Today, they enjoy lower taxes on earnings from the US till they become ‘full residents’ in India. This benefit, derived from the India-US tax treaty, could now disappear.
Returning Indians are in a vulnerable situation after Washington spelt out its position in a recent commentary on the OECD Tax Convention which sets the ground rules for countries to prevent tax evasion and avoid double taxation. Under Indian laws, an ‘ordinary resident’ is taxed on her global income – earnings from India and abroad, while an NRI, who spends less than 182 days here in the previous year, is taxed only on Indian income (like interest from FDs with Indian banks, dividends and capital gains from sale of shares etc).
The statute has a carve-out for returning Indians who are categorised for tax purpose as ‘resident but not ordinary resident’ (RNOR). Till a person remains RNOR, only her Indian earnings are taxed. An RNOR must qualify one of the following criteria: (1) spends more than 120 days but less than 182 days in a year in India and has at least ₹15 lakh income from India, provided the person has spent at least 365 days in the preceding 4 financial years; (2) have been an NRI — i.e, spent less than 182 days in India – in 9 out 10 preceding financial years; or, (3) spent not more than 729 days in India in 7 preceding financial years.
Typically an RNOR becomes a full ordinary resident after spending 2 to 3 years in India. During this period, India doesn’t tax her US income while the US offers lower treaty rates as the individual is considered a ‘tax resident’ in India.
WASHINGTON CLARIFIES TO OECDBut, the US has now said that if an individual is taxed on a limited basis by the contracting state (here, India), the person will not be considered as a tax resident of that state.”The shift arises exclusively from the US side: Washington may now decline to view RNORs as Indian residents for treaty purposes because they are not taxed in India on their global income. This strikes at the core of an individual’s treaty entitlement. The US may refuse eligibility for reduced withholding tax rates on dividends, interest, and payments for technical services, etc.
In addition, it may limit the availability of treaty-based exemptions, including those applicable to annuities and technical service fees. Many cross-border fund arrangements structured on the premise that the RNOR status did not impede treaty residency would require closer scrutiny. Individuals will need to re-evaluate how income flows, investment structures, and timing of return since the Indian tax position itself has not changed, but the ability to rely on the treaty may be constrained,” said Ashish Karundia, founder of the CA firm Ashish Karundia & Co.
Going by the US stand, an RNOR will be taxed by the US at 30% (as against 15-25% under the treaty) on dividends on US stock, mutual funds; 30% as against 15% on interest on FDs with US banks. Also, royalties from US platforms, apps, books, Spotify and YouTube would be taxed at 30% in the US compared with 15-20% now.
The scare seems real. According to Priyanshi Chokshi, advocate, Bombay High Court, “While the OECD Commentary does not have binding legal force and is generally regarded as persuasive guidance only, it remains an important interpretative aid- especially when both countries to a tax treaty are OECD members or have endorsed the Commentary. Since the US is a signatory to the OECD framework and India is a key partner, and has historically drawn from OECD principles in interpreting treaty provisions, it is considered good practice to rely on the Commentary for clarity and consistency.
Courts and authorities often look to it to understand the common intention behind treaty language, even if it is not strictly mandatory.”
A tax treaty applies to residents of two countries. RNOR is a quirk in Indian regulations where a person is not a full resident in India but was considered as one (till now) by the US. Chances are this anomaly may be done away with and RNORs may face higher taxes.