxes in both the country where the income arises and the country in which the person resides. While the DTAA does not exempt an NRI from paying taxes entirely, it helps lower their tax liability and promotes fair tax practices, making the country a more attractive destination for residency and investments.

What is the DTAA between India and the USA?

The DTAA between India and the USA is made to protect people and entities from being taxed twice on income earned in both countries. For example, if a person works in the US and gets any income there, then the US government will charge a tax. However, as an Indian citizen, the Indian government might also charge taxes on this income. As per the DTAA between India and the USA, the relief will be provided by either:

• Exempting the entire income earned in one country (income earned in the USA is exempt from tax in India).
• Giving credit for the amount of tax that has already been paid in the USA.

Applicability of the Agreement

The DTAA is applicable to the following taxes:

In the United States

• Federal Income Tax imposed by the Internal Revenue Code: The DTAA is applicable to the Federal Income Tax of the US, or simply the US income Tax. However, this agreement doesn't apply to the following taxes:
  • Accumulated Earnings Tax: It is usually charged on companies whose plowback ratio of earnings is beyond reasonable limits without distributing dividends to shareholders. The main aim of introducing this tax was to motivate companies to declare dividends to their shareholders. 
  • Personal Holding Company Tax: This tax is charged on closely held corporations where earnings are kept with the motive to avoid higher personal income tax rates. 
• Social Security Taxes: It is charged to both salaried and self-employed individuals and used to fund social security programs in the USA. The DTAA agreement does not apply to Social Security taxes. 
• Exercise Taxes Imposed on Insurance Premiums and concerning private foundations: It refers to the taxes imposed on insurance premiums paid to foreign insurers. In this, the DTAA applies only to an extent where the premiums paid are not reinsured with entities that are not eligible for tax exemptions under the agreement. 

In India 

• Income Tax: The DTAA applies to income tax, excluding income tax on undistributed income of companies. 
• Surtax: This agreement also covers surtax, which is basically an extra tax imposed on certain types of income. It depends on the provision within the DTAA between India and the USA. The rules of DTAA are not applicable to penalties and defaulted taxes. 

An Example 

Mr Gupta works in the United States, but he is an Indian citizen. He gets a salary for the work he does in the US. Now, the Government of the United States charges the Federal Income Tax on the income he earns there. However, the Indian Government may also charge income tax on the same income. The income is earned abroad, but Mr Gupta is a resident of India, which means he will have to pay taxes twice on the same income, which is wrong. To protect taxpayers like Mr Gupta from the complexities of double taxation, the Governments of two or more countries might sign an agreement, which is known as the Double Taxation Avoidance Agreement (DTAA). In short, the Government enters into the DTAA agreement to provide relief to the taxpayers by:

• Either exempting the income earned abroad entirely, which means the entire income that Mr Gupta earns in the US will be exempt in India.
• Or by offering a credit for the amount of the tax that Mr Gupta has already paid in the United States, meaning that if he has paid a certain amount in taxes to the US government, he can deduct that amount for tax liability in India.

The Double Tax Avoidance Agreement applies to the residents of the contracting states, which are India and the USA. This is subject to some exceptions.

What is the Meaning of Contracting States?

Contracting states refer to the countries that enter into the DTAA agreement with another country to protect the same income from being taxed twice.

For example, if country A and country B have entered into a DTAA, they will both be considered contracting states. If the resident of Country A earns income in Country B, the DTAA will verify which country has the right to tax the income and at what rate. If the DTAA specifies that Country A has the right to tax the income, then the person will not have to pay taxes on the same income in Country B. It might also help to learn the specific terms of a DTAA, like the types of income covered, how income is defined, and how the agreement applies to the residents of each contrasting state.

How to Determine the Residential Status?

Determining your residential status is important as it is an important factor in understanding a person's tax obligations in India. To avoid any tax issues, a person must accurately check their residential status and consult a tax professional if needed. Below is some basic information to help determine your residential status:

• Resident:A resident is a person who is responsible for paying taxes for any reason. Be it domicile, residence, citizenship, place of management, place of incorporation, etc. In the following case, the person will not be considered a resident if:
  • The individual is taxed in a country based on where they earn their income and not based on their residence.
  • If the income is earned from a partnership, trust, or an estate, the income of such person is taxed only to the extent of their income taxes in their resident country, regardless of whether taxable in its hands or the partner or beneficiary.

The most general rule is that the person will be considered a resident of the state where their permanent home is situated, but in case a person is a resident of both the contacting states, that is, India and the USA, then their residential status will be checked by the following situations:

Article 6-Income Earned From Immovable Property.

General Rule: Income earned by a resident from an immovable property will be taxed where the immovable property is located.

For Example, if a resident of the US earns rental income from an immovable property which is situated in India, then the rental income will be subject to taxation in India.

Applicability According to the Agreement: The following points will be determined as income from the immovable property:

• Income from agriculture or forestry.
• Income earned from the direct utilization, leasing, or other forms of use of immovable properties.
• Income from immovable property owned by an enterprise.
• Income derived from immovable property used in the provision of independent personal services.

Article 10: Dividend

General Rule: A dividend paid by a resident company in one contracting state to a resident in another contracting state may be subject to taxation in the recipient's state. For example, if a company in the US distributes a dividend to an Indian resident shareholder, that dividend income must be taxed in India. Additionally, the US (the company that is paying the dividend) also has the authority to tax this dividend. However, if the beneficial owner of the dividend is an Indian resident, the tax rate applied shall not exceed:

Article 11: Interest

• General Rule: Interest generated in one contracting state and paid to a resident of another contracting state is also taxable in the recipient's state. (similar to dividend taxation). Following the Double Taxation Avoidance Agreement (DTAA), if interest income arises in India for a US resident, then it will be taxable in the United States. Nonetheless, India may also impose taxes on the interest under the Indian Income Tax Act, which is the contracting state where the interest has arisen. 
• Exception: If the beneficial owner of the interest is a US resident, which means a resident of the other contracting state, then the tax rate in India will be limited to:

Interest includes both the prize and the premium related to debt securities, while penalty fees for late payment can not be classified as interest. If the interest is derived from an establishment situated in another state's territory, owned by a resident of the contracting state. It is taxed as business income or independent personal service income in that other state.

 If an interest payment exceeds a standard amount due to a special relationship between the payer and receiver, only the standard interest amount is considered under this article, with any excess taxed according to other provisions of this agreement or the laws of the contracting state.

Article 13: Capital Gains

Each contracting state has the right to tax capital gains according to the applicable domestic law, except for shipping and air transport companies. To make it easy, capital gains are liable to taxes depending on the domestic laws of the country. For example, if a US resident, named Mr X, sells an Indian property, then it will be subject to taxes as per the Indian Domestic Laws.

Payment Derived by Professors, Teachers, and Research Scholars

For instance, if Mr J is a resident of India who decided to move to the US to work either as a teacher or as a research scholar at any University, College, or well-known educational institution, she may be exempt from taxes, provided that she fulfils the following criteria:

• The duration of the engagement must not exceed two years.
• She should be a resident of the other contracting state (India) immediately before her visit.

Note: This exemption is available for a maximum of two years from the date of her initial visit for the same purpose. Additionally, for research, this exception shall be applicable only if such work is done in the public interest and not primarily for the benefit of a private party.

Article 17: Director's Fees

For instance, if an Indian resident serves as a director for a US-based company, all fees owed to them as a director are taxable in the US.

Article 21: Payments from Students and Apprentices

For instance, if Mr K is an Indian resident and travels to the US for higher education, any financial help he receives from India for living and educational expenses will not be taxable for him. Any scholarships or income from part-time work, in addition to the funds from India, are also exempt from taxation. This exemption typically applies for the duration required to complete the education or apprenticeship.

Relief from Double Taxation

In the United States, the residents are allowed to claim credit against the US tax for:

• Income tax paid to India by or on behalf of such a resident.
• If a US company that owns at least 10% of a company resident in India receives dividends, the US will credit the income tax paid to the Indian government on the profits from which the dividends were distributed.

In India, if an Indian resident earns income that is also taxed in the US, then they claim a deduction equal to the amount of income tax paid in the United States. However, this deduction cannot exceed the amount of Indian tax paid on the foreign income earned. According to the agreement, income will be considered to arise as follows:

For determining the source of the income, the domestic laws of the contracting states shall also apply.

How to Report Income Under DTAA Between India and the USA?

NRIs are required to disclose their income and assets in the ITR and pay taxes on any income that is earned outside India, often known as foreign income. Foreign Income and Foreign Assets earned by an Indian resident must be reported in the Income Tax Return.

Schedule FSI (Foreign Source of Income)

The taxpayer must include details about foreign income, that is, the revenue that is earned outside India. Mention the following information:

• Identification Number for Taxpayers.
• Country Code where the money is earned.
• Mention the income earned outside of India.
• Income tax is paid on earnings received abroad.
• In India, taxes are charged on income earned outside the country.
• Tax relief will be given if the tax paid abroad is less than the tax payable in India, whichever is less.
• Enter the accurate DTAA under which the taxpayer is claiming tax relief.

Schedule TR (Tax Relief)

When a taxpayer fills out the details about foreign income on Schedule FSI, the information on Schedule TR (Tax Relief) will get updated. The double taxation relief is decreased from the tax calculation.

Schedule FA (Foreign Assets)

If taxpayers have foreign assets located outside India, then they should be reported in the ITR under foreign assets.

Form 67

This on the income tax form is vital to claim foreign tax credits. It includes foreign income details and tax relief and can be filed online on the Income Tax website before filing the ITR.

Conclusion

The DTAA \is more than a tax treaty between India and the USA; it is the basis of effective cooperation that benefits businesses and individuals alike by avoiding the burden of double taxation, providing tax relief measures, and ensuring transparency in cross-border taxation. Understanding the rules of the DTAA between India and the USA is important for using its benefits effectively.