What are the tax rules for my children’s Indian bank interest if they live abroad?

One of my kid is living and working in Luxembourg (permanent resident) and the second one is in the USA (Green Card holder). Both of them have bank interest income in India. Do they have to pay tax in their respective countries on Indian interest income? If yes, do they get some rebate in their respective countries on income tax paid in India or rebate in India on taxes paid abroad?

-Name withheld on request

It’s a really common and important question for families with members living across borders. Since your children are permanent residents in Luxembourg and Green Card holders in the USA respectively, they are considered tax residents in those countries. This means their worldwide income, including any interest earned in India, needs to be reported and taxed in their resident countries.

Here’s how it works in three straightforward parts:

Taxation in India

Interest earned from Indian bank accounts is taxable in India under the Indian Income Tax Act. 

If the account is an NRE (Non-Resident External) account, the interest is exempt from tax in India. However, interest from NRO (Non-Resident Ordinary) accounts or fixed deposits is fully taxable at applicable slab rates.

Also read: A quick guide for NRIs wanting to invest in Indian Mutual Funds

Global taxation in their resident countries 

Both the USA and Luxembourg operate on a “worldwide income” principle. This means your children must declare and potentially pay tax on all their income, no matter where it’s earned, including that Indian interest income. 

In the USA, your child must report this income on their IRS tax return, where it will be taxed according to US federal tax laws. Similarly, in Luxembourg, the interest income is also reportable and taxable under its domestic tax rules.

Avoiding double taxation with DTAA 

Here’s where the good news for avoiding paying twice comes in! India has double taxation avoidance agreements (DTAAs) with both the USA and Luxembourg. 

These agreements are designed to prevent your children from being taxed on the same income in both countries. If tax (TDS) has already been deducted in India on their interest income, your children can usually claim a foreign tax credit in their resident country (USA or Luxembourg). This credit reduces their tax liability in their resident country by the amount of tax already paid in India.

For your children, disclosing their Indian interest income on their tax returns in the USA or Luxembourg is crucial. It’s also vital they keep all Indian tax payment records (like Form 16A, Computation of Income, and their Indian Tax Return) to support their foreign tax credit claims.

Given the complexities of cross-border taxation, it’s highly recommended that your children consult a cross-border tax expert who understands the tax laws of both India and their country of residence. This will help them ensure full compliance and optimise their tax situation, as incorrect reporting can lead to penalties or loss of DTAA benefits.

Ajay R. Vaswani – Founder – ARAS AND COMPANY, Chartered Accountants

Also read: The two-minute investment rule that can transform your finances