Query: I have received a query from one of my NRI clients In the U.S. regarding the above subject. He says, he would have to disclose /pay tax in the USA on investments made in India. Since you have a sizeable number of clients based in the USA, I wanted to know if you have any details on this.
The link below sheds more light on the subject
Mr. Gerard Colaco: I have since gone through the US IRS website pertaining to Foreign Bank and Financial Accounts Reporting Requirements (FBAR).
Individual investors who have investments in savings bank accounts, current accounts, bank fixed deposits, mutual funds, stocks, bonds or other financial assets would certainly be required to comply with reporting requirements under FBAR if the value of their accounts exceeds US $10,000/- at any point of time during a given financial year. Therefore, individuals resident in the US who have invested in Indian mutual funds would certainly be subject to FBAR reporting requirements.
Many individuals also confuse FBAR with the filing of tax returns in the US and the Double Taxation Avoidance Agreement (DTAA) between India and US. The right to tax generally vests with the country in which the taxpayer resides. This right is not at all affected by the DTAA between India and the US. Second, the right to tax can also vest with the country in which the income is earned. This right of the country which is the source of the income to tax that income, is also not affected by the DTAA between India and the US.
What then is the DTAA? As the very name suggests, it only seeks to avoid double taxation on the same income. The basis on which an individual is taxed is residence. If a person who is a US citizen is resident in India as defined by the Indian income-tax laws, he may have taxable income in India as well as in the US. Under Indian income-tax law, his citizenship has no relevance for purposes of taxation. It is whether he is resident in India for tax purposes and has taxable Indian income that is relevant. So a US citizen resident in India, who has both Indian income and US income, would be taxed in India on his global income.
Such an individual will be taxed in the US only in respect of his US income and not his global income, because he is a non-resident person in the US. Now, let’s assume he is in the 20% tax bracket on his US income. But this US income has already been included in his Indian tax return and he has paid tax on it at the rate of 10%. The 10% tax paid by him on his US income in India will be available for set off against the tax payable by him in the US.
Similarly, if a person is resident in the US, he will be taxed on his global income in the US. He will be taxed in India on his taxable Indian income only. Let us say he pays tax at 30% in the US on his Indian income. But in India, he is liable for tax at only 10% on the Indian income. He will have to pay no tax in India, as he has paid tax at a much higher rate in the US. Double taxation is thus avoided.
Let us now take the case of dividends, short-term capital gains on shares or equity mutual funds and long-term capital gains on shares and equity mutual funds of an individual resident in the US.
Dividends on equity mutual funds are tax-free in the hands of the investor in India. Dividends on equity shares are also tax-free in the hands of the investor in India. In the case of equity dividends, there is a dividend distribution tax (DDT) paid by the companies to the government before dividends are distributed. This is not tax deducted at source against the individual investor. It is merely a tax on distribution of dividends. It is paid by the companies to the government. It is not paid on behalf of the investor who earns the dividends. Hence DDT is not available as tax credit to a US resident. Dividend on equity mutual funds and stocks will have to be added to his US income and applicable tax will have to be paid in the US on this Indian income.
Short-term capital gains on equity and equity mutual funds are taxed at a flat rate of 15.45%. Such STCG on Indian equities or equity MFs must be included in the US income of a person resident in the US. The STCG tax paid by him in India will be available as a tax credit in the US.
Long-term capital gains (LTCG) on equity and equity mutual funds are essentially tax-free in India. The Securities Transaction Tax (STT) cannot be claimed as a tax credit in the US, just as DDT cannot be claimed. STT is a tax on the transaction or purchase and sale of stocks or the redemption of mutual funds. It is not deducted against the individual investor. So although LTCG on equity and equity mutual funds is exempt from tax in India for all practical purposes, it is to be included in the global income of the US resident and he will be taxed at rates applicable to long-term capital gains tax in the US.
This is my understanding of the subject after discussing with my chartered accountant and also doing a little bit of reading. If subsequently I come across some knowledge that would need the above opinion to be altered, I will certainly let you know.