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Deputed to the US; should you file your tax returns in India or US?

Ramesh Murthy is a 27 year old software engineer, currently working in Detroit on an H1B visa. He first came to the US in 2006 as an MS student. After completing his MS, he stayed on and worked on an H1B visa through 2008 and early 2009. On March 1st 2009, he moved back to India. He returned to US on 31st October 2011. While his company is based in India, he is currently on the payroll of the Indian company’s US office.

From April 2011 to October 2011, he had an income of Rs 8 lakh earned as salary in India of which tax deducted at source was Rs 80,000. After that from November 2011 to December 2011, he earned a US salary. His total US income for this period, as per the W2 was USD 25,600 and federal tax withheld was USD 3,500. He is not a US citizen or a Green Card Holder.

Now as the due date for filing tax returns in the US draws close, Ramesh asks: Do I have to file my tax returns in the US for 2011? Also, do I need to file my India income tax returns for 2011-2012?

Before we answer his questions, we first need to ascertain his residential status. Was he a resident of US or India for 2011?

US Residential Status To find out if Ramesh is a US resident, he must meet the ‘substantial presence’ test. To meet this test, he must have been physically present in the United States on at least:

31 days during 2011, and 183 days during the 3-year period that includes the current year, that is 2011, and the 2 years immediately before that, counting: All the days you were present in the current year, and 1/3 of the days you were present in the first year before the current year, and 1/6 of the days you were present in the second year before the current year.

Ramesh was present in the US for more than 31 days in 2011. Let’s calculate the second part of this test: All the days Ramesh was present in 2011: 61 days 1/3 of the days Ramesh was present in 2010: 0 days 1/6 of the days Ramesh was present in 2009: 10 days Total: 71 days

“Since Ramesh was not present in the US for 183 days during the 3-year period as per the definition above, he does not qualify as a resident. He is therefore a non-resident alien,” Roy Vargis, an Illinois based CPA and promoter of www.IndianCPA.com.

India Residential Status Vineet Agarwal, Director, KPMG India explains.

“To find out if Ramesh is a resident of India in 2011-2012, he must meet one of the following basic conditions: i. he was in India in that year for period amounting in all to 182 days or more, or ii. has within the four years preceding that year been in India for a period amounting in all to 365 days or more, and has been in India for 60 days or more in that year. This 60 day period is increased to 182 days in case of citizens of India who leave India for purposes of employment outside India, and for a person of Indian origin who comes on a visit to India

In addition to the basic condition above, a person qualifies as Resident and Ordinarily Resident (ROR) in India if he satisfies both of the following additional conditions: i. He has been resident in India in at least 2 out of 10 years (according to the basic conditions noted above) preceding the relevant tax year; and ii. He has been in India for a period of 730 days or more during 7 years preceding the relevant tax year.

In brief it can be said that an individual qualifies as an ROR in India if he satisfies at least one of the basic conditions and both the additional conditions.

Ramesh was in India during the period April to October 2011, that is, for 214 days. His stay in the preceding 7 years exceeded 730 days and accordingly he qualifies as a ROR for the tax year 2011-12.”

Now let us get to his questions.

Does he have to file his US tax returns? You are required to file your tax returns in the US if: – You are a US citizen, Green Card holder or a lawful US resident – You are a non-resident alien and earned income from a US source

Now, Ramesh is indeed a non-resident alien. As per the IRS tax code, a non-resident alien is generally subject to US income tax only on their US source income (unlike resident aliens who must pay tax in the US on their global income.) Now, we also need to look at the Double Tax Avoidance Treaty between India and the US. The objective of the treaty is to ensure that the same income is not taxed in India and the US.

According to Article 16: Dependent Personal Services of the India US DTAA, 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 there from may be taxed in that other State.

In Ramesh’s case, he is a resident of India and his US wages would have been taxed only in India if he worked in India. But since he worked in the US, that is, his employment was exercised in the US, and he received his income from the US branch of his company, the US would have the right to tax this income. Ramesh will have to file his taxes in the US for the year 2011. He would have to fill up form 1040NR.

1040NR is different from the regular 1040. A lot of the exemptions in 1040 are not available in 1040NR. For instance, standard deduction is not available in 1040NR (there are certain exceptions for students and business apprentices from India).

1040NR also has certain restrictions on filing status. Generally, you cannot file as married filing jointly if either spouse was a nonresident alien at any time during the tax year. Moreover, you cannot file as head of household if you are a nonresident alien at any time during the tax year. This IRS guide will serve useful.

“Since Ramesh is single, his filing status would be single. But had he been married with kids his filing status would have been different. He would have to file as married filing separately and take a personal exemption for only himself. This would be the case whether his family lived with him in US or they lived in India. Moreover, he would not be allowed a standard deduction. He could itemize deductions claiming unreimbursed employee business expenses, State taxes etc. He could also claim moving expenses if his employer did not reimburse the expenses. Students and business apprentices from India are allowed the standard deduction, personal exemption, spousal and dependents exemption,” Vargis explains.

At the time of filing his returns, Ramesh would either have to pay up more tax on his US income or he might get a refund depending on whether enough taxes were withheld.

“There is also an option called ‘first year choice’. This option is available to a person who has moved to the US in a particular tax year and expects to continue living in the US, that is, become a resident alien, for the next tax year. In such case, the person can file an extension for his 2011 return and wait until he has completed the necessary number of days to qualify under the substantial presence test for 2012. He can then go back and file his returns for 2011 and 2012 as a resident alien. While on one hand filing as a resident alien will give him access to a lot more deductions and credits, it will also attract tax on his global income. This choice must be made only after you evaluate your specific case and after due consultation with a tax advisor,” says Vargis.

Does he have to file his India tax returns? According to the Indian Income Tax laws, an ROR must pay taxes in India and file tax returns in India on his global income. Since Ramesh qualifies as an ROR of India for 2011-2012, he must file his India tax return for that year and pay tax in India on his global income. An important point to remember here is that when he files his tax return in India for 2011-12, he must take his US income up till March 31, 2012 because India follows the fiscal year. Let us assume that his US salary income for the period January-March 2012 is USD 38,400 and tax withheld thereon being USD 5,250. Having done that, he will be eligible to claim a credit in India on the taxes paid in the US.

He would have to claim a relief under section 90 of the Indian Income Tax Act.

The DTAA also clearly mentions the extent of relief in Article 25: Where a resident of India derives income which, in accordance with the provisions of this Convention, may be taxed in the United States, India shall allow as a deduction from the tax on the income of that resident an amount equal to the income tax paid in the United States, whether directly or by deduction. Such deduction shall not, however, exceed that part of the income tax (as computed before the deduction is given) which is attributable to the income which may be taxed in the United States.

Agarwal illustrates a simple way to arrive at the foreign tax credit relief under section 90:

Step 1: Calculate your taxes on India income plus global income. In case of Ramesh, his gross income for the tax year 2011-12 would be Rs 8 lakh plus Rs 32 lakh (USD 64,000 converted at Rs 50), that is Rs 40 lakh. He has no other income in India. Suppose he has made investments of Rs 1 lakh in India, his net income would be Rs 39 lakh. Tax on the same would work out to Rs 10.53 lakh.

Step 2: Calculate the effective tax rate. The effective tax rate would be Rs 10.53 lakh divided by Rs 39 lakh that is 27{982ecbb84816c6d9f589e8211ea46f8047ba0a57e5c66df0879b0b268bf06ad5}.

Step 3: Calculate effective tax on salary income that has been taxed doubly in India and the US. Effective tax on doubly taxed salary income ie US income works out to Rs 8.64 lakh (Rs 32 lakh X 27{982ecbb84816c6d9f589e8211ea46f8047ba0a57e5c66df0879b0b268bf06ad5})

Step 4: Calculate the foreign tax credit to be claimed as deduction from Indian tax liability. The tax withheld in the US is Rs 4.37 lakh (USD 8750 at the rate of Rs 50). (Let us assume that this was Ramesh’s actual tax liability for the period November 2011-March 2012 and he did not pay any additional tax at the time of filing his US tax return) Since this is lower than the tax attributable to the doubly taxed income, the entire Rs 4.37 lakh can be claimed as relief under section 90. If the actual tax paid in the US was more than Rs 8.64 lakh, then the relief would be restricted to Rs 8.64 lakh.

Step 5: Calculate balance tax liability in India. Out of his total taxes due of Rs 10.53 lakh, Rs 80,000 was TDS on his India salary and Rs 4.37 lakh was the amount of foreign tax credit. Therefore his net tax payable in India would be Rs 5.36 lakh.

Alternate scenario Now instead of moving to the US in October 2011, had Ramesh moved in July 2011, it would be a different situation altogether. If he moved on July 1 2011, he would have stayed in India for 91 days. Since that is less than 183 days, he does not qualify as a resident of India for 2011-2012. “He becomes a non-resident and as a non-resident, he is required to file his returns in India only to the extent of his India income. He does not have to declare his US income and the question of claiming tax credit does not arise,” says Agarwal.

Further, in a notification n February 2012, the income tax authorities in India have stated that if a taxpayer’s taxable salary income plus bank interest of up to Rs 10000 does not exceed Rs 5 lakh, he need not file his returns in India. Suppose Ramesh met that condition as a non resident, he need not file his tax returns in India for 2011-2012.

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