Invest in US stocks? Do this to stop your dividends from being taxed twice.

This is in part why a growing number of Indians are dipping their toes—and sometimes an arm and a leg—into American stocks.

If you’re one of these investors, or looking to be, here’s a tip to save tax on dividends using the double tax avoidance agreement (DTAA) between India and the US.

Let’s say you invested $1,000 in Microsoft and received a 0.7% dividend for the year—$70. US tax authorities will levy a 25% ‘withholding tax’ on the dividend, which works out to $17.5 in this case. But that’s not it. Your dividend income will also be taxed in India at your income tax slab rate.

That’s where the India-US DTAA comes in. When filing your income tax return, if you can prove that you’ve already paid 25% tax on your dividends, you can set that amount off against your income tax payable in India.

Using the example above, let’s say you're in the 30% income tax slab. Instead of paying the full $21 ( ₹1,864) tax on your dividend income, you can set off the $17.5 already taxed in the US and pay only the remaining $3.5.

Get your dividend ducks in a row

Prakash Hegde, a chartered accountant in Bengaluru, said to claim the DTAA benefit, investors must have these two forms from their broker:

• Form 1042-S (foreign person's US source income subject to withholding): This is the official US tax document issued by your US broker that reports the income (such as dividends) you earned from US investments and the amount of US tax (withholding tax) that was deducted from it.
• Form 67 (foreign tax credit): This is the form you file with the income tax department to claim a foreign tax credit (FTC) for taxes you have already paid on your income (like dividends) in a foreign country, thus helping you avoid being taxed twice on the same income.

Importantly, if you’re a resident of India, your US capital gains won’t be taxed in the US, only in India.

Ashish Karundia, a chartered accountant in Delhi, said if an investor doesn’t file Form 67 with his tax return to claim the withholding tax in India, his foreign dividends may end up being taxed twice.

In you invest in US or other foreign equities, you also need to include the following documents in your tax return:

• Schedule FA (foreign assets): This form requires you to disclose details of all foreign assets you hold (such as foreign bank accounts, shares, mutual funds, or property) as a resident of India.
• Schedule FSI (foreign source income): Requires you to provide a detailed, country-by-country breakdown of all the income you earned from sources outside India during the financial year, which is taxable in India.
• Schedule TR (tax relief): Summarises the tax relief you are claiming in India (under sections like 90/91 of the Income Tax Act) against the taxes you have already paid on your foreign income, based on the detailed information provided in Schedule FSI.

As for currency conversion, Indian tax authorities use the SBI Telegraphic Transfer (TT) buying rate as of the last day of the preceding month. For example, if you receive a dividend on 10 May, the exchange rate on April 30 will be used for tax filing.

Partial benefit for some

Interestingly, if your income tax rate is lower than the 25% withholding tax, you will be able to set off only that portion of your US taxes, not the full 25%.

Let’s say you’re in the 15% income tax bracket. You can claim a tax credit of only 15% of your US dividend income, even though it was taxed at 25% in the US.

In the example above, the investor’s foreign dividend income would be taxed in India at 15%, or $10.5, so he can only claim that much FTC and the remaining $7 ($17.5 minus $10.5) is lost. Worse still, if a taxpayer falls under the non-taxable category, the entire 25% withholding tax is a deadweight loss.

Also remember that you can invest up to ₹10 lakh a year abroad before a 20% tax credited at source (TCS) kicks in. However, this TCS can be adjusted against the tax deducted at source (TDS) on your salary, or claimed back against advance taxes or while filing your tax return.