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Investing abroad? Check out treaty benefits
February, 27th 2007

Recently, the Reserve Bank of India permitted resident individuals to remit up to $50,000 per financial year. The earlier limit was $25,000 for any permissible current or capital account transaction or a combination of both.

Resident individuals can use this facility to acquire immovable property overseas, open foreign currency accounts outside India, purchase shares/ securities of foreign companies or units of overseas mutual funds, as well as to make overseas gifts, donations, payments for studies, medical treatment, etc.

India has entered into double tax avoidance agreements (DTAA) with many countries which seek to avoid double tax being paid on the same income in two countries. However, DTAAs examine each income stream separately and they differ from country to country. Therefore, if your specific income is taxable or suffers tax in India as well as in the other country, the DTAA which India has with that country would need to be examined to determine whether double tax can be avoided or whether a tax credit can be claimed.

Some illustrations, as below, provide you with a glimpse of tax implications arising from overseas investments. Malaika purchases 1,000 units of a mutual fund in the UK @ POUND 20 per unit. She receives an income of POUND 200 during the year and let us assume that she also pays a tax of POUND 20 in the UK. She believes that mutual fund income is exempt from tax in India. Further as she has paid tax in the UK on this income, she ignores this income in her tax return filed in India. Malaika was unaware that only income from mutual funds registered in India is tax exempt in India and that this income should have been reported in India.

While investing in shares or mutual funds in the UK, you need to be aware that any dividends or income you receive will be taxable in India at the applicable individual tax slab rates since it is only dividends from Indian companies and income from registered mutual funds that are exempt under Section 10(34) and 10(35) of the Income-Tax Act. The tax treaty gives India the right to tax such income, if the recipient is an Indian resident.

Similarly, when the overseas shares or units are sold giving rise to capital gains, tax would be payable in India at the applicable individual tax slab rates. In respect of long-term gains, the rate of tax would be 20% (excluding surcharge and cess) for shares or units held in the UK. The concessional rate of 10% applicable for short-term gains and nil rate for long-term gains would not be available when shares or units are held overseas, because this benefit is only available for securities listed on any recognised stock exchange in India or mutual funds registered in India.

Also, listed securities or units of Indian mutual funds are classified as short-term assets if the period of holding is less than 12 months. However, overseas securities would be classified as short-term assets if these are held for less than 36 months. Therefore, for securing the lower rate of long term capital gains tax of 20%, the overseas securities will have to be held for more than 36 months.

Or let us take another example. Let us assume Malaika purchases a house in Dubai. Since there is no tax in Dubai, there would not be any double taxation and for an ordinary tax resident of India, tax would be payable in India as per the provisions of the Indian Income-Tax Act, both in respect of rental income and capital gains, if any, arising on sale of such property.

News reports cite that the India-UAE DTAA is likely to be revised. However, it appears this is to provide clarity on whether or not a UAE resident can claim protection under the beneficial provisions of the DTAA. It is unlikely to impact Malaika who is an ordinary tax resident in India.

Perhaps Malaika decides to invest in fixed deposits in the US. In this case, the interest income would be fully taxable in India at the applicable slab rate. It is equally likely that this income is also taxed in the US at applicable tax rates since the income will be US sourced.

Thus, when making investments overseas, it is important to look at the provisions of the relevant DTAA. Only if the DTAA provides that a foreign source income cannot be subject to tax in the other country (i.e. India) will you escape tax on such income in India.

In all events, such income is required to be reported in your tax return. A foreign tax credit can be claimed in India for taxes paid abroad. However, other than providing for the general principle that the tax paid in respect of income taxed in the other country (country of source of income) shall be available as a credit against the Indian tax liability, the tax treaties do not prescribe for specific guidelines.

The Indian I-T Act also does not have specific and clear guidelines as to the methodology of claiming such credit. Thus, claiming a foreign tax credit in India is not free from litigation.

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