THE LATEST BUZZ IN IT CIRCLES IN THE VALLEY AND around the U.S. is relocating back to India. With more and more IT companies getting their projects done back home, the demand in India for U.S.-experienced workers has gone up tremendously. Relocating NRI’s are making high salaries and getting huge joining bonuses and incentives.

Many of them come to us and ask “What happens to Income Tax?”. Before starting off on that, one thing that you must remember is that you have to pay Income Tax on every penny or paisa that you make, either in the U.S. or India. You will get tax benefits, but all income has to be reported, either on your U.S. or India Tax Return or both.

Broadly, this discussion can be approached from two directions. The Indian Income Tax Act and the Internal Revenue Code of the U.S. Both of them discuss specific issues applicable to the NRI relocating back to India.

Residential Status under the Indian Income Tax
The Indian IT Act has recently undergone some major changes, especially the revamping of the definition of Resident and Non Resident.
The Act recognizes 3 forms of Residential Status’ based on a seemingly complex calculation of number of days, and years. They are:
1. Resident and Ordinarily Resident,(ROR)
2. Resident and Not Ordinarily Resident.(RNOR)
3. Non-Resident

The significance of these lie in the fact, that the Indian IT Act, taxes individuals based on their status. ROR’s are taxed on their worldwide income, RNOR’s are taxed for all income earned in India and Non-Residents are not taxed under the Act. So, all those relocating to India, after extended stays abroad, should consider their taxability based on their residential status. Mr. A meets the basic conditions for 2001-02 and 2002-2003, but does not meet conditions for Ordinary Resident. However, in 2003-04 he fulfills one basic condition and both secondary conditions to be considered as an Ordinary Resident. Effectively the returning NRIs will be taxed on their worldwide income within a period of 3 years of returning to India.

Double Taxation Avoidance Agreement (DTAA)
For many returning Indians, there might be a scenario where they would be a resident of both India and the U.S. for Tax Purposes. However, under the DTAA, the provisions of the Indian Income Tax Act or the DTAA whichever are more beneficial will be applicable to the Individual.

An interesting scenario arises when the U.S. company pays a salary to the employee in India. Under the Indian Act, if the services are performed in India, irrespective of the fact that the salary is paid by the U.S. company or paid in the U.S., the salary is deemed to accrue or arise in India. Effectively, Non Residents can be taxed in India. However, under the India-UN Model Convention, this tax will apply only if the employee was in the U.S. for less than 183 days and the salary was paid by the Indian company in India.

Social Security and Retirement Benefits
The UN Model Code states that amounts paid to an individual in respect of his past services would be taxable in the country of his residence and on the other hand it states that social security payments shall be taxable by the country paying them. Hence, when the relocating Indian becomes a Resident for Indian Tax Purposes, he will have to seek refuge of the DTAA to avoid double taxation.

U.S. Internal Revenue Code
Residential Status in the U.S.
An individual is considered a U.S. Resident for tax purposes if he or she is physically present in the United States for 183 days taking into account, (i) all of the days present in the U.S. during the current calendar year, (ii) one-third of the days present in the U.S. during the first preceding calendar year, and (iii) one-sixth of the days present during the second preceding calendar year.
The $80,000 Exclusion
The IRC code gives great incentives to the Relocating NRI. The Foreign Earned Income Exclusion allows an exclusion of up to $80,000 of income earned in 2003 to U.S. Citizens and to U.S. Resident Aliens. The effect of this exclusion is that up to $80,000 of your earned foreign income will not be taxed in the U.S.

The important thing to remember however, that only earned income is allowable for this exclusion, i.e. income which has been derived from personal services. This credit is not available for interests, dividends, pensions, rental income etc. Example: If Mr. A earned $75,000 in salary, and qualifies as a Foreign Resident, then he can exclude all of his salary income from the U.S. Tax computation. If his salary is $90,000 then he can exclude up to $80,000 of his income, and can take a foreign tax credit for the tax paid on the $10,000 in India.

This exclusion is available if your tax home is in a foreign country and you meet the bona fide residence test or the physical presence test which are discussed below:

Bona Fide Residence Test: To see if a person meets this test, one must analyze whether he has established residence in India. Bona fide residence is different from domicile. Domicile is your permanent home, the place which you intend to return. Someone could have his domicile in San Jose, CA and a bona fide residence in Bangalore if there is intent to return to San Jose eventually. However, just going to Bangalore does not make it a bona fide residence. Going to Bangalore on a tourist visit or a short business trip, does not qualify. But, if someone goes to India, for an indefinite or extended period and setting up residence for themselves and their family, even though there being intent to return to the U.S. in the future will satisfy the bona fide residency requirement. The residency should be for an uninterrupted period that includes an entire tax year (January through December.)

Physical Presence Test: A person meets the physical presence test, if he is physically present in a foreign country or countries for 330 days(not necessarily consecutive) or a period of 12 consecutive months. This test is relatively simple since it does not depend upon the kind of residence established, or intentions of the taxpayer of returning or the nature and purpose of stay abroad.

Transferring Money to India: All monies earned in the US can be transferred to India, without any issues, since they have already been taxed by the U.S. Although, income earned from these in the form of interest or dividend will be taxed in India on satisfying the residency requirements of the Indian Income Tax Act.

For those who are not familiar with the Indian Tax administration, it is no walk in the park and I would recommend that you seek the assistance of a tax attorney or Chartered Accountant when dealing with the Tax Department.

Hersh Shah is a member of the Tax and Corporate Team at The Chugh Firm. He is a Certified Public Accountant and a Chartered Accountant. You can email him at hersh@chugh.com