This thread is intended to serve as a learning tool to know how to claim tax credit/relief from GOI (not IRS) on non-Indian source income that is double taxed by GOI and also by another country, say US.
In contrast to information on how to claim tax credit/relief from IRS on non-US source income which is easily available on the IRS web site, information about the above is scanty or non-existing.
This thread will be useful for those who R2I, attain ROR status, and have income from US sources which is taxed by IRS as well as GOI. Such income from US sources can be in the form of IRA accruals, but can also take the form of income from after-tax investment accounts in the US.
I believe a separate thread for this topic is warranted, and have taken the liberty of initiating one.
Step 1
I will first (in the next post) collate and post some relevant messages from other threads.
Step 2
Then I will post information on relevant Indian IT law/procedure on the issue.
Step 3
After doing the above, toward understanding what is posted in Step 2, I plan to illustrate the same, starting with a simple example or simple examples first.
Then I will leave the field open for questions and contributions from other forum members.
The collation of posts from other threads that follows shows the kind of exploration that has been done. The operative word is exploration. These posts in the collation are not being offered as established truth.
Also, it appears that all the relevant posts cannot be collated in this one message. Will continue to collate and post another message.
Collating Extracts From Some Relevant Posts From Other Threads
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Post 3 of RRK from Thread Titled "RRK Limits"
Disadvantage: Require time to understand all the intricacies. Need to manage complex tax accounting for two countries. Some may need professional help to manage accounts and file returns in two countries. Can be done for considerable tax savings. Some may even decide to pay 1-2% additional taxes to avoid the complex accounting required to keep up with ROR withdrawals - that involve dual taxation, manage DTAA exemptions, handle different taxing periods between two countries, different filing methods ( India does not allow MFJ). Some may find all this very interesting and do book keeping to save those taxes.
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Post 5 of bmukherji from Thread Titled "RRK Limits"
The nutty issues are still going to be :? 1) Access to affordable help with competence in cross-border taxation in India
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Post 6 of Bobus from Thread Titled "RRK Limits"
Regarding the mechanism that GOI uses to grant tax relief/credit on doubly taxed income, I believe that a separate thread is called for. The mechanism is based on Sec 91 of Indian IT Act, and an IT Dept circular based on the same. To avail tax relief/credit on doubly taxed income (as opposed to tax exemption or avoidance of double taxation itself for which one has to depend on a treaty), Sec 91 which unilaterally grants relief/credit on doubly taxed income is the relevant law. I would be happy to contribute, time constraints permitting, to that thread by illustrating the mechanism, starting with simple examples first. The relief/credit is not based on marginal tax rate of double taxed income, but an "average" tax rate.
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Post 7 of Sohu9 from Thread Titled "RRK Limits"
I think it would be a good idea to have a thread. That would also mean all info related to that topic is in one place and easy to search/browse. Please feel free to open a thread when you are ready to discuss that topic. Let me know if you need help with opening a new thread.
---------------- Post 124 of r2i-2006 from Thread Titled " Development of Spreadsheet for r2i"
Also I would very much appreciate any information you can share on the mechanism for claiming tax credit.
-------------- Post 6 of Bobus from Thread Titled " Development of Spreadsheet for r2i"
Say X has $1 Million in his IRA at ROR start date. Say accruals in the first year of ROR status are $50K, which GOI taxes. Further, assume X withdraws (takes a distribution) of $50K during the first year of ROR which Uncle Sam taxes.
Can one set off (claim credit per tax treaty) taxes on $50K accruals paid to GOI against taxes (not penalty) on $50K distribution paid to IRS? GOI may ask how X came to the conclusion that the $50K distribution came entirely out of $50K accruals, and not from the original $1 Million.
This issue has not been completely investigated by me yet. If GOI question above is valid, it may help to hold several IRAs (split the $1 million suitably after good planning), minimize accruals in all IRAs except one or two, and liquidate the one/two IRAs (where most accruals are recognized) entirely at the time of distribution to facilitate accounting. ------------------ Post 20 of Bobus from Thread Titled " Development of Spreadsheet for r2i"
On how to properly claim credit for double taxation and ease accounting for the same.
IRA custodians usually offer several options for systematic withdrawal (distribution).
Your desired/optimal portfolio allocation will likely involve some mix of fixed income (debt) and equity.
The fixed income portion of the portfolio can be held in one or more separate IRAs, and the IRA custodian can be instructed to distribute all interest to you (interest only option, no principal to be distributed) every year. The distributions (taxed by IRS) from this IRA will be equal to accruals (taxed by GOI) in the same after you become ROR and a tax treaty credit can be claimed on taxes paid/owed on this interest income to the two Governments.
As for the equity portion, perhaps the same can be held in a few separate IRAs, all holding funds that have minimal yearly accruals (low dividends/yields) and where the growth comes primarily via unrealized cap gains (that you can choose to accrue at your convenience by selling) e.g. Vanguard's VTSMX.
Please take the above as tentative suggestion. Will post if better things strike me. I feel the above can be improved. --------------
Post 22 of r2i-2006 from Thread Titled " Development of Spreadsheet for r2i"
Bobus, Splitting up the amounts into a large number of IRA?s is a great approach. Let?s see how this might work. Assume there are ira1, ira2 ? to ira25 for instance, each with starting principal p1, p2?etc. at the start of ROR. ira1 is for fixed income producing i1 interest each year. This entire amount is paid to me and I pay taxes on it to IRS and claim credit with GOI. The principal p1 stays untouched. No confusion about the nature of i1. It is withdrawal in the eyes of IRS and accrual in the eyes of GOI. ira2 is a stock fund producing dividend d2 (which must be kept small by choosing the fund appropriately) each year for n years at the end of which there is long term capital gains of cg2. During these n years, one has to pay tax to GOI on the d2 amounts which should be a trivial amounts. At the end of n years, ira2 is entirely liquidated giving rise to a total of p2 + (n x d2) + cg2. This total amount is taxed by IRS and the amount of cg2-(n x d2) is taxed by GOI. Therefore one can claim from GOI credit for cg2/(p2 + (n x d2) +cg2) x (tax paid to IRS). So one must set up enough iras before ROR in the appropriate manner to have enough flexibility to manage withdrawals. What do you think? -------------- Post 23 of Bobus from Thread Titled " Development of Spreadsheet for r2i"
Great use of notation to communicate precisely. It is a pleasure to read precise communication. Shows you care and have put in effort in what you posted.
This total amount is taxed by IRS and the amount of cg2-(n x d2) is taxed by GOI. The amount taxed by GOI (when you sell the funds in the IRA) will be cg2.
Therefore one can claim from GOI credit for cg2/(p2 + (n x d2) +cg2) x (tax paid to IRS).
The kind of proration that you have done above is not how tax credits work. So please see below:
First, determine the common income item that is being double taxed (taxed by both Govts). You are right that IRS will tax p2 + (n x d2) + cg2.
So the common income item that is being double taxed is cg2.
As far as taxes paid to IRS on p2 + (n x d2) is concerned, there is no provision for claiming offset.
Let G and U denote tax liabilities (before calculation of any tax credit or offset) toward GOI and Uncle Sam, respectively, on cg2.
Had there been no provision for claiming tax credits, your total tax liability on cg2 would have been G + U.
However, given the provision for claiming tax credit on double taxation, the total tax liability that you will actually face (effectively need to pay), after tax credits, will be the higher of G and U i.e. Max(G, U).
So need to calculate G and U.
Calculation of G
For GOI the amount cg2 is cap gain. If the same is classified as long term cap gain (holding period has to be a minimum of 3 years to be qualify for long term cap gain classification), the tax G owed to GOI will be equal to 20% times the cap gain amount of cg2.
Now, for assets in India, to calculate long term cap gain, GOI allows a relief in LT cap gain computation by allowing the tax payer to inflate the acquisition cost of the asset sold by an inflation index. Whether the same is allowed for assets held outside India that are denominated in $, and if so, what inflation index, if any, will be used is unclear to me.
If cg2 is classified by GOI has short term cap gain (holding period less than 3 years), then the same will be added to your ordinary income (on your Indian IT return) and taxed at GOI's graduated tax slab rates (based on the tax bracket you will in).
Calculation of U
cg2 will be added to your ordinary income (on your US tax return) and taxed based on IRS graduated tax slab rates.
Caveat: I have hidden a problem in what I have typed above, which I will describe later.
I am not happy with not being able to claim relief for tax paid to GOI on n x d2. If the IRA custodian could be instructed to distribute dividends as they arise in the equity funds that you hold, it would solve the problem. At present, I do not know of any large custodian that takes this kind of distribution instruction. -------------------- Post 24 of Bobus from Thread Titled " Development of Spreadsheet for r2i"
Regarding last para in previous post # 23, I know that as far as after-tax mutual funds are concerned, the mutual fund company offers standard options on what they should do with distributions within the fund and the options are (a) reinvest in same fund (b) send to bank account (c) invest in some other fund e.g. money market.
However, I do not know if (b) or (c) above is possible in the case of IRAs as a standard distribution option.
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Post 26 of r2i-2006 from Thread Titled " Development of Spreadsheet for r2i"
#25: I took a quick look at Pub 514. I appreciate your posting this link here for us. Here is a paragraph that appears very important. Why Choose the Credit?
The foreign tax credit is intended to relieve you of the double tax burden when your foreign source income is taxed by both the United States and the foreign country. Generally, if the foreign tax rate is higher than the U.S. rate, there will be no U.S. tax on the foreign income. If the foreign tax rate is lower than the U.S. rate, U.S. tax on the foreign income will be limited to the difference between the rates. The foreign tax credit can only reduce U.S. taxes on foreign source income; it cannot reduce U.S. taxes on U.S. source income. One question that had been bothering me was," Am I free to choose who I pay the tax to and who I claim the credit from? For IRA accrual which I withdraw from the US, can I decide to pay GOI and claim credit from IRS instead of the other way around (see #11)?" The last sentence above in red pretty much kills this idea from #11. This IRA accrual is US source income and the IRS wants its due and will not accept my plea that I paid GOI tax on this accrual. They will say, "Pay the IRS and take the credit from GOI" From this it follows that it makes sense to withdraw the accrual in the IRA as soon as it arises in the US and pay both IRS and GOI their rightful due after claiming credit from GOI for tax paid to IRS. Bobus, Is it reasonable to extend this argument the other way and say that GOI will also take a similar stand? Thus for income arising in India I have to pay tax to GOI and claim tax credit to IRS since IRS will tax me (USC) on my global income. If these statements are correct then this aspect just became a bit more clear to me. Please confirm. Thanks again. ------------ Post 27 of Bobus from Thread Titled " Development of Spreadsheet for r2i" #26: Good observation. I did not notice the part that you highlighted, though I was wondering why all the examples in Pub 514 that I went through were only about non US source income.
Here is my conjecture.
The sentence that you highlighted is what US domestic law allows, on its own (unilaterally), in the absence of a tax treaty with another country. In other words, in the absence of a tax treaty with another country, IRS would allow tax credit on taxes paid/owed to that country on non-US source income, but not allow tax credit on on taxes paid/owed to that country on US source income.
Similarly, per Section 91 of the Indian IT Act, in the absence of a tax treaty with another country, an Indian resident is allowed a tax credit on taxes paid to that country, on income that accrues/arises outside India (provided the same is not deemed to accrue/arise in India). But Section 91 is silent about tax credits on taxes paid to another country on income that accrues/arises/is received/deemed to be received in India.
The above is all that the two Govts are willing to forego in taxes, unilaterally. But in tax treaties, the Govts go beyond the above, which is what tax treaties are for.
So if one wants to claim tax credit from IRS on taxes paid to India on US source income, that claim has to come via the US-India tax treaty. Similarly, if one wants to claim tax credit from GOI on taxes paid to IRS on income that arises/accrues/received (or deemed so) in India, that claim has to come via the US-India tax treaty.
So I do not want to a priori rule out the possibility you raised in #11. I am learning too in this process. I will take a look at the tax treaty and revert. ---------------- Post 29 of Bobus from Thread Titled " Development of Spreadsheet for r2i"
My preliminary reading of Article 25 of the US-India tax treaty suggests that the mechanism for claiming tax credit on items of income taxed by both countries is the same as as that under the domestic law of the two countries i.e. IRS saying "Go claim tax credit from GOI on US sourced income" and GOI saying "Go claim tax credit from IRS on income arising in India". So each country seems to zealously guard its tax revenue from income that originates in that country.
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Post 30 of Bobus from Thread Titled " Development of Spreadsheet for r2i"
... it appears that tax credit for double taxation has to be claimed from GOI on the US source income, and not from IRS. For claiming tax credit for doubly taxed income from GOI, it may be helpful to keep the accounting for the same clean by making sure that accruals are received separately (physical segregation of receipt) from capital as outlined in Post 20. But I must also add that since it appears that the doubly taxed income in 5 above (except for cap gains) will fall under the category "Income from Other Sources" under Indian tax law, and since to the best of my knowledge, the taxation of the same is based on the method of accounting regularly followed by the taxpayer, it may not be necessary to receive the accruals separately (in the physical sense), if the taxpayer maintains his own accounting records segregating accruals from capital, as and when he receives money. Perhaps it is advisable to consult a good CA in India about this.
Post 133 of Bobus from Thread Titled "Any LoopHoles for using the 401K/IRA (per tax) Dollars in India ?"
.....number of issues about the mechanism by which tax credits (for taxes paid to another country) are determined by GOI, some of which I will merely allude to below (the list is by no means exhaustive):
GOI tax credit will be given on taxes paid to US on the amount of the common (double taxed) income item. If distribution exceeds accrual, the common income item that is double taxed will be the amount of accrual. GOI will not provide a tax credit on taxes paid to IRS on the distribution that represents withdrawal of "principal"..... How will GOI determine taxes paid to IRS on the accrual (for determining the tax credit amount)? This would be straight forward if IRS charges a flat tax rate on the entire distribution. With graduated US tax rates, a minimum threshold income level before taxes kick in, and the presence of other income items (other than the common double taxed income item) e.g. the "principal withdrawn" in US taxable income for the individual, this issue is not straight foward. In another thread, another member raised the issue of what to do when filing MFJ in the US since India does not have a similar filing status. How will income be apportioned?
I believe we need a separate thread just to understand the mechanism that GOI uses to determine tax credits. ------------ Extracts from posts in the thread titled "Invest in India even though LIA"
#19, bob wrote: What a treaty does, among other things, as far as taxpayer is concerned, is allow for the possibility (in respect of some items of income, depending on treaty provisions) of an ultimate tax liability that is lower than
Max (Tax liability per domestic law of one country, Tax Liability per domestic law of the other country)
Bob, can you pls explain how the ultimate tax liability could be lower ?
I presume one example, though one could come up with many such examples, should suffice for illustration purposes to discredit the notion that ultimate tax liability is always equal to
Max (Tax liability per domestic law of one country, Tax Liability per domestic law of the other country)
Take US social security payments or US Govt pensions received by a US citizen who is an ROR in India, qualifies to be a resident of India per the India-US tax treaty, is filing MFJ for US tax purposes, has no dependents other than spouse, and ask the following questions.
To make things more concrete and easy, assume that the person receives $15K in US social security and US Govt pensions in India during April to Dec 2004, has no other income, and makes no contributions to instruments like PPF and ELSS that reduce taxable income in India.
(a) Per Indian domestic tax law, (i.e. in the absence of an India-US tax treaty), what is the tax liability to GOI?
(b) Per US domestic tax law, (i.e. in the absence of an India-US tax treaty), what is the tax liability to Uncle Sam?
(c) What is the Max of (a) and (b) above?
(d) Now apply the provisions of the India-US tax treaty (Article 19) and ask what is the tax liability of the tax payer?
(e) Compare (d) and (c) and check if (d) is lower than (c) or equal to it.
#24, that is good example to prove the point. I am in agreement. In this example, the DTAA for sure provide some relief in absence of it, GoI would have taxed the resident a lot.
In most situtation, people have mixed income ( dividend, interest, earned, rental etc). I am not sure tax relief is applicable in individual category. Since the income tax is applied on graduated rates and some basic exemption is provided in overall basis, the total tax liability has to be considered. My understanding is all the income has to be considered for which tax relief is sought. On that basis, there are only two numbers finally. 1) total tax liability in US 2) total tax liability in India after the tax credit applied, Max ( Indian tax, US tax) is the result. Correct me if I am wrong. --------------- From: Bobus175Sent: 9/19/2005 3:35 PM
..... let me refer to example provided in Post #24:
In that example, tax credit for taxes paid to the other country is zero. Yet there is a lot of tax relief that the treaty provides. For the same of completeness, the answers to questions in # 24 are:
(a) A lot based on graduated Indian income tax rates on income of $15K
(b) Zero because the person is MFJ and allowable standard deduction and personal exemptions overwhelm $15K.
(c) The number in (a)
(d) Zero because Article 19 gives exclusive right of taxation to the country that pays the Govt pensions and SS payments, which means India has no right to tax.
#28, something that was going on my mind while I try to answer the questions in #24. I would like to share. since the person in question is asked to file MFJ, we could assume the person is married and has a spouse. As per Indian law, MFJ is not possible, hence have to file alone. Also for simplicity here we assumed the spouse has no other income, hence no filing in India and no taxes or tax relief. But if that is not the case, and further if we assume the 15K$ US SS income is split between spouses, 7.5K$ is applicable as individual income in case of GoI. Adn with standard deduction kicking in, there will be taxes but that burden is not as much. This is mute point to the discussion or conclusion. But i want us to remember the taxation and DTAA relief becomes more complicated due to these small differences in filing status.
The purpose of posting the previous two posts which collated some relevant posts from other threads is just to show that there are more questions than answers.
As for the answers given in the collation in the two posts above, I now know that some of them are plain wrong, some inaccurate, and some misleading (applies to answers given in my posts too).
Based on the collation done above, I am fairly confident only about the following:
If some US source income e.g. from IRA, from US after-tax mutual funds etc is taxed by both GOI and IRS, then IRS will not give relief/credit for double taxation. The authority to approach for relief is GOI (not IRS) because the income source is foreign for GOI, not for IRS.
Claiming relief/credit on double taxed income is different from claiming exemption from tax on some income from a country or claiming a reduced rate of tax on some income from country. For claiming exemption or reduced rate of tax, one has to use the tax treaty. For claiming relief/credit on double taxed income, treaty is not needed.
This thread will deal with claiming relief/credit on double taxed income, not how to claim treaty benefits.
In particular, this thread will deal with claiming relief/credit on double taxed income from GOI where the source of income is outside India e.g. US (IRAs, US after-tax mutual funds ...) because the right authority to approach for tax relief/credit on such income is GOI, not IRS.
Sec 91 of Indian IT law and an IT Dept circular based on the same is the relevant law for the above.
Will post Sec 91 and the relevant IT Dept circular some time this week in this thread, which will take us to Step 2.
The truth starts here with a verbatim reproduction of Sec 91 of Indian IT Act. Will post meaning of terms in Sec 91 later in another post later.
IT Dept Link to IT Act (Chapter IX, which has just two sections 90 and 91). Sec 90 empowers GOI to enter into double taxation avoidance agreements. Sec 91 provides for unilateral tax relief/credit on double taxed income.
While Sec 91 is the relevant section for income from countries with which no tax treaty exists, it is also by default the relevant section for income from countries with which tax treaty exists, if all the assessee wants is to claim credit/relief on double taxed income (e.g. via Article 25 of India US tax treaty), as opposed to exemption from tax or double tax avoidance.
What follows is a verbatim reproduction of relevant (not entire) parts of Sec 91:
------------------ Countries with which no agreement exists. 991. (1) If any person who is resident in India in any previous year proves that, in respect of his income which accrued or arose during that previous year outside India (and which is not deemed to accrue or arise in India), he has paid in any country with which there is no agreement under section 90 for the relief or avoidance of double taxation, income-tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income10at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal. Explanation.In this section, (i) the expression Indian income-tax means income-tax 11[***] charged in accordance with the provisions of this Act; (ii) the expression Indian rate of tax means the rate determined by dividing the amount of Indian income-tax after deduction of any relief due under the provisions of this Act but before deduction of any relief due under this 12[Chapter], by the total income; (iii) the expression rate of tax of the said country means income-tax and super-tax actually paid in the said country in accordance with the corresponding laws in force in the said country after deduction of all relief due, but before deduction of any relief due in the said country in respect of double taxation, divided by the whole amount of the income as assessed in the said country; -------------------
Now am reproducing below a relevant IT Dept Circular on the above issued in 1963.
------------ Section 91 Unilateral Double Taxation Relief ?Relief? includes relief allowed under section 90 - The words ?after deduction of any relief due under the provisions of this Act? in clause (ii) of the Explanation to section 91 would also include any relief allowed to an assessee under any agreement for avoidance of double taxation entered into by the Central Government with the Government of any foreign country under section 90.?Circular: No. 11/68/63-TPL, dated 13-12-1963.
Based on Message 5 reproduction of relevant law, the conditions that must be met before even thinking of going anywhere near IT Dept to claim double taxation tax credit/relief are:
Must be resident of India i.e. RNOR or ROR, not NR (non-resident) Income which has been double taxed must have accrued/arisen outside India. Must have paid tax on that doubly taxed income to the other country.
Law does not seem to clearly say whether said tax to the other country must have been paid in that same financial year or could have even been paid in prior years. How will credit for double taxation be computed? Tax Credit from GOI = Amount of Doubly Taxed Income * Lower of {Indian rate of tax, Foreign rate of tax}. where * denotes multiplication sign [ "into" as it is called in India] Apologies for bad humor - need some amusement, even if horrible, for myself, to plod on with this stuff and retain my sanity. Amount of Doubly Taxed Income should be easy to identify in most cases. What the heck are Indian rate of tax and Foreign rate of tax? Definitely not marginal rates of tax on doubly taxed income. Numerator for Indian Rate of Tax Tax liability (tax owed) to GOI computed before taking (subtracting) any relief due under Section 90 (tax treaty) or Sec 91 (double tax credit), but after taking (subtracting) all other available exemptions/credits available under IT Act. Denominator for Indian Rate of Tax Total Income per Section 5 of Indian IT Act. Please note that total income per Sec 5 is not necessarily equal to total taxable income. For example if a person has Rs. 3.5 lacs total income in 2004-2005, his taxable income can be 1.5 lacs (1 lac exemption available to all before any tax kicks in, and another 1 lac exemption allowed for investments in specified instruments like PPF etc). Numerator for Foreign Rate of Tax Tax paid to foreign country, after taking into account all deductions available in that foreign country, but before taking any relief/deduction under tax treaty or relief/credit for double taxation that the foreign country may allow. Denominator for Foreign Rate of Tax If US, then Gross Income on US tax return (not AGI, not taxable income).
Will start with simple examples from next post later to illustrate above.
Makes IRA withdrawals and has other investment income from US on which he pays tax to US.
X is working in India and so also has salary income from India, as well as investment income, on which he pays tax to GOI.
Can X claim double taxation relief from GOI?
Answer
First, double taxation relief on which income?
If it is on IRA withdrawals and US investment income, NO, because as RNOR X is not liable to pay any tax on this income to GOI. So such income is not double taxed.
What about double taxation relief on Indian salary income and Indian investment income? First, have to claim it, if any, from IRS, since it is foreign income for IRS, not for GOI.
IRS allows foreign earned (salary) income exclusion, so it will likely be not taxed by IRS anyway, and double taxation is vacuous.
On Indian investment income, if X is liable to pay tax to IRS (because X is filing as resident for US tax purposes, and is therefore subject to tax on his global income to IRS), then the double taxation relief has to be claimed from IRS, not GOI.
X and Y are both USC, married to each other, file MFJ for US tax purposes, have no qualified dependents and are ROR in India for the financial year April 1, 2005 to March 31, 2006.
On December 31, 2005 X made an IRA withdrawal of $30,000 for which the premature distribution penalty applies. The $30K IRA withdrawal consisted of $20K withdrawal of "principal" (IRA accruals prior to ROR start date) and $10,000 of IRA accruals from April 1, 2005 to December 31, 2005. In addition, for the period April 1, 2005 to March 31, 2006, there were $5,000 of IRA accruals that were not withdrawn.
Y has no income of her own.
X and Y had no other income or transactions.
(a) What is X and Y's US tax liability for 2005? (b) What is X and Y's GOI tax liability for the period April 1 2005 to March 31, 2006 before computing double tax relief? (c) Are they eligible for double tax relief from GOI? If so, how much?
Answer
(a) X and Y, filing MFJ can claim standard deduction of $10K and personal exemptions of $3,200 * 2 = $6,400.
US Gross Income = $30K US Taxable Income = $30K - $16.4K = $13.6K
2005 US Tax Liability = 10% of $13,600 = $1,360
In addition to the $1,360, X and Y need to pay IRS 10% of $30K = $3,000 as premature distribution penalty.
So payment to IRS = $4,360
(b) GOI Total Income of X for 2005-2006 = $15,000 of IRA accruals, of which $10,000 was withdrawn and $5,000 was not withdrawn.
Assume an exchange rate of 45:1
$15K * 45 = Rs.6,75,000 on which the basic tax is, per 2005-2006 Indian individual tax table:
30% of [675K - 250K] + 20K + 5K = Rs.152,500
Education cess of 2% on 152,500 = Rs. 3,050
So Indian tax liability (before any double tax relief) = Rs. 155,550
(c) Common double taxed Income = $10K of accruals withdrawn = Rs.450K
Indian rate of tax = 155,550 divided by 675,000 = 23.04%
US rate of tax = 1,360 divided by 30,000 = 4.53% (penalty is not tax)
Lower of US rate of tax and Indian rate of tax = 4.53%
So double tax credit from GOI = 450,000 * 4.53% = Rs.20,385
So tax payment due to GOI = 155,550 - 20,385 = Rs. 135,165
Clearly, after attaining ROR status, each year, it makes sense to withdraw the entire accrual in the IRA pertaining to that year, and not leave the $5K accrual that was not withdrawn in the above example. The distribution instructions to IRA custodian or the accounting for the same that will accomplish this is not yet clear to me.
Also, after attaining ROR status, it makes sense to minimize the yearly accruals in the IRA.
The next couple of examples, to be posted as and when time permits, will illustrate the above by modifying Example 2 slightly.
X and Y are both USC, married to each other, file MFJ for US tax purposes, have no qualified dependents and are ROR in India for the financial year April 1, 2005 to March 31, 2006.
On December 31, 2005 X made an IRA withdrawal of $30,000 for which the premature distribution penalty applies. The $30K IRA withdrawal consisted of $15K withdrawal of "principal" (IRA accruals prior to ROR start date) and $15,000 of IRA accruals from April 1, 2005 to December 31, 2005. For the period April 1, 2005 to March 31, 2006, there no additional IRA accruals (beyond the $15K).
Y has no income of her own.
X and Y had no other income or transactions.
(a) What is X and Y's US tax liability for 2005? (b) What is X and Y's GOI tax liability for the period April 1 2005 to March 31, 2006 before computing double tax relief? (c) Are they eligible for double tax relief from GOI? If so, how much?
Answer
(a) X and Y, filing MFJ can claim standard deduction of $10K and personal exemptions of $3,200 * 2 = $6,400.
US Gross Income = $30K US Taxable Income = $30K - $16.4K = $13.6K
2005 US Tax Liability = 10% of $13,600 = $1,360
In addition to the $1,360, X and Y need to pay IRS 10% of $30K = $3,000 as premature distribution penalty.
So payment to IRS = $4,360
(b) GOI Total Income of X for 2005-2006 = $15,000 of IRA accruals.
Assume an exchange rate of 45:1
$15K * 45 = Rs.6,75,000 on which the basic tax is, per 2005-2006 Indian individual tax table:
30% of [675K - 250K] + 20K + 5K = Rs.152,500
Education cess of 2% on 152,500 = Rs. 3,050
So Indian tax liability (before any double tax relief) = Rs. 155,550
(c) Common double taxed Income = $15K of accruals withdrawn = Rs.675K which also happens to be total income for GOI tax.
Indian rate of tax = 155,550 divided by 675,000 = 23.04%
US rate of tax = 1,360 divided by 30,000 = 4.53% (penalty is not tax)
Lower of US rate of tax and Indian rate of tax = 4.53%
So double tax credit from GOI = 675,000 * 4.53% = Rs.30,578
So tax payment due to GOI = 155,550 - 30578 = Rs. 124,972
The tax liability to GOI is still very high, and the double tax relief/credit quite small.
Double tax credit will be small because it is computed on the lower of the two "average" tax rates (US and Indian)
The next example will modify the data above to a lower IRA accrual number.
Bobus175 (Original Message)Sent: 11/7/2005 3:54 PM 
as it is called in India]