Total World Income Exempt from Tax

Total World Income Exempt from Tax Under Indian Income Tax Law

Understanding which portions of global income are exempt from taxation is crucial for Indian residents with foreign income sources. This article provides a detailed overview of the exemptions and reliefs available under Indian Income Tax Law concerning total world income. It aims to clarify the legal provisions and their practical implications.

Residency Status and Taxability of Global Income

The taxability of income in India hinges primarily on the residential status of the assessee. Under the Income Tax Act, 1961, an individual can be classified as:

Resident and Ordinarily Resident (ROR): An ROR is taxed on their global income, i.e., income earned anywhere in the world.
Resident but Not Ordinarily Resident (RNOR): An RNOR is taxed on income that is:
- Received or accrues or arises in India.
- Deemed to accrue or arise in India.
- Income that accrues or arises outside India, if it is derived from a business controlled in or a profession set up in India.
Non-Resident (NR): A non-resident is taxed only on income that:
- Is received or accrues or arises in India.
- Is deemed to accrue or arise in India.

Therefore, if you are an ROR, your entire global income is subject to Indian income tax. Understanding your residency status is the first step in determining your tax liability. Sections 6 of the Income Tax Act, 1961 contain provisions of determining the residential status.

General Principles of Income Taxation

Before delving into specific exemptions, it’s important to remember the general principles governing income taxation:

Accrual vs. Receipt: Income can be taxed on an accrual basis (when the right to receive it arises) or on a receipt basis (when it is actually received). Indian tax law generally uses the accrual basis, though specific provisions might consider the receipt basis.
Source Rule: Income is generally taxed in the country where it originates (i.e., where the activity that generates the income takes place). However, residency-based taxation overrides this in many cases, particularly for RORs.
Tax Treaties (Double Taxation Avoidance Agreements – DTAA): India has DTAAs with numerous countries. These treaties aim to prevent double taxation of the same income. They often specify which country has the right to tax certain types of income and may provide for tax credits or exemptions to avoid double taxation.

Exemptions and Reliefs Available Under Indian Income Tax Act

While RORs are generally taxable on global income, specific exemptions and reliefs exist under the Income Tax Act, 1961, which can reduce the overall tax burden.

1. Foreign Income Tax Credit (Section 91):

Section 91 provides relief from double taxation where no DTAA exists. If an Indian resident has paid tax on income in a country with which India does not have a DTAA, they can claim a credit for the tax paid in the foreign country against their Indian tax liability.
Conditions: The income must have been taxed in both India and the foreign country. The credit is limited to the lower of the foreign tax paid or the Indian tax payable on that income.
Example: If an individual residing in India earns $10,000 in a country with which India has no DTAA, pays $2,000 in foreign taxes, and the Indian tax liability on that income is ₹1,00,000 (approximately $1,200), they can claim a credit of ₹1,00,000. If the Indian tax liability is ₹2,00,000, the credit is limited to the foreign tax paid which is $2,000 converted to INR at applicable rates.

2. Relief Under Double Taxation Avoidance Agreements (DTAAs) (Section 90):

Section 90 empowers the Central Government to enter into agreements with other countries to avoid double taxation of income. These agreements outline the rules for determining which country has the primary right to tax different types of income.
Benefits: DTAAs can provide for exemptions, reduced tax rates, or tax credits to eliminate or mitigate double taxation. The specific provisions vary depending on the treaty.
Key DTAA Provisions: Common DTAA provisions cover income from:
- Dividends: DTAAs often specify the maximum rate at which dividends can be taxed in the source country (the country where the company paying the dividend is located).
- Interest: Similar to dividends, DTAAs often limit the tax rate on interest income in the source country.
- Royalties and Fees for Technical Services: These are frequently subject to reduced tax rates under DTAAs.
- Capital Gains: DTAAs often specify which country has the right to tax capital gains arising from the sale of assets. The rule usually depends on the nature of the asset and the residency of the seller.
- Salaries: DTAAs generally provide that salaries are taxable in the country where the employment is exercised. However, there are exceptions for short-term assignments.
- Business Profits: Business profits are typically taxable in the country where the business has a "permanent establishment" (e.g., a branch or office).
Applying DTAA Benefits: To claim benefits under a DTAA, the assessee must typically provide a Tax Residency Certificate (TRC) from the foreign country. The TRC serves as proof that the individual or entity is a resident of that country for tax purposes. Form 10F is also required to be submitted for availing DTAA.

3. Income Specifically Exempted Under the Income Tax Act, 1961:

While not directly related to foreign income per se, certain types of income are exempt regardless of their source. These exemptions can indirectly affect the taxability of global income. Some notable examples include:

Agricultural Income (Section 10(1)): Agricultural income earned in India is exempt from income tax. This exemption could extend to income derived from agricultural land located outside India, depending on specific interpretations and case law. The definition of agricultural income can be contentious.
Interest Income (Selected Exemptions): Certain interest income, such as interest on specific types of savings certificates or deposits, may be exempt up to a certain limit under various sections (e.g., Section 10(15)).
Gifts (Limited Exemptions): Gifts received from relatives are generally exempt. Gifts from non-relatives are exempt up to a certain threshold.
Exemptions for Special Economic Zones (SEZs): Income derived by units located in SEZs may be exempt from tax for a specified period, subject to certain conditions.

4. Foreign Allowance and Perquisites:

General Rule: Allowances and perquisites received by Indian citizens posted abroad by the government of India are generally exempt. This exemption is often provided to incentivize individuals to work abroad.
Conditions: The exemption typically applies to allowances and perquisites that are directly related to the foreign posting and are intended to cover the higher cost of living or specific expenses incurred due to the foreign assignment.
Relevant Provisions: Specific notifications or circulars issued by the Central Board of Direct Taxes (CBDT) may provide further details on the scope and conditions of this exemption.

5. Remittance of Foreign Income:

No Tax on Mere Remittance: The mere remittance of foreign income into India does not automatically trigger taxation. The taxability depends on the accrual or receipt of the income and the individual’s residency status.
Example: If an individual earned income in a foreign country while they were a non-resident, and they subsequently remit that income to India after becoming a resident, the income is generally not taxable in India, as it was earned when they were a non-resident.

Practical Implications and Considerations

Documentation is Key: Maintaining thorough records of foreign income, taxes paid, and supporting documents (e.g., pay slips, tax returns filed in the foreign country) is crucial for claiming exemptions and reliefs.
Professional Advice: Given the complexity of international taxation, seeking advice from a qualified tax professional is highly recommended. A tax advisor can help determine your residency status, analyze the applicable DTAAs, and ensure that you are claiming all available exemptions and reliefs.
Reporting Requirements: Indian residents with foreign assets or income are required to disclose these in their income tax returns. Failure to do so can result in penalties. Schedule FA (Foreign Assets) in the ITR forms deals with the reporting of foreign assets.
Changes in Law: Tax laws are subject to change. It is important to stay updated on the latest amendments and judicial pronouncements.

Key Legal Provisions

Income Tax Act, 1961:
- Section 4: Charge of income tax.
- Section 5: Scope of total income.
- Section 6: Residence in India.
- Section 90: Agreement with foreign countries or specified territories.
- Section 91: Countries with which no agreement exists for relief or avoidance of double taxation.
- Section 10: Incomes not included in total income (exemptions).
Double Taxation Avoidance Agreements (DTAAs): Consult the specific DTAA between India and the relevant foreign country.
Circulars and Notifications: Issued by the Central Board of Direct Taxes (CBDT).

Conclusion

While Indian residents are generally taxable on their global income, various exemptions and reliefs are available under Indian Income Tax Law and DTAAs. Understanding your residency status, the source of your income, and the relevant tax treaties is essential for accurately determining your tax liability and minimizing your tax burden. Always maintain accurate records and seek professional tax advice to ensure compliance and optimize your tax planning.