DTAA between India and USA

The Double Tax Avoidance Agreement (DTAA) is a treaty signed by two or more countries to avoid taxing the same income twice. It is signed to make a country an attractive destination and enable NRIs to avoid paying taxes multiple times. 

DTAA ensures that taxpayers can avoid international tax burdens and pay taxes in both countries. It allows all taxpayers to reduce the tax implications of their income earned in India and reduces instances of tax evasion. 

Applicability of the Agreement

The DTAA applies to the following taxes:

United States:

• Federal Income Tax imposed by the Internal Revenue Code (IRC): The DTAA applies to the Federal Income Tax of the US or in other words, the US income tax. However, the agreement does not apply to the following taxes:
  • Accumulated Earnings Tax: This tax is usually levied on companies whose retention ratio of earnings is unreasonable. The main intention of introducing this tax is to encourage companies to declare dividends to shareholders.
  • Personal Holding Company Tax: This tax is levied on closely held corporations where earnings are retained with an intent to avoid higher individual tax rates.
• Social Security Taxes: This tax is leviable on salaried individuals and self-employed taxpayers. The amount is used to maintain the nation's social security.
• Exercise taxes imposed on insurance premiums and with respect to private foundations: The DTAA applies to the premium paid to foreign insurers only to the extent the risks are not re-insured with a person who is not entitled to exemption from such taxes.

In India:

• Income Tax including a surcharge (excluding income tax on undistributed income of companies)
• Surtax

It is to be noted that the provisions of DTAA are not applicable for penalties and defaulted taxes.

 An Illustration 

Mr X, a resident of India works in the United States. In turn, for the work done, Mr X is given some remuneration in the United States. Now, the US Government levies the Federal Income Tax on the income earned in the US.
However, the Indian Government may also charge income tax on the same sum, i.e., the remuneration earned abroad, as Mr X is a resident of India. 
To save innocent taxpayers like Mr X from the harmful effects of double taxation, the Governments of two or more countries may enter into an agreement known as the Double Taxation Avoidance Agreement (DTAA). Thus, Governments enter into Double Taxation Avoidance Agreements with the intent of providing relief to the tax-payers:

• By either exempting the income earned abroad in its entirety, (In our example, the entire income earned by Mr X in the US will be exempt in India);
• By providing credit to the extent of tax already paid in the US (The tax paid by Mr X in the US will be eligible for deduction in India).

The DTAA applies to the residents of the contracting states i.e. India and USA, subject to certain exceptions.

Meaning of Contracting States

Contracting states refers to the countries entering into DTAA agreement. In this case the contracting states are India and USA.

Residential Status

• Resident: A Resident refers to a person who is liable to pay tax by reason of domicile, residence, citizenship, place of management, place of incorporation, etc. 
• In the following cases, the person is not considered as a resident:
  • The person is taxed in a country based on the income source - not on the basis of residence.
    • If income is derived from a partnership, trust or an estate, the income of such person is taxed only to the extent of its income taxed in its resident country, irrespective of whether taxable in its hands or the partner or beneficiary.
• If a person is a resident of both contracting states, then residence will be determined as follows: 
  General Rule: The individual is deemed to be a resident of the state where his permanent home is available

Article 6 - Income from Immovable Property

General Rule: Income derived by a resident from immovable property is to be taxed in the state where the immovable property is situated. 

For example, if a US Resident derives rental income from immovable property situated in India, then the rental income will be liable to tax in India. 

Applicability as per the agreement: For instance, the following points will be considered as income from the immovable property:

• Income from agriculture or forestry
• Income derived from the direct use, letting or use in any other form of the immovable property
• Income from immovable property of an enterprise
• Income from Immovable property used for the performance of independent personal services

Article 10: Dividend

General Rule: Dividend paid by a resident company of a contracting state to a resident of the other contracting state, may be taxed in that other state. 
For example, if a US Company pays a dividend to an Indian Resident shareholder, then the dividend income will be liable to tax in India. Further, USA (The 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:

Article 11 - Interest

General Rule: Interest arising in a contracting state and paid to a resident of the other contracting state may be taxed in that other State. (similar to dividend taxation)
As per the DTAA, if interest income arises in India and the amount belongs to a US Resident, then the said amount shall be taxable in the US. However, such interest may be liable to tax in India as per the Indian Income Tax Act (ie the contracting state where the interest has arisen). 
Exception: If the beneficial owner of the interest is a resident of the USA (resident of the other contracting state), then the tax charged in India shall not exceed:

Interest also includes prize and premium attached to debt securities. Penalty charges for late payment cannot be considered as interest. 

If the interest arises from any establishment situated in other state, owned by the resident of the contracting state, such interest is taxed in other state as business profits or independent personal services.

If any interest payment which exceeds normal interest amount because of any special relationship between payer and receiver, only the normal interest amount is considered in this article. The excess amount taxed as under other provisions in this agreement or laws of contracting state.

Article 13 - Capital Gains

Every contracting state may tax capital gains as per the applicable domestic law with an exception to shipping and air transport companies. In other words, generally, capital gains are subject to tax based on the domestic laws of the country. For eg: If a US Resident, say, Miss J, sells an Indian Property, then the property is liable to tax as per the Indian Domestic Laws.

Payments Received by Professors, Teachers and Research Scholars

Eg: If Miss K, an Indian Resident moves to the US to serve either as a teacher or as a research scholar at any University or College or Recognized Educational Institution, then Miss K may be exempted from tax on the fulfilment of the following conditions:

• The engagement should be for a period not exceeding two years and
• Immediately before the visit, the individual (Miss K) is a resident of the other contracting state (in our case India)

Note: This exemption shall be available for a maximum period of two years from the date he/she first visits that state for the aforementioned purpose. Additional Condition for Research: This exception shall be applicable only if such research is undertaken by the individual in the public interest and not primarily for the benefit of some private party.

Article 17 - Director's Fees

For example, if an Indian resident is a director of a company based in USA, all the director's remuneration due to him is taxed in USA.

Article 21 - Payments received by Students and Apprentices

• For example, if Mr. P, an Indian resident going to USA for higher education, any amount received from India for his maintenance and education is not taxable in the hands of Mr.P.
• If he receives scholarships and income from part time employment in addition to the amount received from India, that income and scholarships are also eligible for exemption.
• This exemption is usually available only for the period normally required to complete such education or apprenticeship.

Relief From Double Taxation

In USA: USA shall allow its residents’ credit against the US Tax with respect to:

• Income Tax paid to India by or on behalf of such resident
• If the US Company owns at least 10% of the voting stock of a company which is a resident of India and the US Company receives dividends, then the income tax received by the Indian Government from the Indian company with respect to the profits from which dividends are paid shall be allowed as a credit.

In India: 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. As per the agreement, income shall be deemed to arise as follows:

However, for the purpose of ascertainment of the source of income, the domestic laws of the contracting states shall also apply.

DTAA Between India and USA – Reporting in ITR

Non-residents in India must disclose and pay tax on any income generated outside of India, sometimes known as foreign income.

Foreign income and foreign assets earned by Indian residents should be reported in the Income Tax Return.

Schedule FSI (Foreign Source of Income)

The taxpayer should include information about foreign income, which is revenue obtained outside of India. Enter the following information:

• Country Code - Choose the country where the money is earned.
• Identification Number for Taxpayers
• Income earned outside of India - Enter the amount earned outside of India.
• Outside-of-India taxes - Income tax paid on earnings obtained outside of India
• In India, taxes are levied on income received outside the country.
• Tax relief is given if the tax paid outside India is less than the tax payable in India, whichever is less.
  appropriate DTAA Article - Enter the appropriate DTAA article under which the taxpayer claims tax relief.

Schedule TR (Tax Relief)

When a taxpayer enters information about foreign income on Schedule FSI, the information on Schedule TR (Tax Relief) is updated. The relief from double taxation is deducted from the tax calculation.

Schedule FA (Foreign Assets)

If the taxpayer holds any foreign assets outside India, they must report it under Schedule FA i.e. Foreign Assets.

Form 67

To claim the overseas tax credit, the taxpayer must first file Form 67 on the income tax website before filing Form 1040. Form 67 contains information on foreign income and tax breaks.