Taxation of Foreign Source Income under Indian Income Tax Act

As global mobility increases, many Indian taxpayers earn income from foreign sources. Whether it is a salary from an overseas employer, dividends from foreign companies, or interest from offshore bank accounts, understanding how such income is taxed under Indian law is critical to remaining compliant and avoiding legal risks.

The Income Tax Act, 1961, governs how foreign income is taxed in India. The taxability primarily hinges on the residential status of the taxpayer during the relevant financial year.

What is Foreign Source Income?

Foreign source income refers to income that is earned outside India. This includes:

• Income that accrues or arises outside India
• Income received outside India
• Income deemed to accrue or arise outside India
• The source of income is considered foreign when the origin of the income or the activity generating it is located outside Indian territory.

Residential Status: The Key Determinant

Under Section 6 of the Income Tax Act, individuals are classified into:

Resident and Ordinarily Resident (ROR)

Resident but Not Ordinarily Resident (RNOR)

Non-Resident (NR)

The classification determines the scope of income that will be taxable in India.

1. Resident and Ordinarily Resident (ROR)

An individual classified as ROR is liable to pay tax on global income, which includes both Indian and foreign source income. All foreign income—whether received in India or abroad—is fully taxable.

2. Resident but Not Ordinarily Resident (RNOR)

An RNOR is taxed only on:

• Income received or accrued in India
• Income deemed to accrue or arise in India
• Foreign income that is derived from a business or profession controlled or set up in India
• Other foreign income is not taxable for RNORs.

3. Non-Resident (NR)

Non-Residents are taxed only on:

• Income received in India
• Income accrued or deemed to accrue in India

Foreign income earned and received outside India is not taxable for a non-resident.

Types of Foreign Source Income and Their Tax Implications

Foreign source income may arise from various streams. The tax treatment under Indian law is as follows:

Salary earned abroad: Taxable in India only for ROR individuals

Interest on foreign bank accounts: Fully taxable for ROR; exempt for NR

Dividends from foreign companies: Taxable for ROR under “Income from Other Sources”

Capital gains from foreign assets: Taxable in India for ROR based on applicable capital gains rules

Business income from foreign entities: Taxable in India if the individual is ROR and controls the business from India

Rental income from foreign properties: Taxable for ROR, as it is a part of global income

Double Taxation Avoidance Agreement (DTAA)

India has DTAA treaties with over 90 countries. These agreements help taxpayers avoid paying tax on the same income in both India and the foreign country.

Two Methods of Relief under DTAA:

Exemption Method: Income is taxed in only one of the two countries.

Tax Credit Method: Income is taxed in both countries, but the taxpayer can claim credit in India for the tax paid abroad.

To avail DTAA benefits, the taxpayer must obtain a Tax Residency Certificate (TRC) from the foreign country and submit Form 10F.

Foreign Tax Credit (FTC)

Rule 128 of the Income Tax Rules allows Indian residents to claim credit for taxes paid in foreign countries against Indian tax liability. Key points:

• File Form 67 online before filing ITR
• Must have documentary proof like foreign tax payment receipts
• FTC is allowed only if the foreign income is offered for tax in India

Reporting Requirements and Compliance

Indian residents, especially RORs, are required to report all foreign assets and income in their Income Tax Return. This includes:

• Foreign bank accounts
• Financial interests in foreign entities
• Foreign directorships
• Immovable property held abroad
• Foreign retirement accounts or insurance

Failure to report can attract penalties under the Black Money (Undisclosed Foreign Income and Assets) Act, 2015. Severe penalties and prosecution may follow for non-compliance.

Conclusion

Taxation o foreign source income is a sensitive and complex matter under Indian tax law. The correct understanding of residential status, DTAA benefits, and reporting obligations is essential for individuals and businesses engaged globally. Indian residents earning income abroad must ensure proper disclosure and compliance to avoid penal consequences and optimize their tax liability through legitimate relief provisions.

1. Is foreign income taxable in India?

Yes, foreign income is taxable in India only if the taxpayer is classified as Resident and Ordinarily Resident (ROR). Non-residents and RNORs are taxed only on income received or accrued in India.

2. How is residential status determined for foreign income taxability?

Residential status is based on your physical presence in India during the financial year. If you're classified as a Resident and Ordinarily Resident (ROR), your global income is taxable. If you're an RNOR or NR, only Indian-sourced income is taxed.

3. What is Double Taxation Avoidance Agreement (DTAA)?

DTAA is a tax treaty between India and other countries to ensure that taxpayers are not taxed twice on the same income. It allows either exemption or tax credit relief, depending on the agreement terms.

4. Can I claim credit for taxes paid abroad on foreign income?

Yes, under Rule 128, you can claim Foreign Tax Credit (FTC) for taxes paid abroad by filing Form 67 along with your ITR, provided you include the foreign income in your Indian tax return.

5. What happens if I do not disclose my foreign income or assets in ITR?

Non-disclosure can attract penalties under the Black Money Act, 2015, including hefty fines and even prosecution. It's mandatory for ROR taxpayers to disclose foreign assets in the Schedule FA of the ITR.