Taxation of Foreign Source Income

Rules of Taxation of Income

All countries across the globe impose a tax on income based on two rules - Source rule and Residency rule.

• Source Rule: As per the source rule, income is subject to tax in the country where it is earned. It takes into consideration the source of the income i.e., whether it is earned by persons of 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 UK, you will have to pay tax in the UK.
• Residence Rule: As per the residency rule, the taxpayer's country of residence imposes a tax on the income earned by that person, whether the income is earned in that country or any other country in the world. For example, if you are an Indian resident but earn income in the UK, India will impose tax on your foreign income in India.

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What is a Foreign Source of Income?

Foreign source income refers to earnings such as dividends, interest, royalties, and fees for technical services from sources outside India. For income to be considered earned outside India, the beneficiary must conduct the related activities abroad. You may provide services from within India, but they must be used by a recipient conducting activities outside India.

Additionally, even if the income is earned abroad, you should not receive it directly in India. The initial receipt must occur outside India, and you can remit it to India afterward. If you receive the income directly in India, it will be taxable in India.

The taxability of foreign source income also depends on the residential status of the individual.

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What does foreign asset include?

For tax residents of India, a "foreign asset" encompasses a broad range of holdings outside India, including:

• Bank accounts
• Financial interests in entities
• Cash value insurance policies
• Annuity contracts
• Immovable property
• Custodial accounts
• Equity and debt interests

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Residential Status and Tax Liability

The initial phase in grasping the tax implications of overseas earnings involves comprehending one's residential status. In India, individuals are categorized into three groups depending on their residential status: Resident and ordinary resident (ROR), Resident but not ordinary resident (RNOR), and Non-resident (NR). Precise classification holds significance as it delineates the scope of one's tax obligations.

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How is Residential Status Determined?

• Resident and ordinary resident (ROR): A taxpayer attains the status of an Indian resident if they fulfill either of the following criteria: spending 182 days or more in India during a given year or residing in India for 365 days or more in the immediate preceding four years, coupled with a minimum of 60 days in the relevant financial year.
• Resident but not ordinary resident (RNOR): An individual is classified as RNOR if they have not been an Indian resident for 9 out of the 10 preceding years or have not stayed in India for a period exceeding 729 days during the 7 preceding years.
• Non-resident (NR): An individual failing to meet any of the aforementioned conditions will be designated as a non-resident Indian.

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Tax Treatment of Foreign Income Based on Residential Status

The tax on foreign income in India varies based on residential status:

ROR (Resident and Ordinarily Resident):

• As a ROR, you are taxable on your entire global income, including income earned abroad.
• This income is combined with your Indian income and taxed according to the applicable income tax slabs in India.
• There might be some relief for foreign taxes paid under Double Taxation Avoidance Agreements (DTAA) that India has with many countries.

RNOR (Resident but Not Ordinarily Resident):

• The rules for RNOR are slightly complex. It depends on the number of years you've been resident in India in the past ten years.
• Generally, RNORs' income from foreign sources is not taxable in India if it's not received in India.
• However, income earned from an Indian business or profession is taxable even for RNORs.

NR (Non-Resident):

• As a non-resident, you are generally only taxable on income earned or accrued in India.
• There are some exceptions, though, like interest income, royalty, fees for technical services, and capital gains from certain assets in India.

Note: For all these categories, it's important to consider Double Taxation Avoidance Agreements (DTAA) that India has signed with many countries. These agreements help avoid paying tax on the same income twice.

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Taxation of Foreign Income for Residents

Foreign Income Taxation for Residents:

Residents, whether ROR or RNOR, face taxation on foreign income at rates applicable to domestic earnings. Taxes must be paid on time to avoid trouble; if foreign income is received in India, it must be settled in the same fiscal year. For income not received in India, taxation occurs in the financial year when it is realized or accrued.

Distinguishing the Tax Treatment for ROR and RNOR:

While RORs are taxed on their global income, including earnings from foreign sources, RNORs face taxation solely on income received or accrued in India or from a business controlled or a profession set up in India. This nuanced differentiation aligns the tax liability with the individual's degree of connection to the Indian economy.

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Taxation of Foreign Source Income for Non-Residents

Specified Income Categories for Non-Residents:

Non-residents encounter a distinct tax framework. Specific income categories, such as interest, royalties, fees for technical services, and capital gains, are subject to taxation in India. Section 195 of the Income Tax Act governs how non-residents are taxed on income from a foreign source.

Withholding Tax for Non-Residents:

Income paid to non-residents is subject to withholding tax by the payer. This mechanism ensures that the Indian government can collect taxes on certain types of income earned by non-residents within its jurisdiction.

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When must taxpayers declare foreign assets?

Any individual holding foreign assets, even if acquired through disclosed sources or if the income is below the taxable threshold, is "required to fill out the foreign asset (FA) or foreign source income (FSI) schedule in their ITR. Failure to disclose foreign asset or income in the ITR can attract a penalty of Rs 10 lakh under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.

The last date to file late return and revise the return for FY 2023-24 (AY 2024-25) is 31st December 2024. Hurry Up! File Today

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Double Taxation Avoidance Agreements (DTAA)

Now, you must be wondering if you have to pay taxes twice in both India and the country from where you earned the income. The answer is ‘No’.

In response to the dilemma of double taxation, wherein income faces taxation in both the source and residence countries, India has engaged in numerous Double Taxation Avoidance Agreements (DTAA). These agreements are significant in relieving taxpayers by allowing them to claim relief from the tax paid on foreign income against the tax payable in India.

Individuals can claim foreign tax credits for the incomes that are taxed in a foreign country and in India. This can be claimed under sections 90 and 91 of the Income Tax Act. These sections allow taxpayers to claim credit for taxes paid in foreign countries if the same income is also subject to tax in India.

Form 67

Form 67 of the Income Tax Act is required for any taxpayer wishing to claim a foreign tax credit when filing their ITR under section 139(1). This credit is available to taxpayers who earn income outside India and are subject to taxes in both countries.

Schedule FA of the Income Tax Act

Schedule Foreign Assets (FA) in the Income Tax Return (ITR) requires you to provide details of your foreign assets, such as foreign shares, mutual funds of foreign companies, and employee stock options (ESOPs) from foreign companies.

In other words, you must disclose all foreign assets you hold, whether legally, as a beneficiary, or as a beneficial owner, when filing ITR-2 or ITR-3, as applicable.

Hindu Undivided Families (HUFs) classified as residents and ordinarily residents (R&OR) are mandatorily required to disclose their foreign assets in their Income Tax Returns. This requirement ensures transparency in international financial interests and helps maintain tax compliance.

Failure to disclose foreign assets or income earned abroad in their income tax return (ITR) could result in a Rs 10 lakh penalty under India’s anti-black money law. The deadline to submit revised or belated ITRs is December 31. Get online CA services and relax while our experts file your ITR and ensure you get a maximum tax refund. Get expert-assisted ITR filing now!

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