In Depth Insight Into India - U.S Tax Treaty & its Implications.

 

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My husband and I have been in the United States for thirty years and only when we mention that to someone else that it seems like a long time! If you have been a reader of my blog, you may know that we are from India. Or if you did not, now you do! 

Naturally when I started my practice, it seemed like more people from the South Asian diaspora gravitated towards my practice. Maybe there is confidence that I can empathize with them and not only understand the cultural nuances but also all of the quirks of navigating the system. But most importantly, I know how many zeroes go in One Lakh and how many in One Crore! 

In the process of helping clients from my birth country, I have learnt to rely on the India-U.S. Tax Treaty for guidance. The language in Tax Treaties tend to be technical, dense and confusing. It is definitely not language one can "decode" without expertise and experience. 

First, what is a tax treaty?

A tax treaty is a bilateral agreement between two countries to resolve issues involving double taxation of passive and active income of each of their respective citizens. They generally determine the amount of tax that a country can apply to a taxpayer's income, capital, estate or wealth. 

An income tax treaty is also called a "Double Tax Avoidance Agreement". 

This is an important tool in a tax professional's kit when working with clients who have a cross-border presence and possibly foreign income and financial assets. It is referenced frequently to determine if there are any treaty benefits that could help in mitigating double taxation. 

We always have to remember though that the Savings Clause can override all other articles when it comes to the U.S. tax rules that apply to U.S. Citizens. 

Hence one should tread carefully when going through a treaty to check for benefits, the savings clause has stumped many experts!

India-US Treaty Details

The tax treaty between the governments of the United States and the Republic of India was signed in 1989. 

This treaty is applicable to:-

 Indian Students or Researchers in the U.S. 

Most students from India arrive in the U.S on an F-1 or J-1 visa. 

• Social Security & Medicare taxes: Generally, students on F-1 (on the 1st 5 years employment income) or exchange visitors/ teachers or researchers on J-1 visas (on the 1st 2 years of employment income) are not subject to Social Security and Medicare taxes on their employment income.

• Deduction on US Tax Return: Days of stay are not counted for F-1 visa holders for the first 5 years of their stay in the U.S. Thus, the student files a Form 1040-NR which is a form filed by non-residents. A Form 1040-NR denies the filer the standard deduction as well as being able to file jointly with a spouse. However, under the India-U. S tax treaty, Article 21(2), an Indian student on an F-1 visa can claim the standard deduction, they can also claim a spouse as a dependent as long as the spouse is not a dependent of another taxpayer.  

•  Income Exempt From Tax: Under Article 21 of the Treaty, the Indian F-1 student is not subject to income tax on compensation earned outside the United States. Article 22 talks about remuneration to those under the J-1 visa. See Table I below- Items D & E.   

"NRI's" or Non-Resident Indians in the United States on non-immigrant visas or in the U.S for a short period of time.

"NRI" is a term often used to describe an Indian Citizen who lives outside India. For the purposes of today's post, we consider an NRI as an Indian citizen in the U.S for a short period of time/ on a non-immigrant work visa.

• It is a common misconception among NRIs that income generated in India need not be reflected on the U.S return if a return has been filed in India. 

• Depending on the visa the NRI is on, if they are a tax resident of the U.S., they need to include their India income from all sources on their U.S. return without regard to its actual taxability in India.

• Treaty benefits are available to NRIs on their India source income on their U.S. tax returns and India tax returns. Such an individual may also be able to file a Tax Residency Certificate {TRC} from the Internal Revenue Service and claim income exemptions in India. See table I below- Items A to C.  

• They can use the Foreign Tax Credit {FTC} on their U.S. returns for the tax paid on the same income in India. They may have to forego certain tax deductions in India during the time they are not tax residents of India.

For example: Income from an Indian Partnership. In India, taxes are paid at the entity level and not at the partner level. The NRI's share of income needs to be reflected on the U.S return. 

 

Table I:

Individual’s Income	Number of Days of Stay in the U. S	Employer/ Payor	Max. Compensation Allowed	Under Treaty Article
A. As Employee other than fees paid to Director of U. S Corporation	183 Days	Any Foreign Person without a Permanent Establishment in the U. S.	No Limit.	16
B. As a Contractor other than fees paid to Director of U. S Corporation	89 Days	Any Foreign Person. This cannot be attributed to the individual’s U.S. base/ stay.	No limit.	15
C. From Public Entertainment	No Limit	Any foreign person or U. S resident payor.	$1,500	18
D. From Teaching	2 years	U.S. Educational Institution	No limit. Cannot be for research conducted for private benefit.	22
E. For full-time students- remittances or allowances	5 years	Any foreign resident	No Limit	21(1)

 Table: Prepared by Manasa Nadig, EA for The Buzz About Taxes. 

 

U.S. Citizens, Lawful Permanent Residents (Green Card holders) in the United States with India income and specified financial assets.

• Green Card holders will continue to be Indian Citizens and are eligible to invest in certain fixed and financial assets that are not available to U.S. Citizens.

For example: Individuals who are not Indian citizens cannot purchase agricultural land or such property under the Foreign Exchange Management Act {FEMA}.

• If this individual or an NRI makes frequent trips to India, they need to be counting the number of days they spend in the country. Under recent India regulations and guidelines (2024), if they have stayed in India for over 181 days, their worldwide income may be subject to tax by India and they will be obligated to declare their worldwide financial assets to the Indian government as well. The treaty does not cover this aspect.  

• A U.S Citizen with ancestral ties to India or if they were Indian citizens themselves before becoming naturalized citizens in the U.S. can apply for and get an Overseas Citizen of India or "OCI" card. OCI cardholders have parity with non-resident Indians in most economic, financial, and educational fields. However, they cannot acquire agricultural or plantation properties in India.

U.S. Citizens, Lawful Permanent Residents (Green Card holders) living in India and have become "Ordinary" residents for tax purposes.

1. Working in India. 

• As we know, U.S citizens or Green Card holders even if living in India as Ordinary tax residents have a continued obligation to file U.S tax returns on their worldwide income and declare their Indian financial assets if they cross the FBAR and FATCA thresholds under U.S’ Citizenship Based Taxation rules. 

• The India- U.S Tax Treaty allows that they can make use of the Foreign Earned Income Exclusion {FEIE} as well as the Foreign Tax Credit {FTC} in order to mitigate double taxation.

• The source of their income is used to determine taxability and apply tax treaty benefits accordingly. 

• Green Card holders can take a treaty position to claim "closer connection" to India and thus lower taxes due to the U.S. Taking this position comes with other consequences so everything needs to be taken into account before using this option.  

2. Retired and are drawing their U.S. Retirement Income including Social Security benefits in India.

If an individual is retired and is living in India, they may have pensions, 401K- type retirement accounts, IRAs and Roth IRAs, and Social Security benefits and other investment income from U.S sources. 

In any of the cases listed, the retiree can claim a Foreign Tax Credit on their US return for taxes paid to the Indian Government.

Note: Retirement income is NOT considered “Earned” income for exclusion under FEIE.

The India- U.S Tax Treaty allows that: 

• Government pensions and Social Security benefits are taxable in the U.S. and are not taxable by India.

• Private pensions, like 401K-type retirement accounts, IRAs and other private annuities can be taxed in India.

• The treaty does not apply to lump-sum payments from retirement or other investment income from U.S sources. Thus, both countries may be able to tax lump-sum distributions or investment income.

• Note: The treaty does not address Roth IRA distributions. For U.S. taxes, Roth IRA distributions are tax free if all conditions are met. Since the treaty has not been updated since 1989 and the Roth IRA came into legal existence in the U.S. in 1997, we assume that India does not recognize that the Roth IRA distributions may be tax free in the U.S.

 

 Non-resident aliens or NRAs with U.S source passive income.

·    An Indian citizen living in India with U.S source income like interest, dividends or capital gains, pensions or social security will be taxed at source by the U.S. trade or business at 30% flat rate.

• The treaty lowers the rate or eliminates it. See Table II below.
• In case the treaty does not apply and/ or to claim a refund of taxes overpaid, the NRA can file a Form 1040-NR, which is a non-resident tax return to claim a refund of the taxes paid to the U.S institution/ business.

 

Table II.

Income Type	U.S. Tax Rate under Treaty	Under Treaty Article
Interest	15%	11(2)
Dividends- Paid by U.S Corporations	25%	10(2)
Qualifying Dividends	15%	10(2)
Pensions – Government & private	0%	20(1) to 20(4)
Social Security Benefits- up to 85%	30%	20(2)

  Table: Prepared by Manasa Nadig, EA for The Buzz About Taxes. 

 U.S State Taxes.

Most states in the U.S. do not recognize tax treaties and will impose tax on their residents based on number of days of stay. In this case, a state return needs to filed with the state authorities if an individual is resident of such a state for the whole year or part-year or has state sourced income. Tax is paid to the state if due by the individual even if there is no federal return due.

Inheritances and Gifts.

The U.S does not have an Estate And Gift Tax Treaty with India. Inheritance Law in India is based on an individual’s religion and family relations. 

Most states in the U.S have their own gift, inheritance, and death taxes. Hence individuals with U.S situs assets even if they are NRAs will have to deal with U.S estate tax at both the federal and state level. NRAs are not allowed the same lifetime exclusions on gifts and estates as are allowed to U.S. citizens/ permanent residents. 

We will address Inheritances and Gifts in the U.S. for NRAs in a different blog post.

As we wrap up, you can see there are many factors to be taken into account when filing a tax return under any one of the above circumstances. Understanding and analysis of the tax treaty needs expertise and very thorough knowledge of Tax Law and the Internal Revenue Code. 

Trying to take treaty positions as a Green Card holder might result in an involuntary surrender of their Green Card and they may end up owing expatriation tax. 

Please work with a knowledgeable and experienced tax professional to make sure you are filing an accurate and complete return. 

Related Blog Posts of Interest

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The New ITIN Rules, PATH Act and My 100th Post!

Oh My! You Have Substantial Presence In The US? Now You Have To File Taxes!

Investing In Real Estate In The United States As An NRA? Know FIRPTA! 

Top Five FAQs About Cross Border Tax Matters. 

What's New On The 2018 Form 1040NR: Small Changes, Big Impact!

New Countries on FATCA: India & UAE...What This Means For You!

Bibliography: Migration Policy Institute; India-U.S Tax Treaty; Foreign Exchange Management Act (FEMA); Overseas Citizen of India; Social Security Benefits Tax Treatment – SSA.gov

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