Dual Taxation Regime

India’s taxation framework is predicated upon a dual taxation regime, incorporating both source-based and residency-based principles. This duality ensures that income is taxed both where it is earned (source) and where the individual resides (residency). Source-based taxation mandates that any income generated within India is taxable, irrespective of the taxpayer’s residency. Conversely, residency-based taxation stipulates that Indian residents are liable for taxes on their global income. This structure is particularly significant for Non-Resident Indians (NRIs), whose tax obligations hinge on the nature and location of their income.

Taxation for NRIs : Key Changes

The recent budgets introduced significant reforms, particularly impacting capital gains tax and dividend income, including for NRIs, underscoring the importance of staying attuned to evolving regulations. NRIs are subject to tax on income earned from Indian sources, but recent legislative changes have revised tax rates, especially for capital gains and dividend distributions, compelling them to reassess their investment strategies.

1. Changes in Capital Gains Tax

Capital gains taxation, including for NRIs, has been revised in 2024, affecting both short-term and long-term gains.

• Long-Term Capital Gains (LTCG): The threshold for long-term capital gains (LTCG) has been increased, with the tax rate rising from 10% to 5% (effective July 23, 2024) on gains exceeding ₹1.25 lakh. This change primarily impacts NRIs with substantial investments in equities, mutual funds, and other long-term securities.
• Short-Term Capital Gains (STCG): For NRIs investing in listed equities and mutual funds, the short-term capital gains tax rate has been increased from 15% to 20% (effective July 23, 2024). This revision may affect NRIs who are more active traders or those with short-term holdings in Indian securities.

These changes necessitate a re-evaluation of investment strategies by NRIs, as the increased tax rates can affect profitability, particularly in volatile markets.

2. Dividend Income

Dividend income, which was previously tax-exempt for investors, including NRIs, is fully taxable under the Finance Act 2020.  Earlier, such dividend was subject to dividend distribution tax in the hands of companies and hence, there was reduced tax compliance in the hands of the dividend recipient.  This reform has continued into 2024:

• Dividend Taxation: Dividend income earned by NRIs from Indian companies is subject to tax at the applicable slab rate for the individual, making dividends a taxable income source. For high-income NRIs, this could mean a significant tax burden, depending on their other sources of income.

This move aligns with global trends where dividend income is taxed at personal income tax rates, but it increases the need for NRIs to manage their portfolios efficiently.

3. Residency Rules for High-Income NRIs

The Finance Act 2020 introduced provisions that target high-income NRIs by altering the residency rules for those earning over ₹15 lakh in India.

• 120-Day Rule: For Indian citizens or Persons of Indian Origin (PIOs) with income exceeding ₹15 lakh from Indian sources, residency is now determined by a 120-day stay in India during the financial year, as opposed to the standard 182-day rule. This change means that high-income NRIs staying in India for 120 to 182 days could be classified as residents for tax purposes, significantly increasing their tax liabilities by subjecting their global income to Indian taxes.
• RNOR Status: Those who qualify under the 120-day rule may still benefit from being classified as Resident but Not Ordinarily Resident (RNOR), which limits their tax liability to Indian-sourced income, avoiding taxes on their global income.

4. Increased Taxation on Real Estate

NRIs with investments in Indian real estate will also feel the impact of capital gains taxation changes:

• Removal of Indexation Benefit for Real Estate: The Finance Act 2024 removed the indexation benefit for long-term capital gains on real estate. This means that NRIs selling property in India will face higher tax liabilities, as they can no longer adjust the property’s acquisition cost for inflation over the holding period.

This adjustment could influence the timing and decision-making of NRIs looking to liquidate property assets in India, making real estate a less tax-efficient investment.

5. Exemptions and Incentives for NRIs

While many changes have increased tax rates, certain tax incentives remain available to NRIs:

• Deductions under Section 80C and 80D: NRIs are still eligible to claim deductions for investments in certain financial products (like Public Provident Fund (PPF)) and insurance premiums, which help reduce taxable income.

Double Taxation Avoidance Agreements

India’s Double Taxation Avoidance Agreements (DTAAs) further complement this regime by mitigating the risk of dual taxation. DTAAs ensure that NRIs are not taxed twice on the same income—once in India and again in their country of residence—by defining clear rules for tax liabilities under both source and residency-based frameworks.

DTAAs typically offer relief by reducing tax rates on certain types of income—such as interest, royalties, dividends, and capital gains—or providing tax credits for taxes paid in one country, which can be used to offset the tax liability in the other country. DTAAs also reduce withholding tax rates on various forms of income, making cross-border investments more favorable for NRIs.

Residency and Taxation Rules for NRIs

For NRIs, tax liability in India is determined based on their residential status, which depends on the duration of their stay in India during the financial year, as outlined under Section 6 of the Income Tax Act, 1961.

Test of Residence

In India, as in many countries, income tax liability varies by residence. Taxable entities include residents and non-residents. Residents are further divided into “resident and ordinarily resident” (ROR) and “resident but not ordinarily resident” (RNOR). The law sets two residence tests for individuals based on physical presence in India during the “previous year” (April 1 to March 31). A person is a resident if they are in India for 182 days or more or if, having been in India for 365 days over the past four years, they are present for 60 days or more in the current year.

However, the 60 days threshold is extended to 182 days in the following cases:

• An Indian citizen who leaves India for employment or as a member of the crew of an Indian ship;
• An Indian citizen or a Person of Indian Origin (PIO) who resides abroad and comes to India for a visit during the financial year​.

Additionally, for citizens of India who are members of the crew of a foreign-bound ship, their period of stay in India is determined based on rules regarding Continuous Discharge Certificate (CDC) entries for their voyage​.

Special Provisions for High-Income NRIs:

If an Indian citizen or PIO with income (excluding foreign sources) exceeding ₹15 lakh visits India, they will be considered a Resident if they stay in India for 120 days or more but less than 182 days during the financial year, provided they have also stayed for 365 days or more during the 4 preceding years​.

Resident but Not Ordinarily Resident (RNOR)

An individual is classified as Resident but Not Ordinarily Resident (RNOR) if:

• They have been a non-resident for 9 out of the 10 previous years preceding the financial year,
  OR
• They have stayed in India for 729 days or less during the 7 years preceding the financial year.

In addition, Indian citizens or PIOs with Indian income exceeding ₹15 lakh, who stay in India for 120 to 182 days, will also qualify as RNOR.

Non-Resident Status

An individual is classified as a Non-Resident (NR) if they do not meet any of the conditions specified for Resident status. Non-residents are taxed only on income earned or accrued in India, including income from property, investments, or businesses based in India.

Residential Status for HUF/Firms/AOP

• Resident: HUFs, Firms, or AOPs are considered resident if any part of the control and management of their affairs is situated in India.
• Non-resident: These entities are considered non-resident if the entire control and management is outside India.

Residential Status for Companies

For companies, residency is determined by the Place of Effective Management (POEM). While an Indian company is always considered a resident, a foreign company will be considered a resident if its POEM is located in India. POEM refers to the place where key management and commercial decisions necessary for the business are made. Holding board meetings outside India is not enough to establish POEM abroad if key management decisions are made within India.

Role of the Authority for Advance Rulings (AAR)

The Authority for Advance Rulings (AAR) plays a vital role in providing clarity on tax issues for NRIs engaged in complex cross-border transactions. The AAR allows NRIs to obtain binding rulings on tax liabilities before undertaking major transactions, thus offering much-needed certainty in tax matters.

For NRIs involved in business or investment activities that span multiple jurisdictions, obtaining a ruling from the AAR can help avoid unforeseen tax disputes and ensure compliance with both Indian and international tax laws.

Tax Planning Strategies for NRIs

KNAV experts suggest that effective tax planning is essential for NRIs to minimize their tax exposure and ensure compliance with Indian tax laws. Key strategies include:

• Leveraging Residency Status: NRIs can optimize their tax liabilities by understanding their residency status and planning their stay in India accordingly.
• Maximizing DTAA Benefits: By utilizing the provisions of relevant DTAAs, NRIs can claim tax relief and avoid paying double taxes on the same income.
• Investment Structuring: NRIs should consider how to structure their investments—whether in real estate, equity, or debt—so as to maximize available tax incentives.

Conclusion

India’s dual taxation regime, coupled with the significant changes introduced in the Finance Act 2024, presents both challenges and opportunities for NRIs. By understanding the intricacies of capital gains tax, dividend income, residency rules, and DTAAs, NRIs can better navigate their tax obligations. Strategic tax planning, leveraging corporate tax incentives, and utilizing resources like the AAR can significantly enhance NRIs’ ability to optimize their tax liabilities and maximize returns from their Indian investments.

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