Double Taxation: What to Do If You’re Taxed in Two Countries on Same Income

In our increasingly interconnected global economy, opportunities for work and investment across borders have multiplied. However, this international mobility also introduces unique challenges, particularly in the realm of taxation. If you find yourself as a tax resident in one country while earning income in another, the specter of double taxation may loom. This article delves into how countries following Residence-Based or Citizen-Based Tax Systems tackle this complex issue and offers solutions to mitigate the burdens of double taxation.

In countries adhering to either a Residence-Based Tax System or a Citizen-Based Tax System, individuals bear the weight of taxation on their worldwide income by virtue of their residence or citizenship, respectively. But what exactly constitutes “worldwide income”? This broad term encompasses all earnings garnered by a taxpayer within the country in which they qualify as a tax resident due to their residential status. This includes income derived within that country, as well as income generated from financial assets or investments in other nations, such as interest, dividends, rental income, or capital gains.

Let’s illustrate this concept through a couple of examples:

Example 1: Meet Mr. Rohit, originally of Indian descent, who has made the UK his new home. He plies his trade as a software engineer in a British software company, earning his income in British Pounds (GBP). In addition to his work, Mr. Rohit possesses a property in India, which he has rented out, thereby generating rental income.

Answer: Mr. Rohit, in the eyes of tax authorities, is regarded as a tax resident of the UK. Consequently, he bears the responsibility of paying taxes on his global income, which encompasses not only his GBP salary but also the rental income from India when filing his tax return in the UK.

Example 2: Let’s shift our focus to Mr. John, originally hailing from Germany, who has settled in India and established a career as a doctor. In tandem with his medical practice in India, he also maintains investments in Germany that yield income.

Answer: Mr. John is recognized as a tax resident of India, obligating him to pay taxes on his global income. This includes earnings from his medical practice in India and income generated from his investments in Germany.

In such scenarios, taxpayers often find themselves in the uncomfortable position of being taxed by two countries on the Johne income, such as interest, rental income, or capital gains. They are considered a resident for global income in one country and concurrently classified as a non-resident in another country where their investments originate.

This vexing issue of double taxation can be mitigated through the mechanism of Double Taxation Avoidance Agreements (DTAA) between an individual’s resident country and the country where the income source resides. These agreements incorporate provisions for Foreign Tax Credit (FTC), enabling taxpayers to offset the burden of double taxation when filing tax returns in their resident country.

Key provisions of Foreign Tax Credit (FTC) rules in each country typically encompass:

Taxpayers can claim credit and exemption in their resident country for taxes paid as non-residents in another country.

FTC is permitted in the year when the corresponding income is taxed as global income in the resident country.

FTC is restricted to the amount of tax payable in the resident country on the corresponding income. Any surplus foreign tax paid beyond the resident country’s tax liability will not be credited.

FTC can only offset tax, surcharge, and cess payable on the corresponding income in the resident country. It cannot be applied against interest or penalties due under the resident country’s income tax laws.

In situations where a taxpayer qualifies as a tax resident in both the source and resident countries, tax residency is determined by DTAA tie-breaker rules or by competent authorities as specified in the DTAA.

Now, let’s unravel the concept of tie-breaker rules with specific reference to the India-USA treaty agreement:

Suppose a U.S. citizen or Green Card holder resides and works in India for an entire year. In this case, owing to U.S. citizenship, they become a tax resident of the U.S. due to citizenship-based taxation. Additionally, they become a tax resident of India due to residence-based taxation, as they have lived in India for more than 182 days in the tax year. Consequently, they are deemed residents in both countries.

In this intricate scenario, tax residency is determined by DTAA tie-breaker rules or competent authorities to provide clarity on tax obligations. In the context of the India-USA DTAA, the tie-breaker rule for ascertaining an individual’s tax residency typically hinges on criteria such as the “permanent home” and the “center of vital interests.”

Here’s a step-by-step guide to determining tax residency using these criteria:

Permanent Home: An individual is considered a resident of the country where they possess a permanent home available to them. If they have a permanent home in both India and the USA, the tie-breaker rule moves to the next criterion.

Center of Vital Interests: If the individual has a permanent home in both countries or none, they are regarded as a resident of the country where they have their center of vital interests. This determination takes into account factors such as personal and economic ties, family, social and professional activities, and other significant connections. The country where the individual has stronger connections is deemed their tax residency.

Habitual Abode: If it remains impossible to determine tax residency based on the above criteria or if the individual maintains a habitual abode in both countries or none, the authorities of both countries collaborate to resolve the residency issue through mutual agreement.

Let’s consolidate our understanding through the following examples:

Example 1: Returning to Mr. Rohit, the Indian-origin resident of the UK with rental income from India. As we established earlier, he is a tax resident of the UK and has a tax obligation on his global income, including the rental income from India. Furthermore, Mr. Rohit must also fulfill an Income Tax Return (ITR) in India as a Non-Resident. Since he is a tax resident of the UK, he is entitled to leverage the Double Taxation Avoidance Agreement (DTAA) benefits in the UK, based on taxes paid and ITR filed in India as a non-resident.

Example 2: Let’s revisit Mr. John, who has made India his new home and maintains investments in Germany. As a tax resident of India, Mr. John is typically subject to Indian taxation on his worldwide income, encompassing earnings from his medical practice in India and income generated from investments in Germany. Mr. John also bears tax obligations in Germany on the income generated from his investments there. He is required to report this income to the German tax authorities and file tax returns as a Non-Resident. Being a tax resident of India, he is eligible for benefits in India and must file Form 67 online, accompanied by proof of foreign tax payment.

Example 3: Now, let’s introduce Alex, a citizen of India and a permanent resident (Green Card holder) of the United States. Alex maintains permanent residences in both countries. However, he spends 8 months in India and 4 months in California, USA, throughout the year, with substantial financial and personal ties to both nations.

In this case, we need to determine Alex’s tax residency according to the tie-breaker rule in the India-USA DTAA.

Answer: Upon evaluation, it becomes evident that Alex spends more time in India (8 months) than in the USA (4 months) throughout the year. Consequently, according to the tie-breaker rule, Alex would be considered a tax resident of India under the India-USA DTAA.

In conclusion, when confronted with taxation in two different countries, follow these steps to navigate the complex terrain, avoid double taxation, and maximize benefits in your resident country:

Determine Your Eligible Resident Country for FTC (Foreign Tax Credit): Initially, identify your resident country eligible for foreign tax credit relief, either through normal rules or tie-breaker rules as prescribed in DTAA.

Timely Submission of Required Forms: Ensure prompt submission of necessary forms to claim foreign tax credit benefits within the prescribed timeline. For claiming FTC in India, Form 67 must be duly filed, verified, and certified by a Chartered Accountant before furnishing the Return of Income under Section 139(1).

Maintain Proof of Foreign Tax Payment: Keep meticulous records of the foreign taxes you have paid. These records serve as crucial evidence when seeking relief in your resident country for taxes paid abroad. Proper documentation is indispensable to substantiate your claim.

Comply with Foreign Country’s Tax Laws: In the foreign country where you have earned income and paid taxes as a non-resident, adhere to their tax laws and regulations. This may necessitate filing income tax returns in that country and adhering to the specific guidelines for non-resident taxpayers.

Include Global Income in Resident Country’s Tax Returns: When filing your income tax returns in your resident country, ensure that your global income is included. This entails reporting all earnings, including those acquired abroad for which you have already paid taxes in another country.

Claim Relief for Taxes Paid Abroad: In your resident country’s tax return, you can assert relief for taxes paid in the foreign country. This relief may take various forms, such as exemptions, deductions, or foreign tax credits, contingent on your resident country’s tax laws and any existing tax treaties or agreements between the two countries.