Tax Residency may Increase Tax Burden on Returning Indian

US Clarification on Tax Residency May Increase Tax Burden for Returning Indians (RNORs)

The India–US Double Taxation Avoidance Agreement provides concessional tax rates on certain income streams, such as dividends, interest, and royalties, to individuals who qualify as tax residents of either India or the United States. Indians returning from the US often qualify as residents but not as ordinary residents under Indian taxation law. Residents, but not ordinary residents, are taxed in India only on income received or accrued in India and income from a business or profession controlled or set up in India.

Foreign income remains outside the scope of Indian taxation for 2–3 years, depending on their prior residential history.

DTAA Applicability – Earlier Position

Historically, United States of America payers treated residents but not ordinary residents as Indian tax residents for Double Taxation Avoidance Agreement purposes. Consequently, dividends and interest from US sources were subject to a 15% withholding tax. & Royalties and fees were taxed at 15–20%, instead of the domestic United States of America withholding rate of 30%. This was based on the assumption that RNORs were “liable to tax” in India and therefore eligible for treaty benefits.

US Clarification/Changed Interpretation

The US has now aligned its interpretation with the Organisation for Economic Co-operation and Development Commentary, clarifying that A person taxed only on a limited or territorial basis in a country cannot be treated as a “resident” of that country for Double Taxation Avoidance Agreement purposes. Since RNORs are not liable to tax in India on global income, the United States of America position is that RNORs do not qualify as Indian tax residents under the The India–US Double Taxation Avoidance Agreement

Implications for RNORs

If US payers apply this interpretation strictly:

Income Type	Earlier DTAA Rate	Possible US Tax Now
Dividends (US stocks, ETFs, mutual funds)	15%	30%
Interest (US bank deposits, bonds)	15%	30%
Royalties (apps, books, Spotify, YouTube, platforms)	15–20%	30%

This effectively doubles the US tax cost for residents but not ordinary residents during their transition years.

India has not changed its position: Residents but Not Ordinarily Residents remain “residents” under Indian domestic law. The issue arises because Double Taxation Avoidance Agreement residency requires liability to tax on global income, not merely residential status. This is a treaty interpretation issue, not a change in Indian law.

Practical Consequences & Planning Points

Returning Indians should reassess:

• Timing of return (before or after liquidating US investments).
• Holding United States of America assets through entities or trusts.
• Shifting investments before the Residents but Not Ordinarily Residents phase begins.
• Use of third-country structures (where legally permissible).
• Whether to claim treaty benefits and risk IRS scrutiny.

In many cases, deferring United States of America income recognition until becoming ROR (when India can offer foreign tax credit) may be more tax-efficient.

The United States of America clarification significantly alters the tax landscape for RNOR Indians. While RNOR status provides relief under Indian tax law, it may now increase United States of America withholding taxes due to loss of DTAA benefits. Returning Indians should proactively review cross-border income streams and restructure finances well before changing tax residency.

Checklist for Indians Planning to Return from the US

• Residential status planning is the most critical step for Indians planning to return from the United States of America. First of all, a person must determine likely residents but not ordinary residents, usually 2–3 financial years after return & based on days of stay in India and past residency history.
• RNOR Plan the year of return carefully and Returning before 31 March may reduce RNOR years and returning after 1 April often preserves Residents but Not Ordinarily Residents’ benefits longer
• Residents but Not Ordinarily Residents avoid unintended ROR status for Track days in India strictly (especially first 2 years)

Before returning, the person must review their US investments & income over there.

• A person must make a list of all United States of America source income, like US stocks/ETFs/mutual funds, bank FDs/bonds, ESPPs/RSUs, rental income, and royalties (apps, books, YouTube, Spotify, and SaaS platforms).
• That Person must evaluate impact of 30% United States of America withholding Whether RNOR may lose Double Taxation Avoidance Agreement benefit, so Decide whether to Liquidate assets before return or Hold and accept higher United States of America tax or Restructure ownership
• Person must consider selling appreciated United States of America assets while still United States of America tax resident, like capital gains, which may be more efficient pre-return.

New Issue must be checked RNOR vs DTAA Risk Assessment

• Person must assume the United States of America may deny Double Taxation Avoidance Agreement benefits during RNOR period. and Expect 30% withholding on Dividends, Interest, & royalties.
• Residents but Not Ordinarily Residents must evaluate whether treaty claims via Form W-8BEN can be substantiated
• RNOR must maintain documentation if treaty benefit is claimed (risk of IRS scrutiny)

Timing of Income Recognition

Residents but Not Ordinarily Residents should Defer US dividends/royalties, if possible, until You become ROR, or you can claim Foreign Tax Credit (FTC) in India. Also RNOR should avoid high US income during RNOR phase where credit is unavailable

Bank Accounts & Financial Structuring

• RNOR Convert Indian bank accounts from Resident savings to NRO/NRE (as applicable)
• Residents but Not Ordinarily Residents must review United States of America bank accounts and confirm banks allow non-resident maintenance and try to Avoid automatic closure risks.
• RNOR should evaluate remittance strategy: Bring funds to India before return where possible

Stock Options, Restricted Stock Units and Employee Stock Option Plans

• RNOR review vesting schedules Pre-return vesting vs post-return taxation & India taxes Employee Stock Option Plans differently once resident
• Residents but Not Ordinarily Residents understand double tax exposure on US withholding and Indian taxation once ROR
• RNOR must Obtain valuation and grant documents

Retirement Accounts (401k, IRA)

• RNOR do not rush to liquidate High United States of America penalties & tax & Understand Indian tax treatment like tax on receipt when ROR & Complex reporting under Schedule FA
• Residents but Not Ordinarily Residents should maintain clean records of Contributions, employer matches & rollovers.

Indian Tax & Compliance Preparation

• PAN & Aadhaar linkage checked
• Understand applicable ITR form (ITR-2 / ITR-3)
• Prepare for Schedule FA (foreign assets) once ROR, FTC claims under Rule 128 & Advance tax obligations

FEMA & RBI Compliance

• RNOR must re-designate accounts on change of residency
• Residents but Not Ordinarily Residents avoid holding resident-only instruments after becoming non-resident & Comply with FEMA asset holding rules

Highly important documentation & records to be maintained by Residents but Not Ordinarily Residents like United States of America tax returns (last 3–5 years), W-2, 1099, brokerage statements, Cost & acquisition records of assets, and proof of tax paid in the United States of America. These are critical for FTC claims, assessments, and notices in India.

RNOR status is beneficial under Indian law but may now be costly from a United States of America tax perspective. Tax planning before returning, not after, is the difference between tax efficiency and permanent tax leakage.

Residents, but Not Ordinarily Residents Should Consult from tax expert related to cross-border CA/CPA, a Double Taxation Avoidance Agreement specialist, & an investment advisor familiar with RNOR planning. Moreover, avoid “generic advice”; RNOR planning is case-specific

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