Income Tax on Foreign Income: Around the world, many individuals benefit from the principles of liberalism, allowing them to earn income from a variety of sources around the world. However, this global income-generating scenario raises questions about how taxation is applied in different countries. In India, a person’s tax obligations depend on his residential status and the source of his income.
Generally, Indian residents are subject to taxation on their complete income, while non-residents face taxation only on their Indian income. Exceptions and specific provisions apply to different types of income, including interest, royalties, and capital gains.
Additionally, India has established Double Taxation Avoidance Agreements (DTAA) with several countries to protect the same income from being taxed in both the countries of source and residence. Through these agreements, resident Indians can seek credit for tax paid on foreign income, offsetting it against their tax liability in India.
Rules of Taxation of Income
Source Rule: As per the source rule, income is subject to tax in the country where it is earned. It takes into account the source of income, i.e., whether it is earned by persons in that country or from the resources of that country. For example, under the source rule, even if you are an Indian resident but have earned income in the U.K., you will have to pay tax in the U.K.
Residence Rule: As per the residence rule, the residence country of the taxpayer taxes the income earned by that person, whether the income is earned in that country or in any other country in the world. For example, if you are an Indian resident but earn income in the U.K., India will tax your foreign income in India.
What is Foreign Source of Income?
Foreign source income refers to income such as dividends, interest, royalties and fees for technical services which come from different countries of the world except nation itself. For the income which is considered earned outside India, just the beneficiary must conduct the relevant activities abroad only. You can provide services from within India, but they must be used by the recipient who conducts activities outside India.
Additionally, even if the income is earned abroad, you must not receive it directly in India. The initial receipt must be outside India, and you can remit it to India later. If one directly earns in India, then he will be payer of tax in India.
It’s all depends on the beneficiary’s residential status that either he is payer or non payer of tax in India.
Residential Status and Tax Liability
The initial step in understanding the tax implications of foreign income involves understanding one’s residential status. In India, individuals are classified into three groups based on their residential status: resident and ordinarily resident (ROR), resident but not ordinarily resident (RNOR), and non-resident (NR). The exact classification is important as it reflects the scope of one’s tax obligations.
Foreign Income Taxation for Residents:
Residents, whether RORs or RNORs, face taxation on foreign income at the rates applicable to domestic income. Taxes should be paid on time to avoid hassles; if foreign income is received in India, it should be settled in the same financial year. For income not received in India, taxation takes place in the financial year in which it is received or accrued.
Difference in Tax Treatment for RORs and RNORs:
While RORs are taxed on their global income, including income from foreign sources, RNORs are taxed only on income received or accrued in India or on business controlled or profession established in India. This subtle differentiation aligns the tax liability with the degree of engagement of the individual with the Indian economy.
Taxation on Foreign Source Income for Non-Residents
Specified Income Categories for Non-Residents:
- Non-residents face a different tax structure. Specific income categories, such as interest, royalties, fees for technical services and capital gains, are reasonable to pay tax in India. Section 195 of the Income Tax Act shows how foreign source of income to non-residents of India is taxed.
Tax Deductions for Non-Residents:
- Income paid to non-residents is subject to tax deduction by the payer. However this mechanism ensures that the Indian government can also collect some tax on certain types of income earned by non-residents in its jurisdiction region.
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