Professionals and retirees returning to India from the United States may face a higher tax burden due to a recent clarification regarding the India-US tax treaty. This change could significantly impact their financial planning and the timing of their return.

The Waning Treaty Benefit

Currently, many returning Indians benefit from lower taxes on their US earnings until they become 'full residents' in India. This advantage stems from the Double Taxation Avoidance Agreement (DTAA) between India and the US. However, a recent commentary from Washington on the OECD Tax Convention, which establishes rules for preventing tax evasion and double taxation, has cast a shadow over this benefit.

Resident Status and Global Income

Under Indian laws, an 'ordinary resident' is taxed on their global income, encompassing earnings from both India and abroad. Non-Resident Indians (NRIs), who spend less than 182 days in India during the previous year, are taxed only on their Indian income, such as interest from fixed deposits, dividends, and capital gains from the sale of shares.

The law includes a provision for returning Indians classified as 'resident but not ordinary resident' (RNOR) for tax purposes. Until an individual attains full resident status, only their Indian earnings are subject to taxation. To qualify as an RNOR, a person must meet one of the following criteria:

1. Spend more than 120 days but less than 182 days in India during the year and have at least ₹15 lakh in Indian income, provided they have spent at least 365 days in the preceding four financial years.
2. Have been an NRI, spending less than 182 days in India, in nine out of the ten preceding financial years.
3. Have spent no more than 729 days in India during the seven preceding financial years.

Typically, an RNOR becomes a full ordinary resident after two to three years of residing in India. During this RNOR period, the individual's US income is not taxed in India, while the US offers lower treaty rates because the individual is considered a tax resident in India.

Impact of the US Clarification

The US clarification may eliminate the benefit of lower tax rates on US earnings for returning Indians. Those classified as RNOR could face increased withholding taxes on dividends, interest, and royalties from the US. This situation necessitates a reassessment of financial planning and the timing of their return to India.

Double Taxation Avoidance Agreement (DTAA)

The Double Taxation Avoidance Agreement (DTAA) between India and the US aims to prevent the double taxation of income earned in both countries. The DTAA applies to individuals, companies, partnership firms, trusts, and any entity earning income in both countries. It encompasses federal income tax in the US and income tax, including surtax and surcharge, in India. The treaty specifies which country has the right to tax the income and to what extent. It employs relief mechanisms, primarily the credit method, to prevent double taxation. Under the exemption method, income earned and taxed in one country may be exempted from tax in the other.

Planning and Compliance

Returning Indians should seek expert advice to navigate these complex tax implications. Careful planning and compliance with tax regulations are crucial to avoid potential penalties. It is important to accurately report details in the Income Tax Return (ITR) and file Form 67 with proof of US taxes paid to claim DTAA benefits.