Have income from foreign source? Keep this in mind while filing taxes

• India has tax-treaties with several countries to eliminate double taxation for the taxpayers.
• Selecting the appropriate tax return form (ITR 2 or ITR 3) based on the sources of income is important.
• Employees should be careful to report income if any stock options are provided to them in a foreign country.

When filing your taxes, you need to report income earned anywhere in the world, not just in India. The rules pertaining to foreign income could be different, hence it is important to be aware of them.

Mandatory to report

The Income-tax Act, 1961 does not provide a specific definition for the term 'foreign income.' Generally, foreign income refers to the earnings or profits derived from sources outside of India. It includes income that does not accrue or arise in India, or is not deemed to accrue or arise in India. In other words, any income generated from a source located outside India would be considered foreign income for tax purposes.

“Firstly those who have income earned from foreign sources (sources outside India) and are resident in India must mandatorily file an income tax return, and report such income. This applies even when their total taxable income is below the minimum exemption limit,” says Archit Gupta, CEO, Clear, a fintech company.

Foreign income schedules are available in the Income Tax Return (ITR), those must be duly filled and reported in. The following information must be provided : country of origin, country code, institution paying, opening and closing balances, amounts credited etc.

Types of foreign income

Different types of foreign income have different tax treatment. We take a look.

Income from shares (outside India)

If the shares are held as capital assets, the gains or profits arising from their transfer are treated as capital gains. “If the capital gains are arising out of the shares held outside India, the individual taxpayer who is an ROR in India would be taxable as per the rates in the Indian tax laws,” says Akhil Chandna, Partner, Grant Thornton Bharat, a professional services firm.



Source: Grant Thornton Bharat

Taxation is different for dividend income, which would vary from country to country. For example, in the US, dividends are subject to a flat tax rate of 25%, with the company deducting the taxes before distributing the remaining amount to the investor.

Income from ESOP received outside India

Income from ESOPs received outside India is taxable in India to the extent the same is provided to the individual for rendering services in India. “If a person is qualifying as an ROR in India, he is subject to tax on his global income. Accordingly, the said income would be taxable for him in India subject to the availability of Foreign Tax Credit (FTC),” says Chandna.

Employees should be careful to report income if any stock options are provided to them in a foreign country.

Income from any property outside India

Any income generated from a property located outside India, such as rental income, or capital gains from selling the property, is taxable in India if the individual qualifies to be a ROR in India as per the Indian tax laws. “The rental income is taxed at applicable slab rates as “Income from House Property” whereas the capital gains are offered to tax at 20% as long term capital gains in case the holding period is more than 36 months, and at applicable tax rates as short term capital gains if the holding period is less than 36 months,” says Chandana.

How to avoid double taxation

Ideally, you should not pay taxes on the same income twice. India has established tax treaties with numerous countries to address the issue of double taxation for taxpayers. These treaties outline specific mechanisms to determine the tax obligations of individuals who earn income in both India and another country. They also allocate the taxing rights for each country concerning the respective sources of income. By utilising the provisions outlined in these treaties, taxpayers can effectively eliminate the burden of being taxed twice on the same income.

“When you are a resident of one country but have earned an income from another country; naturally you want to avoid paying tax twice on the same income in both the countries. To avoid paying double tax, one has to refer to the DTAA (Double Tax Avoidance Agreement) between the two countries,” says Gupta.

Also, where any source of income is subject to tax in both India and the other country, the tax treaty provides for claiming foreign tax credit in the country of residence. “This allows taxpayers to eliminate double taxation by offsetting the tax liability in India with taxes paid outside India,” says Chandana. For example taxes on capital gains paid for US shares can be used to offset income tax payable in India.

“When you are a resident of one country but have earned an income from another country; naturally you want to avoid paying tax twice on the same income in both the countries. To avoid paying double tax, one has to refer to the DTAA (Double Tax Avoidance Agreement) between the two countries,” says Gupta.

India has signed tax-treaties with several countries to eliminate double taxation for the taxpayers. “These treaties provide mechanisms to determine the tax liability of individuals who have income in both India and the other country and accordingly determine the taxing rights for each of the countries with respect to such source of income. By applying the provisions of said treaties, taxpayers can eliminate double taxation.

What to keep in mind

To report income earned outside India accurately, consider the following points:

1.Select the appropriate tax return form (ITR 2 or ITR 3) based on the sources of income.

2.Understand the taxability of foreign income based on Indian tax laws, and relevant DTAAs.

3.Report taxable income under the correct head while exempt income is mentioned in the 'Exempt Income Schedule' of the tax return.

4.Convert overseas income to Indian Rupees using the prescribed exchange rates mentioned in Rule 115 of the Income-tax Rules, 1962.

5.Resident and Ordinary Resident (ROR) individuals are required to disclose foreign assets, or accounts under the 'Foreign Asset Reporting' Schedule, including bank accounts, properties, and financial interests such as shares, employee stock ownership plans (ESOPs), etc.

It's important to consult with a tax professional and refer to the specific provisions of Indian tax laws and relevant DTAAs to ensure accurate reporting of income earned outside India.