Let me first give you all a brief background of tax system in both countries (i.e. India and USA).
In India, the income tax is levied on the income that is generated during a fiscal year which commences on 1st April and ends on 31st March of each year. The due date of filing the Individual tax return is 31st July.
In USA, the income tax is levied on the income that is generated during a calendar year which commences on 1st January and ends on 31st December of each year. The due date of filing the Individual tax return is 15th April.
Firstly, a taxpayer who pays or accrues a foreign income tax may not take the tax into account in calculating the foreign tax credit or deduction until the related income is taken into account for USA income tax purposes.
So let us assume that you have disclosed all your income generated in India in your USA Tax Return. This includes income that is tax free in India e.g. Dividend Income, PPF (Public Provident Fund) interest, Long Term Capital Gain (on listed Companies), etc.
Now the question, how can you claim the benefit of taxes paid in India on your USA Tax Return.
USA tax payer is allowed a credit or deduction against USA income liability for foreign taxes paid or accrued to a foreign country. Qualified foreign taxes do not include taxes that are refundable to you or used to provide a subsidy to you.
You can choose to take the amount of any qualified foreign income taxes paid or accrued during the year as a foreign tax credit or as a deduction.
To choose the deduction, you must itemize deductions on Form 1040, Schedule A.
To choose the foreign tax credit you generally must complete Form 1116 and attach it to your Form 1040.
If you use Form 1116 to figure the credit, your foreign tax credit will be the smaller of the amount of foreign tax paid or accrued, or the amount of United States tax attributable to your foreign source income. Penalties, interest, fines and similar obligations are not creditable foreign taxes.
Generally, it is more advantageous for a USA tax payer to claim the tax credit because it is taken against the tax payers USA liability on a dollar-for-dollar basis. In contrast, a deduction for foreign taxes merely reduces a taxpayers income subject to tax.
Credit or Deduction shall be taken as follows:
Interest Income: In India on the interest income the payer is required to deduct TDS (Tax deducted at source) and pay only the net amount to the payee. At the end of the year (i.e. 31st March ) the payee receives a statement referred to as Annual TDS Certificate. This TDS Certificate shall reflect the amount of TDS deducted from payee on a quarterly basis. So, if a USA person has included the Income for the three quarters say April to December, then he should take TDS amount paid as foreign tax credit or deduction for only period April to December.
Capital Gains and Other Income: Take the income that is generated in your Calendar Year as Income and take TDS paid on that income as a credit or deduction.
Advance Tax: The Term Advance tax in India is similar to Estimate Tax in USA. Now here I have couple of examples for everyone:
For income such as interest, let us assume that you have earned income of Indian Rupees (“INR”) 5,00,000 in a fiscal year and total tax you paid on your Indian income is INR 25,000. Average rate of tax thus comes to 5%. If in the calendar year, you have earned income of INR 3,50,000 then you need to show this income in your US tax return and claim foreign tax credit of Rs. 17,500.
Let us take another scenario, say you sold a property on 15th October 2011 and tax liability on the sale of the property came to INR 100,000. In India, you would pay Advance Tax on 15th December of INR 60,000 and on 15th March of INR 40,000. Now for USA point of view, as you would have disclosed the entire income of Capital Gain in calendar year 2011. You would able to take the entire tax paid or accrued as credit or deduction. In this case the INR 60,000 would be regarded as Paid and INR 40,000 would be regarded as Accrued.
Self Assessment Tax: The Term Self Assessment tax in India is similar to Amount you Owe on your line 76 of Form 1040 in USA. You can take proportionate credit of the taxes paid, for the income that you have disclosed in your USA tax return.
Now someone may ask after reading 1 to 4 above, what if I had a refund in the foreign country. Well then you need to find out what is your Average Rate of Tax and take credit only to that extent.
So what is Average Rate of Tax:
Let us take an example: You have following Income:
Interest INR 300,000
Other Income INR 200,000
Short Term Capital Gain INR 500,000
Total Income INR 1,000,000
Tax on the Above Income INR 150,000
Less: TDS on Interest INR 60,000
Less: TDS on Other Income INR 40,000
Less: Advance Tax paid INR 200,000
Refund Due INR 50,000
Now you cannot claim the entire TDS and Advance Paid as your credit as you got a refund of INR 50,000. Your Average Rate of Tax would be 15% and not 20%. You can claim credit to the extent of 15%.
The bottom line is that you can take credit or deduction of taxes paid in the foreign country towards the foreign income disclosed in your USA tax return. The credit or deduction should not be more that the Average Rate of Tax that you paid in the foreign county.
As you would only come to know about your Average Rate when you file the return in the foreign country (in India by July 31st ), you have two alternatives: Either file for an automatic extension of six months in USA or estimate what your Average Rate of Tax is going to be in the foreign county (if it turns out that your estimate was incorrect then the final arrived percentage, then you will have to revise your return).
Foreign Tax Credit involves complex analysis of each transaction. There are special rules for allow credit only of fulfillment of certain criteria’s. Please consult knowledgeable USA – India Tax advisor for proper tax disclosure and maximum tax benefits.
In India, the income tax is levied on the income that is generated during a fiscal year which commences on 1st April and ends on 31st March of each year. The due date of filing the Individual tax return is 31st July.
In USA, the income tax is levied on the income that is generated during a calendar year which commences on 1st January and ends on 31st December of each year. The due date of filing the Individual tax return is 15th April.
Firstly, a taxpayer who pays or accrues a foreign income tax may not take the tax into account in calculating the foreign tax credit or deduction until the related income is taken into account for USA income tax purposes.
So let us assume that you have disclosed all your income generated in India in your USA Tax Return. This includes income that is tax free in India e.g. Dividend Income, PPF (Public Provident Fund) interest, Long Term Capital Gain (on listed Companies), etc.
Now the question, how can you claim the benefit of taxes paid in India on your USA Tax Return.
USA tax payer is allowed a credit or deduction against USA income liability for foreign taxes paid or accrued to a foreign country. Qualified foreign taxes do not include taxes that are refundable to you or used to provide a subsidy to you.
You can choose to take the amount of any qualified foreign income taxes paid or accrued during the year as a foreign tax credit or as a deduction.
To choose the deduction, you must itemize deductions on Form 1040, Schedule A.
To choose the foreign tax credit you generally must complete Form 1116 and attach it to your Form 1040.
If you use Form 1116 to figure the credit, your foreign tax credit will be the smaller of the amount of foreign tax paid or accrued, or the amount of United States tax attributable to your foreign source income. Penalties, interest, fines and similar obligations are not creditable foreign taxes.
Generally, it is more advantageous for a USA tax payer to claim the tax credit because it is taken against the tax payers USA liability on a dollar-for-dollar basis. In contrast, a deduction for foreign taxes merely reduces a taxpayers income subject to tax.
Credit or Deduction shall be taken as follows:
Interest Income: In India on the interest income the payer is required to deduct TDS (Tax deducted at source) and pay only the net amount to the payee. At the end of the year (i.e. 31st March ) the payee receives a statement referred to as Annual TDS Certificate. This TDS Certificate shall reflect the amount of TDS deducted from payee on a quarterly basis. So, if a USA person has included the Income for the three quarters say April to December, then he should take TDS amount paid as foreign tax credit or deduction for only period April to December.
Capital Gains and Other Income: Take the income that is generated in your Calendar Year as Income and take TDS paid on that income as a credit or deduction.
Advance Tax: The Term Advance tax in India is similar to Estimate Tax in USA. Now here I have couple of examples for everyone:
For income such as interest, let us assume that you have earned income of Indian Rupees (“INR”) 5,00,000 in a fiscal year and total tax you paid on your Indian income is INR 25,000. Average rate of tax thus comes to 5%. If in the calendar year, you have earned income of INR 3,50,000 then you need to show this income in your US tax return and claim foreign tax credit of Rs. 17,500.
Let us take another scenario, say you sold a property on 15th October 2011 and tax liability on the sale of the property came to INR 100,000. In India, you would pay Advance Tax on 15th December of INR 60,000 and on 15th March of INR 40,000. Now for USA point of view, as you would have disclosed the entire income of Capital Gain in calendar year 2011. You would able to take the entire tax paid or accrued as credit or deduction. In this case the INR 60,000 would be regarded as Paid and INR 40,000 would be regarded as Accrued.
Self Assessment Tax: The Term Self Assessment tax in India is similar to Amount you Owe on your line 76 of Form 1040 in USA. You can take proportionate credit of the taxes paid, for the income that you have disclosed in your USA tax return.
Now someone may ask after reading 1 to 4 above, what if I had a refund in the foreign country. Well then you need to find out what is your Average Rate of Tax and take credit only to that extent.
So what is Average Rate of Tax:
Let us take an example: You have following Income:
Interest INR 300,000
Other Income INR 200,000
Short Term Capital Gain INR 500,000
Total Income INR 1,000,000
Tax on the Above Income INR 150,000
Less: TDS on Interest INR 60,000
Less: TDS on Other Income INR 40,000
Less: Advance Tax paid INR 200,000
Refund Due INR 50,000
Now you cannot claim the entire TDS and Advance Paid as your credit as you got a refund of INR 50,000. Your Average Rate of Tax would be 15% and not 20%. You can claim credit to the extent of 15%.
The bottom line is that you can take credit or deduction of taxes paid in the foreign country towards the foreign income disclosed in your USA tax return. The credit or deduction should not be more that the Average Rate of Tax that you paid in the foreign county.
As you would only come to know about your Average Rate when you file the return in the foreign country (in India by July 31st ), you have two alternatives: Either file for an automatic extension of six months in USA or estimate what your Average Rate of Tax is going to be in the foreign county (if it turns out that your estimate was incorrect then the final arrived percentage, then you will have to revise your return).
Foreign Tax Credit involves complex analysis of each transaction. There are special rules for allow credit only of fulfillment of certain criteria’s. Please consult knowledgeable USA – India Tax advisor for proper tax disclosure and maximum tax benefits.
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