Income Tax On Foreign Source Income For NRIs & Residents

Foreign-source income is income earned from countries outside India. This includes income earned from businesses, investments, or employment in foreign countries. For Indian residents, foreign income is taxable; for NRIs, it is tax-free. 

In cases where income is taxable in both the foreign country and India, taxpayers can claim a credit for the double tax paid, known as the foreign tax credit.

In this blog, we will discuss the meaning of residency and the source rule, including understanding residency status, the taxability of income for NRIs and Indian residents, the meaning of the FTC (foreign tax credit), and how to compute it. 

The Taxation Of Income Rule

Every country in the world imposes income tax on its taxpayers based on either of the following. 

• Source Rule or
• Residence Rule

Source Rule

Under the source rules, income is taxable in the country where it is earned, regardless of where the person lives. 

It is considered the source of income because it takes into account that income is earned by the people of that country or from the resources of that country.

For instance, under the source rule, if you are an Indian resident earning income in the USA, you will still have to pay tax in the USA, even though you are physically not present there. You have used the country's resources to earn the income. 

Residence Rule

Under this rule, the country in which the person is a tax resident imposes income tax on any income that is earned by that person. This income can be earned in India or in any other country worldwide. According to this rule, the source of income is not considered, and it considers only the residential status of the person earning the income. 

In a nutshell, if you are a tax resident of a country, the global income you earn will be taxable in that country. Whereas, if you are not a tax resident, the tax treatment of global income is the opposite. 

What Is A Foreign Source Income?

Foreign income means any income, such as dividends, royalties, fees for technical services, interest, and so on, earned from sources outside India. This includes income such as wages from foreign employment, bank interest, dividends from foreign stocks, or rental income from a property abroad. 

However, please ensure that even if the income is earned abroad, you must not receive it directly in your Indian bank account. The income must be received outside India initially, and you can then remit it to India later. If you receive income in India directly, it will be taxable regardless of your non-resident status. 

Residential Status Determination in India

The residential status in India is determined under Section 6 of the Indian Income Tax Act, 1961. 

As per this section, there are three types of residential status in India that individuals can have. 

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

The tax treatment of foreign income depends on an individual's residential status. 

Conditions For Residential Status

You will be classified as an ordinary resident in India if any one of the conditions mentioned below is satisfied. 

Basic Conditions: (Any one condition is met)

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

Additional Condition (Both the conditions have to be satisfied)

• You must be a resident of India for at least 2 years out of the 10 immediately preceding the last year and 
• You must have stayed in India for 365 days or more in the immediately preceding year and 60 days or more in the current relevant fiscal year.

As an individual, if you satisfy any one of the basic conditions and both the additional conditions, you will be categorized as an ordinary tax resident in India. Thus, this means your global income will be taxable in India. 

However, other conditions must be considered when determining one's resident status. 

Tax Implications Based On The Residential Status

 The following are the tax implications for ordinary residents in India and for non-resident Indians. 

For Ordinary Residents in India: As mentioned above, the global income of ordinary residents will be taxable in India. Henceforth, in whatever country you may earn the income, that income will be taxable in India even though the country in which the income has been earned has already collected tax on it. 

For Non-Ordinary Resident/Non-Residents: For such individuals, foreign income is taxable in India only if it arises, accrues, or is received in India. As a non-resident Indian, if you have earned income in any foreign country, that income will not be taxable in India, provided it is not received in India. 

No Double Taxation & What Is Foreign Tax Credit

When cross-border income is involved, almost every taxpayer wonders whether they are to pay taxes twice on the foreign-source income, that is, once in India and once in the foreign country. Well, the answer is No. India has signed double taxation agreement with more than 100 countries to avoid double taxation. The agreements are known as Double Tax Avoidance Agreements (DTAAs). 

• FTC, that is, foreign tax credit, is available for income that is already taxed in a foreign country and is taxable in India as well. 
• The FTC is governed by Sections 90 and 91 of the Income Tax Act provisions. With respect to these sections, taxpayers can claim credit for the tax they have already paid in foreign countries; the same income is also taxed in India under the Domestic tax laws of India. 

The Bottom Line

The tax implications of foreign-source income depend on the source rule and the residence rule. Indian residents and non-resident Indians (NRIs) must understand these rules to ensure compliance with cross-border taxation. Furthermore, to claim the advantage of DTAA, you need to have a Tax Residency Certificate. Whereas to claim the foreign tax credit, you need Form 67, which needs to be filed along with the relevant documents. 

As an NRI, are you seeking professional assistance on the tax implications of how the foreign income is taxed? Connect with Savetaxs. Our experts will consult you on your residential status by analyzing your entry stay, reviewing your passport entry and exit stamps, and your visa to calculate the number of days you have stayed in the country.

Furthermore, our experts will also consult on how the taxes are calculated and provide end-to-end complaint support throughout. 

Connect with us as we serve our clients 24/7 across all time zones.