Taxation of salary income received from US employer in India

It may happen that an Indian resident is sent to USA on some deputation work, or a USA resident comes to India and renders services here. These situations can give rise to double taxation whereby both USA and India will try to tax this income. In such a situation, tax implications arise from the point of view of both countries domestic tax law and in case income is doubly taxed, the Double Tax Avoidance Agreement (DTAA) between India and USA would also come in the picture.

In such cases, there can be n number of scenarios and hence there is no generalized answer. The answer will depend on the facts of each specific case. Also, the biggest challenge is to interpret the DTAA provisions given its confusing legal language and lack of available legal precedents on the issue. However, one can take help of the OECD Commentary on Model Tax Convention and good commentaries available on DTAA in the market.

In this post, I’ve tried to analyse the applicable provisions for Indian domestic tax law as well as India USA DTAA for taxation of USA salary income in India and will try to put across the various contentious issues. Having said this, given the complex nature of query and associated penal implications, I would insist that you consult a qualified tax consultant on such matters.

Taxation of USA salary income under domestic tax law

As per India’s domestic tax law which is Income Tax Act, 1961 (ITA), Section 5 determines the scope of income, Section 6 talks about residential status and Section 15 talks about salary income.

So, under the ITA, first we need to determine the residential status of a person for the concerned financial year to find out whether the foreign income is taxable in India or not. I have written a detailed post on this, you can read that to get more clarity:

Reg. Indian tax law: How to calculate Residential Status for Tax Purposes in India

Reg. USA tax law: How to calculate Residential Status for tax purposes in USA

The treatment of salary income in India based on residential status is as follows:

• Non-Resident (NR) or Resident and Not Ordinarily Resident (RNOR):  Only Indian income is taxable. Foreign salary income is not taxable. (See Notes below though)
• Resident and Ordinarily Resident (ROR): Global income of all types is taxable in India, irrespective of the fact that it is also taxed outside India. DTAA relief is available, as we discuss later in this post

Some other points:

1. If income is directly received in India, then it is a contentious issue – though the general principle is that income “received” in India is taxable in India irrespective of residential status of a person, however situation is different in case of salary income where the pre-condition for taxability in India is that the services must be rendered in India – there have been cases where seafarers who render services in international waters & receive salaries directly in Indian bank accounts have faced a lot of harassment from ITD on this issue and I’ve written in detail: NRI Seafarer Taxation: Way forward after 2016 ITAT Tapas Kr. judgement  My view is, to be on a safer side, take the credit of salary income in USA bank account and then remit to India
2. If income is received from an Indian company, then by virtue of Section 5, the income accrues in India and is taxable in India, irrespective of your residential status and even where the salary is for work done in USA and/or payment is credited in a bank account in USA
3. If a person qualifies as “resident” as per domestic tax laws of both countries, then we need to resort to Article 4 of DTAA which gives out a tie-breaker rule depending upon criteria such as situation of permanent home, centre of vital interests, habitual abode etc.

Taxation of USA salary income under India USA DTAA

In such cases, it is most likely that the US employer would have deducted withholding tax as applicable under the US tax law, and hence for an ROR, a case of possible double taxation will arise. And here, we have to check the applicable provisions of DTAA to see what relief is available. Note that DTAA would over-ride domestic tax laws of both India and USA and assessee has an option to select DTAA provision, if it is beneficial.

In the India USA DTAA, salary or employment income is defined as “Dependant Personal Services” (DPS) and applicable Article is Article 16. Below, I have reproduced the text of the Article 16 as follows:

ARTICLE 16

DEPENDENT PERSONAL SERVICES

1. Subject to the provisions of Articles 17 (Directors’ Fees), 18 (Income Earned by Entertainers and Athletes), 19 (Remuneration and Pensions in respect of Government Service), 20 (Private Pensions, Annuities, Alimony and Child Support), 21 (Payments received by Students and Apprentices) and 22 (Payments received by Professors, Teachers and Research Scholars), salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.

2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State, if:

(a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the relevant taxable year;

(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and,

(c) the remuneration is not borne by a permanent establishment or a fixed base or a trade or business which the employer has in the other State.

3. Notwithstanding the preceding provisions of this Article, remuneration derived in respect of an employment exercised aboard a ship or aircraft operating in international traffic by an enterprise of a Contracting State may be taxed in that State.

(emphasis supplied)

Important points from a reading of Article 16 are as follows:

1. As a base rule, income from a US company is taxable only in USA.
2. However, if person was physically present in India during the exercise of employment, then income will be taxable in USA as well as India.
3. A special situation occurs where a person who qualifies as an Indian resident as per DTAA is working in US – If conditions in rule 2 are satisfied (the person has stayed less than 183 days in US, remuneration is not paid by US company directly & has not been borne by US company’s PE in India, then the income will be taxable only in India. In such a case, a safer option for the person is to person can file nil return in US quoting the respective Article of DTAA relied upon & claim a refund for any tax deducted by US company.

Some more points:

If the person is a US citizen/GC holder and beneficial provision in DTAA can’t be availed, then in addition to India, USA also has a right to tax that income (this is also expressed in Article 4 of DTAA which says every country can tax its residents irrespective of DTAA).  Person can claim credit of US federal income tax in Indian tax return (also known as “Credit Method”)

Various scenarios on USA income taxation scenarios in India

Now, lets discuss some key scenarios in detail to fully understand the interplay of US & India taxes & DTAA in each situation.

Scenario # 1: Indian citizen returned back after working in USA

Rajesh is a citizen of India. He has been working in Apple Inc. for couple of years and returns to India in May 2016. He qualifies as a Resident and Ordinarily Resident (ROR) under Indian tax law for the FY 2016-17. He wants to know whether he needs to offer the USA income for April and May 2016 in Indian tax return or can he claim it as exempt in Indian tax return? His employer in USA has deducted tax in USA on that income.

Answer: In this case, facts are as follows:

1. Rajesh is a resident of India (ROR) and hence liable to tax on worldwide income.
2. Rajesh’s salary is “US connected income” as per US tax law and salary is withheld in USA
3. Rajesh is not a tax resident of USA so tie-breaker rule under Article 4 will not come into question.
4. Place of rendering service is USA for the USA salary income in question.

Now, to interpret the treaty provision, let us tweak the language of the DTAA and replace the name of countries:

“1. ……. salaries, wages and other similar remuneration derived by a resident of INDIA in respect of an employment shall be taxable only in INDIA unless the employment is exercised in USA. If the employment is so exercised, such remuneration as is derived there from may be taxed in USA.

2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of INDIA in respect of an employment exercised in USA shall be taxable only in INDIA, if:

(a) the recipient is present in USA for a period or periods not exceeding in the aggregate 183 days in the relevant taxable year;

(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of USA; and

(c) the remuneration is not borne by a permanent establishment or a fixed base or a trade or business which the employer has USA.

……..”

Now, in this case, the answer is that the income is taxable in India as well as USA. Rajesh will have to file tax returns in US as well as India. While filing tax return in India, Rajesh can claim the credit of “federal income tax” paid in USA.  This information will be available to him in his W-2 statement that he receives from his US employer.

Only exception could have been if Rajesh would have fulfilled ALL three conditions in point no. 2, salary would be taxable only in India. In that case, he would have filed a nil tax return in USA (claiming treaty exemption) and got a refund of the whole tax deducted in USA. Consequently, in Indian tax return, he would not take credit of tax withheld (and now claimed as refund) in USA.

However, in the instant case we see that though condition (a) regarding 183 days is satisfied, condition (b) and (c) does not – he is employed with Apple Inc. which is a not a resident of India nor a Permanent Establishment/Fixed Base of an Indian company. Hence, his income will be taxable in USA in addition to being taxable in India.

Scenario # 2: Salary borne by a foreign PE of an Indian company

In scenario #1, assume Rajesh is working for Infosys. Infosys has a PE in USA and the salary expense is borne by that PE in USA. Will the answer change?

Answer: Since condition in 2© is not satisfied, answer is NO. Salary will be taxable in India as well as USA.

Scenario # 3: US citizen returned back after working in India

Daniel is a citizen of USA. He has been working in Alphabet Inc. for a couple of years and returns to USA in May 2016. His salary is being paid directly from Alphabet USA & not borne by a PE in India. He is a non resident under Indian tax law for the FY 2016-17. He wants to know whether he needs to offer the India income for April and May 2016 in Indian tax return or can he claim it as exempt in Indian tax return? His employer in India has deducted tax on that income.

Answer: In this case, facts are as follows:

1. Daniel is a US citizen and hence his worldwide income is liable to be taxed in USA.
2. Place of rendering service is India for the India salary income in question.
3. Residential status of Daniel in India does not matter, as u/s 5 of Income Tax Act (ITA), any income earned for services rendered in India is taxable irrespective of the person’s residential status in India.
4. There is a clear case of double taxation.
5. Daniel is not a tax resident of India for the year hence tie-breaker rule under Article 4 need not be checked.

Now, to interpret the treaty provision, let us tweak the language of the DTAA and replace the name of countries:

“1. ……. salaries, wages and other similar remuneration derived by a resident of USA in respect of an employment shall be taxable only in USA unless the employment is exercised in INDIA. If the employment is so exercised, such remuneration as is derived there from may be taxed in INDIA.

2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of USA in respect of an employment exercised in INDIA shall be taxable only in USA, if:

(a) the recipient is present in INDIA for a period or periods not exceeding in the aggregate 183 days in the relevant taxable year;

(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of INDIA; and

(c) the remuneration is not borne by a permanent establishment or a fixed base or a trade or business which the employer has INDIA.

……..”
Now, in this case, all three conditions are satisfied. Income is taxable only in USA. India does not have the right to tax the income. While filing tax return in India, Rajesh can disclose the income in Schedule FSI however put “0” in the amount taxable field and quote 15(2) In the place where he is required to quote the relevant article in DTAA.  Also he can disclose the US income in Schedule EI.

Other points

1. While taking credit of US taxes in India, there is no credit available for state tax, federal penalty tax, medicare tax etc. – so, in a sense, you can say that it is not that full double tax is avoided – only a part of it (comprising of the federal income tax) can be avoided by taking the credit method. Hence, first step should always be to check if we can claim exemption method.
2. Person (resident/non-resident as per domestic tax law of India) can apply for an Advance Ruling in India, to determine the taxation of such income in India provided the transaction has happened or proposed to happen in India (for example, a returning Indian working in USA and getting salary from US employer cannot get an advance ruling on taxability of such salary income in India)
3. If there is non-disclosure of foreign income or assets by an Indian resident (ROR), the implications of Black Money Act which came into effect on 1/7/2015 are very severe. I have discussed it in detail here: Black Money Act: An Analysis
4. The income, assets and relevant DTAA relief if available need to be disclosed in Schedule FSI (Foreign Source Income) and Schedule FA (Foreign Assets) in the tax return – hence, it is very important to choose the right return and disclose the income properly in the said schedules – I’ve written a post on this here: How NRI should disclose their foreign income/ assets in Indian tax return

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