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In our previous article, an attempt was made to answer some basic issues pertaining to the US tax laws related to Non-resident Indians1 (NRIs) including Indian expatriates working in the US or those who are the US Citizens or Green Card holders who are not tax residents of the USA and brief discussion on enactment of FATCA and its impact, Residential Status in the US, Exempt Income in the US, FBAR (FinCEN Reporting) and Form 8938 reporting. To take a step further, this article2 attempts to throw light on taxation of passive income (such as Capital Gains, Dividend and rental income). In order to elucidate issues clearly, they are discussed in a Questions- Answers format.
Introduction
In the USA, complying with the tax laws can be very challenging as the same is fraught with complications. Indian Citizens who have moved to the US for employment or for better prospects and in the process have become residents of the US or Green Card Holders should understand the nuances of local tax laws very carefully and start strictly complying with the same from day one. Non compliance or non awareness of taxability of certain income in US can be a very costly affair, as the US has one of most stringent laws with respect to interest and penalty provisions for non compliance.
If you are a tax resident (even if a non citizen i.e. resident alien) in the US, then you are taxed on your worldwide income, just as in case of a Citizen of the USA. In other words, you are taxed on your worldwide income in US2 during the period u you are tax resident of the USA. In the US, the income is basically categorized in two types of Income i.e.,
Trade or business income or
Passive Income (Capital Gains, Dividends, Rental Income etc.) In this article, we would discuss the nuances regarding the taxability of passive income of the US tax residents from outside the USA (i.e., from India) both in the US and India. We would also touch upon the taxability (in both jurisdictions) of passive income arising to Indian Residents from the US.
Capital Gains from Sale of Immovable Property situated in India
1. How capital assets are defined for “Resident Alien”3 in the US and how their cost is determined? Whether a “Resident alien” in US is required to declare his capital assets located in India?
Capital Assets in the US are defined to mean almost everything one owns and uses, for personal or investment purposes. Examples include a home, personal-use items like household furnishings, car and stocks or bonds held as investments.
The US IRS (Internal Revenue Service) uses the term “Basis of Assets” for the cost. Basis is the amount of investment in asset for tax purposes. The basis is the amount one pays for it in cash, debt obligations, and other property or services. It includes sales tax and other expenses connected with the purchase. For stocks or bonds, basis is the purchase price plus any additional costs such as commissions and recording or transfer fees. Basis is increased to incorporate cost of improvements and decreased to consider depreciation, non dividend distribution on stock/stock splits etc.
“Resident Alien” in the US is required to report capital assets wherever located while filing his tax return in Form 8938 or FBAR as may be applicable. Thus, it can be seen that the definition of “Capital Asset” under the US tax law is quite similar to the Indian tax laws.
2. What are the provisions pertaining to Long term capital gains on sale of Immovable properties located in India and pertaining to the US resident alien?
In India, sale of Immovable property is considered as long term, if it is sold 3 years after its date of acquisition. Long Term Capital Gains from immovable property situated in India is taxed @ 20% plus 3% Education Cess + Surcharge, as may be applicable. However, as per the US Tax law, the time period for computing “Long term asset” is one year. In US, the tax rate on Long term Capital Gains depends upon the ordinary income tax bracket of an individual.
3. Can a NRI (Who is Resident Alien in the USA) claim exemption in India of Capital gains earned from sale of Immovable Property situated in India?
Section 54 to 54F of the Income-tax Act, 1961 contains provisions regarding exemptions/relief from Long Term Capital Gains in India. These exemptions/reliefs are subject to fulfillment of certain conditions. Exemptions are available if capital gain earned is invested in a residential house situated in India or some specified bonds in India. These sections restrict the exemption to an individual and HUF. The exemption is not dependent on the residential status or citizenship of the seller/assessee. Thus a NRI residing outside India can claim exemption [as per provisions of section 54 to section 54F] in respect of the sale proceeds/capital gains arising from transfer of a long term capital asset.
Further as per section 54 and 54F, capital gains are exempted if NRI invests in a new house property. As per the recent Amendment in the Income Tax Law4, the location of the new house property should be in India.
4. H ow Capital Gains earned in India by a NRI (who is a “Resident Alien” of US) are taxed in USA? Can he claim tax exemption in the US for the property sold in India?
Capital Gains arising in India in the hands of a NRI, who is a Resident tax Alien in the US, will be computed in the US as per the US tax laws, irrespective of the tax treatment that gains suffered in India. As per the US tax laws, Long term Capital Gains on sale of a main home, is exempted up to $ 2,50,000/5- subject to certain conditions. Exemption of $ 250,000/6 – for sale of a property depends on the ownership requirement and use requirement.
However, when the US resident alien files his tax return in the US, he/she has to take into account the difference in the time period for calculating long term capital gain, the exemption available as per the tax laws of US and treat his Indian capital gains as per the time period specified in the US law.
NRI can claim a foreign tax credit in his/her US tax return as per India – USA DTAA .
To elucidate the matters more clearly, let us consider an example (it will be not possible to cover and analyse all types of situations that may arise in real life situations) which is given below in Q 5.
5. Mr. Rich, a NRI and “US Resident Alien” owns a house in New York, USA (being his Main Home) and a Flat in Mumbai. He sells the Flat in Mumbai for Rs. 75 lakh and earns Rs. 55 lakh as Long term Capital Gains. Can he invest Rs. 50 lakh in REC/NHAI Bonds u/s. 54EC? What would be implications under the US Tax Law? What are the Implications under India – US DTAA?
As per the India US DTAA , Capital Gains are taxed in India as well as USA in accordance with the provisions of the respective domestic tax laws. Therefore, the capital gains arising from the sale of flat in Mumbai would be taxable in India.
As explained above a NRI residing outside India can claim exemption under section 54 to section 54F of the Incometax Act, 1961. Thus, out of the capital gains arising from transfer of a flat i.e. long term capital asset the investment under 54EC is permissible.
Mr. Rich being a US resident will pay taxes on Capital Gains of Rs. 55 lakh as per the US Law. As his house in New York is the “main home” (satisfies the ownership and the user requirement of the main home), he will be not able to take the benefit of the exclusion provided as per the US Laws for the Mumbai Flat7 . Though, as per India – US DTAA he would be allowed credit for the taxes paid in India against the taxes payable in US.
6. What are the provisions relating to Capital gains arising from shares, debentures and Bonds in India? Can a NRI claim exemption from Capital gains u/s. 10(38) of the Income-tax Act earned from sale of equity shares of Indian Companies?
Taxability in india
Profits and gains earned on sale of any shares, debentures, mutual funds and other securities are taxed under the head of “Capital Gains” under the income-tax act, 1961.
Gains on shares, debt or balanced schemes of mutual funds, are defined as Long term capital Gain if the same are held for more than 12 months.
Short term Capital Gains on sale of shares or mutual funds which are debt oriented are taxed at normal rate of tax along with other taxable income. However, Short term Capital Gains on sale of equity shares or units of an equity oriented fund on which STT is paid, is taxed at the rate of 15% plus 3% education cess plus curcharge as may be applicable.
Long term Capital Gains (LTCG) from sale of equity shares or unit of equity oriented mutual fund listed in india on which Stt is paid, is exempt u/s. 10(38) for both residents and non-residents. However, LTCG from unlisted securities shall be taxed at 10%. LTCG on Listed Securities on which Stt is not paid is taxed @ 10% without indexation, whereas taxed @ 20% with indexation plus 3% education cess plus curcharge as may be applicable.
7. How Capital gains earned in India by a NRI, who is a US Resident Alien, are taxed in USA?
Taxability in the USA
In the US, the tax rates on Long term and Short term Capital Gain will depend on tax brackets of the ordinary income of an individual. Given below is the table of various
Tax rates applicable8 to an individual depending upon his/ her tax bracket:-
|
tax Brackets
for a Single individual
|
ordinary
income tax rate
|
long term capital Gain rate
|
Short term capital
Gain rate
|
|
$0 – $9075
|
10%
|
0%
|
10%
|
|
$9076 – $36900
|
15%
|
0%
|
15%
|
|
$36901 – $89350
|
25%
|
15%
|
25%
|
|
$89351 – $186350
|
28%
|
15%
|
28%
|
|
$186351 – $405100
|
33%
|
15%
|
33%
|
|
$405101 – $406750
|
35%
|
15%
|
35%
|
|
$406751 & Above
|
39.6%
|
20%
|
39.6%
|
Let us consider one more example to understand the impact under both tax laws:-
Mr. Rich, a NRI and US Resident Alien, owns Rs. 10 crore worth of shares of listed Indian Companies. he sells all the shares and earns long term Capital gains of Rs. 5 crore and Short Term Capital gains of Rs. 1 crore. What are the implications under India and US Tax law? Whether such Capital gains would be taxable in the US? Can Mr. Rich claim tax credit in US of taxes paid in india?
Implications as per Income-Tax Act, 1961
As per section 5 of the income-tax act, any income arising in india will be taxable in india. however, Long term Capital Gains on sale of equity Shares is exempt u/s. 10(38) of the act. Though, Short term Capital Gains arising from sale of equity shares would be taxable at the rate of 15% (plus 3% education Cess and applicable surcharge) u/s. 111a of the act. Hence in the given example, Mr. rich would be exempt from tax on Long term Capital Gains but would be taxed at 15% (plus 3% education Cess and applicable Surcharge) on Short term Capital Gains.
Implications under US Tax Laws:-
Mr. rich would be taxed on his worldwide income in the uS and hence, he would be taxed on the Capital Gains arising in india. however, as per article 25 of india – US DTAA, he can avail foreign tax credit of the taxes paid in india against the uS taxes.
Long term Capital Gains and Short term Capital Gains arising on sale of shares will be taxable as per the tax brackets of Mr. Rich. even though Long term Capital Gains from sale of equity are exempt from tax in india, such gains will be taxable in the US. Short term Capital Gains are taxed in the US as per the ordinary income tax rates, whereas the Long term capital gains are taxed at a concessional rate depending upon the ordinary income tax bracket. The table of tax rates for both short term and long term capital gains is given above for reference.
Taxation of Dividend Income
8. What are the implications under Indian and US Tax laws for a US Resident receiving Dividends from indian Companies?
In india, the recipient of dividends is not liable to pay any tax on dividend received/accrued as the company distributing the dividend is liable to pay dividend distribution tax at the rate of 15% plus surcharge and education Cess. Thus, a US tax resident receiving dividends from the indian company which has paid dividend distribution tax is not subjected to tax in india. However, such dividend would be taxed in US as per the normal income tax rates.
Taxation of Rental Income
9. Mr. Rich, a NRI, residing in the US. he has given his residential house in India on rent. What will be the implications of the rental income received by Mr. Rich under the US tax law?
Rental income received by mr. rich will be taxed both in india and uS. article 6 of the india – uS dtaa provides that rent from immovable property (real property) may be taxed in the country where it is situated. thus, mr. rich has to pay tax on rental income in india as the property is situated in india and he has to pay tax in the uS also, being taxed on worldwide income. the major difference in india and uS is that in india mr. rich would get a standard deduction of 30% whereas in uS taxation only actual expenses incurred would be deducted from such rental income. following deductions will be allowed against such income:
– mortgage Property taxes
– insurance
– utilities
– depreciation – allowed for building; any furnishings; appliances (except land).
However, the taxes paid in india would be available as foreign tax Credit under indian – US DTAA.
Taxation of Interest
10. how is interest income of a NRI (who is resident alien in USA) taxed in India and US?
As per the india – US dtaa, the right of taxing interest primarily lies with the Country of residence of the person earning it. However, article 11 does give right of taxation to the source country but the maximum rate at which it can get taxed is capped at 15%. 9
Taxation of Income of Non-resident Aliens (i.e. Indian residents) in US
So far we have discussed taxability of nris settled in USA who (mostly regarded as resident alien or uS Citizen) have sources of income in india. Let us now turn to a situation where indian tax residents have sources of income in USA.
11. A resident Indian sells an immovable property in US (acquired 2 years ago) and earns a capital gain of $15,000/-. What would be implications under the US Tax law and the Indian IT Act? What is the India – US Tax Treaty implications on the same?
In the given case, since the property was held for two years, the capital gains would be treated as Long term Capital Gains in the US. The net capital gain is normally taxed at the appropriate10 graduated tax rates. however, if withholding tax is applicable, then tax is deducted by the purchaser at the rate of 10% of the gross sale proceeds. Resident Indian would therefore be required to file income tax return in the US and pay appropriate capital gains tax, subject to exemption of $ 2,50,000/-, if gains arise on sale of main home. In certain cases, subject to certain filings and fulfillment of conditions withholding of tax can be avoided.
Resident Indian while filing his income tax return in India would have to treat such capital gains as short term capital gains as the period of holding is less than three years. however, as per the india – US DTAA, resident indian will be able to claim the foreign tax credit for the taxes paid in the US while filing his tax return in India.
12. A resident Indian has earned Capital gains on sale of a foreign property (long term capital asset) which was held for more than three years, Will he be able to claim capital gains exemption as per the IT Act by investing in a residential house in india or NHAI bonds in india?
A resident indian can avail exemption u/s. 54eC and 54f upon fulfillment of certain conditions if the investment made from transfer of a long term capital asset. The exemption is available irrespective of the fact that the capital asset is situated outside india.
13. What are the implications under Indian and US Tax laws for an Indian Resident receiving Dividends from US Companies?
In the US, dividends are considered as part of passive income. Generally, tax at the rate of 30% or lower treaty rate (i.e. 25% as per india – US DTAA) is withheld by a uS Corporation on the dividends distributed to a non-resident.
In india, such dividends would be taxed in the following manner
(i) If dividend is received by an indian Company from its Wholly owned subsidiary in uS, then it is taxed @15%; and
(ii) In all other cases, at the applicable tax rate.
The tax withheld by the US Corporation would be available as foreign tax credit against the tax payable in india.
14. What will be the implications under the US tax law for the rental income received by Indian resident from renting of property in US?
As per the US Laws, tax rates depends on whether a non- resident alien is able to choose to treat all income from real property as effectively/not effectively connected with a trade or business.
If the rental income is in connection with any trade or business in USA, then the tax would be levied on a graduated applicable tax rates, otherwise tax would withheld @ 30% on gross rental. The taxpayer i.e. an indian resident has to make appropriate declaration by exercising choice at the time of filing his tax return.
Epilogue
The US tax law is a complex subject. one cannot possibly cover all aspects in a short write-up. The intention of few FAQs mentioned herein above is to highlight some of the nuances of US & indian tax laws on passive income in india pertaining to nris in the USA (resident alien or uS Citizen) & passive income in the uSa of indian tax residents.
