Taxation of Foreign Source Income

With the advent of technology, you may be earning income from different sources around the world. You must be wondering what incomes will be taxable in India and whether any income will be taxable in a foreign jurisdiction. There might be situations where income can be taxed in India as well as a foreign jurisdiction. This is too confusing, isn’t it? Let us remove that confusion for you.

Rules of Taxation of Income

Every country in the world imposes tax on income basis two rules (i) Source Rule and (ii) Residence Rule

Source Rule: According to this rule, income is taxable in a country where it is earned irrespective of the person earning it. It considers the source of the income i.e., whether the income is earned by/through or from the resources/persons of that country, it does not consider the residential status of the person earning the income. 

So, even if you are a tax resident of India and earn an income in the United Kingdom (UK), the UK will impose a tax on such income based on the source rule.

Residence Rule: According to this rule, a country where a person is a tax resident imposes a tax on any income earned by that person. That income can be earned in that country or any other country in the world, i.e., this rule does not consider the source of the income; it considers only the residential status of the person earning the income. If you are a tax resident of a country, then global income earned by you will be taxable in that country.

Continuing the above example, you, being a tax resident of India, earned an income in the UK, and the UK imposed a tax on such income based on the source role. So now the question is whether India will impose a tax on such income. The answer is yes. As you are a tax resident of India, your global income is taxed in India, and hence, you will have to pay tax on your income in India also.

As discussed, the tax in India on income earned in a foreign country depends on your residential status, so let’s first understand how to determine an individual's residential status in India.

What is a Foreign Source of Income?

Foreign source of income means an income earned by an individual such as dividend, interest, royalties, fees for technical services etc. from sources outside India. For considering such an income to be earned outside India, the ultimate beneficiary should be conducting the activity outside India only. i.e., you may provide services while being there or while being in India but the services should be used by a recipient with the activity being carried out in a place outside India.

There is one additional condition: Even if the income is earned outside India, you should not receive such income in India. The first receipt of income should be outside India; you can remit this income to India after it. If you receive the income directly in India, it will be taxable in India.

There are also differences in the taxability of foreign sources of income basis the residential status of a person. 

Residential Status in India

A residential status of an Individual in India is governed by Section 6 of Indian Income-tax Act, 1961.

As per it there are three types of residential status that an individual can have in India:

• A resident and ordinarily resident (ROR)
• A resident but not ordinarily resident (RNOR)
• A non-resident (NR)

Taxability of an income depends on the type of residential status of an Individual.

Conditions for Residential Status

For a thumb rule, you would be considered as ordinarily resident in India, 

Basic Conditions: (Any one condition to be satisfied)

• You have stayed in India for 182 days or more during the relevant financial year or
• You have stayed in India for 365 days or more in the immediately 4 preceding years and 60 days or more in the relevant financial year.

Additional Conditions: (Both the conditions to be satisfied)

• You have been resident of India for at least 2 years out of 10 immediately preceding previous years and
• You have stayed in India for 730 days or more in the immediately 7 preceding years.

If you satisfy any one of the basic conditions and both the additional conditions, you will be an ordinary tax resident of India (i.e., Your global income will be taxable in India)

There are certain other conditions also to be considered while determining residential status.

Tax Implications Based on Residential Status

For Ordinary Residents in India: As mentioned above, global income will be taxable in India for such residents, so wherever you may earn income, that income will be taxable in India even if the country where such income is earned has already collected tax on it.

For Not Ordinary Residents/Non-Residents: Taxability of an income will arise in India only if an income is accrued or arise or received in India. So as a non-resident if you earn an income in any country other than India that income will not be taxed in India (subject to the condition that income should not be received in India).

Elimination of Double Taxation and Foreign Tax Credit

With this much discussion you must be wondering whether you need to pay tax on foreign source income twice, i.e., in India and in foreign country. The answer is No, there are Agreements in place between countries over the world to avoid this situation where a taxpayer is required to pay tax on a single income in more than one country. They are known as Double Tax Avoidance Agreement (DTAA).

Foreign Tax Credit is available for incomes which are taxed in a foreign country as well as taxable in India. It is governed by the provisions of Sections 90 and 91 of the Act. As per this sections you can claim credit of the taxes that you have paid in a foreign country if the same income is getting taxed in India according to the domestic tax laws of India.

Final Word

So, you can take advantage of DTAAs entered between India and different countries. You need to obtain a Tax Residency Certificate to claim the benefit of DTAA in a foreign country.

Further, to claim the foreign tax credit Form 67 needs to be filed along with the relevant documents.

Related Articles

Determining Residential Status

Double Tax Avoidance Agreement 

Foreign Tax Credit

Form 67

Tax Residency Certificate