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An insight into Foreign tax credit

February 17, 2017[2017] 78 185 (Article)

While I was going to Mumbai I was sitting across an IT professional who was an expatriate. On making him know about my background (tax professional), he stood up and I could make out that the next two hours in the flight are going to be a Q&A session. While I could understand his exasperation on the enormous tax provisions which existed in cross border transactions, what stood out was that there was a lot of confusion on the foreign tax credit rules.

Central Board of Direct Taxes (CBDT) has recently come out with foreign tax credit (FTC) rules which might be a great relief for a number of expatriates. Before deep diving into the new rules, I thought of giving a purview on the source of these rules, i.e. the issue of double taxation.

In the present era of cross border transactions across the world, where every country seeks to increase its tax share, more often than not, there arise situations wherein one income is taxed twice. The following are the situations/ circumstances where there is double taxation:

  Conflict between residence rule and source rule: One income might be taxed twice. Once in the country in which the income is sourced (source rule) and secondly in the country in which the person is a resident thereof (residence rule).For instance, if an US entity lends money to Indian entity, then the interest income earned by the US entity will be chargeable to tax in India since the income is sourced in India. Similarly, the US entity, would be subject to tax on its worldwide income in the US based on it being a resident of US. This gives rise to double taxation. To oversee the hardship of double taxation faced by the taxpayers the government has framed foreign tax credit rules in the tax treaty/ Income Tax Act.
  Overlapping of residency rule: When a person is considered as a resident in two or more countries simultaneously. For instance, Entity X is a resident of India by virtue of Place Of Effective Management rules (yet to be effective) and simultaneously, it is a resident of US, due to its incorporation in US.
  Overlapping of source rule: When two countries are of the view that a particular income arises in their country, then there arises double taxation.

The following are the options available to a taxpayer to claim the relief from double taxation:

1.   Where there is a Double Taxation Avoidance Agreement (DTAA) between India and the foreign country (Bilateral relief provided in Section 90 of the Income Tax Act, 1961):
  Under this method, the Governments of two countries enter into an agreement to provide relief against double taxation by mutually working out the basis on which the relief is to be granted.
  India has entered into agreements for relief against double taxation with more than 50 countries which include Sri Lanka, Switzerland, Sweden, Denmark, Japan, Federal Republic of Germany, Greece, etc.
  Bilateral Relief may be granted by either of the following methods:
a.   Exemption method, by which a particular income is taxed in only one of the two countries and is exempt in the other country; and
b.   Credit/ Tax relief method, under which, an income is taxable in both countries in accordance with their respective tax laws read with the DTAA. However, the country of residence of the tax payer allows him credit for the tax charged thereon in the country of source.
  In India, double taxation relief is provided by a combination of the two methods.
2.   Where there is no DTAA between India and the foreign country (Unilateral relief provided in Section 91 of the Income Tax Act, 1961): This method provides for relief of some kind by the home country even where no mutual agreement has been entered into by the two countries.
  The amount of deduction shall be calculated on such doubly taxed income at the lower of the following rates:
  Indian rate of tax; or
  Foreign country's rate of tax
  Unilateral relief would be granted provided all the following conditions are fulfilled:
i.   The assessee is a resident in India during the previous year in respect of which the income is taxable
ii.   The income accrues or arises to him outside India.
iii.   The income is not deemed to accrue or arise in India during the previous year
iv.   The income in question has been subjected to income-tax in the foreign country in the hands of the assessee.
v.   The assessee has paid tax on the income in the foreign country
vi.   There is no agreement for relief from double taxation between India and the other country where the income has accrued or arisen.
  This relief is to be computed on country wise basis and not on the basis of aggregation of income of all foreign countries.
  Even though options are available, there is still a lot of ambiguity with respect to FTC. Recently CBDT has come out with rules clarifying the mechanism of obtaining FTC in India. The rules have been summarized below in the form of FAQs for a clear understanding:

Q1. What constitutes FTC?

Ans. In respect of a country with which India has entered into a DTAA – FTC covers taxes covered under that tax treaty. In respect of any other country – FTC covers the tax payable under the law in force in that country in the nature of income tax.

Q2. What is the mode of payment of foreign tax?

Ans. Direct payment of tax or by way of deduction

Q3. In which year is the FTC available?

Ans. FTC shall be available to the taxpayer in the year in which the income corresponding to such foreign tax has been offered/ assessed to tax in India.

Where the income corresponding to foreign tax is offered to tax in more than one year, FTC shall be available across those years, in proportion to the income offered/ assessed to tax in India

Q4. FTC is available against which taxes?

Ans. FTC shall be available against the amount of tax, surcharge and cess payable under the Income-tax Act, 1961 (the Act). FTC shall also be allowed against tax payment under Minimum Alternate Tax (MAT)/ Alternate Minimum Tax (AMT) provisions

Q5. Against which items, FTC is not availabale?

Ans. FTC is not available against the following:

  Against payment of any interest, fee or penalty under the Act
  Any amount of foreign tax disputed by the taxpayer

Q6. What is the treatment of disputed Foreign tax?

Ans. Credit of disputed foreign tax shall be available for the year in which the corresponding income is offered to tax or assessed to tax in India, if the taxpayer furnishes the following evidence within 6 months from the end of the month in which disputed foreign tax is finally settled:

  Evidence of settlement of dispute;
  Evidence to the effect that the liability for payment of such foreign tax has been discharged by the taxpayer; and

An undertaking that no refund in respect of such amount has been directly/ indirectly claimed or shall be claimed by the taxpayer

Q7. What is the mode of computation of FTC?

Ans. Total available FTC shall be the aggregate of the amounts of FTC computed separately for each source of income arising from a particular country.

FTC shall be the lower of:

  Tax payable under the Act on such income; or
  Foreign tax paid on such income

Where the foreign tax paid exceeds the amount of tax payable under the provisions of tax treaty, such excess amount shall not be considered.

Q8. What are the documents required to claim FTC?

Ans. The taxpayers shall be required to furnish following documents on or before due date of filing of tax return under the Act:

  A statement of foreign income offered to tax and the foreign tax deducted or paid on such income in Form No. 67; and
  Certificate or statement specifying the nature of income and foreign tax deducted or paid:
  From the tax authority of the foreign country; or
  From the person responsible for deduction of such tax; or

FTC has always been a moot point of discussion in the litigative circles due to involvement of different countries and their respective tax jurisdictions. Though, we have various judicial precedents in India which clarifies various contexts and computation dilemmas, the concept still has its own nuisances.

While the real plight would only be revealed once the FTC rules are operational (with effect from 1st April 2017), CBDT has tried to bring a lot of clarity and uniformity with these rules. This should reduce the litigations and confusions to a great extent, hence, definitely a welcome move.


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