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Foreign Tax Credit

Foreign Tax Credit – Some key Questions

Taxpayer who is Resident in India is allowed Foreign Tax Credit for the foreign taxes paid on income earned overseas by way of deduction or otherwise in the year in which the said income has been offered to tax in India as his worldwide income is taxable in India. If the income on which foreign tax has been paid or deducted, is offered to tax in India in more than one tax year, credit of foreign tax shall be allowed across those years in the same proportion in which the income is offered to tax in India.

 

In this paper we shall discuss some important aspects of foreign tax credit for the Indian Resident taxpayers ‘s prospective.

 

Legal Framework

Section-90 and Section-90A of Income tax act: When DTAA Exist..

 

  • When a country or specified territory in which foreign tax paid has DTAA with India, the credit shall be as per the specific provisions of respective DTAA in the absence of any specific Provision in Indian Income tax Act. This may have some inherent limitations like tax concessions or incentives like R & D deduction allowed in foreign countries do not effective accrue to Resident taxpayers, and no benefit of tax sparing credit.

 

  • Two situations are envisaged for FTC in Section-90(1)(a): i) DTAAs have been entered into for granting relief in respect of income on which Income tax is paid both under domestic law and law of country of source; ii) DTAAs have been entered into for granting relief in respect of income tax chargeability under domestic tax law and under corresponding law in force in the country of source to promote mutual economic relations, Trade and investments. There is a huge difference between these two situations; first one talks about income tax paid in both jurisdictions as pre-condition for relief and the second one, talks about chargeability of income in both jurisdictions whether or not it leads to payment of tax. In other words, it is example of simple credit method and full credit method respectively.

 

Section-91 of ITA: When DTAA Does not exist..

 

  • Unilateral credit under the provisions of Income tax Act shall be lower of Indian rate of tax and the rate of tax paid in foreign country i.e. a clear guidelines how to compute relief.

 

Note: Section-91 can be availed even if the taxpayer is covered under Section-90 if it is more beneficiary.

 

Rule 128 of Income Tax Rules: Foreign Tax Credit

Inserted by the IT (Eighteenth Amendment) Rules, 2016, w.e.f. 1-4-2017. Provides the procedure for claiming foreign tax credit by Indian Resident taxpayers.

Key Questions:

 

Q: What is not allowed as credit?

A:  Following are something which is not allowed as foreign tax credit:

  • Any sum paid as interest, fee or penalties; but includes any tax on income or business profit imposed by federal, state or municipal level.
  • Any among of foreign tax which is disputed.

 

However, credit of the disputed amount shall be allowed for the year in which such income is offered to tax in India if the tax payer within 6 months from the end of the month in which dispute is finally settled, furnishes evidence of settlement and an evidence to the effect that the liability of the payment of such foreign tax has been discharged and furnishes undertaking that no refund in respect of such amount has directly or indirectly has been claimed or shall be claimed.

 

Q: What if the income on which foreign tax has been paid is EXEMPT in India?

A: In the case of Wipro Ltd v Dy. CIT 383 ITR 179 (Kar.), If the case is covered under section-90(1)(a)(ii)  of ITA, the taxpayer would be entitled to take credit of Income tax paid in foreign Country even in relation to the income which is exempted under section-10A.

 

Q: Can the tax payer eligible for refund of foreign tax paid in such situations?

A: As per the scheme of tax credits, based on the domestic law, the international tax literature band Model convention commentaries, there is no situation in which excess foreign tax credit can result in a situation in which taxpayers can get refunds, from the exchequer of residence jurisdictions, in respect of taxes paid to the exchequer of source jurisdiction. Proviso of sub rule 5 of Rule 128 of Income tax rules, 1962 specified that where the foreign tax paid exceeds the amount of tax payable in accordance with the provisions of DTAAs, such excess credit shall be ignored leaving no room for any Carry forward or refund of excess credit of foreign tax but prospectively from 1.4.2017 the effective date of application of the rules.

 

 

Q: Whether the foreign tax paid, which are not eligible for credit or refund, will be allowed as deduction while computing income under the provisions of ITA?

A: S-40(a)(ii) of ITA provides that any sum paid on Account of any rate or tax levied on the profits or gains of any business and profession is not allowed. Section-2(43) defines ‘tax’. So any sum covered as tax shall not be allowed as deduction of business expenditure.

 

Q: Whether unadjusted foreign tax credit can be carry forward in India?

A: No.

 

Q: Whether tax sparing credit is available to Indian Resident taxpayers in India?

A: Tax sparing credit is granting a tax credit in the resident state for the amount of tax that would have been payable in the source state had there been no reduction or exemption under the tax regime of source state.  In many Countries, incentives are given to overseas taxpayers by way of tax holiday, by the virtue of which no or less tax is payable in those countries. As most of the DTAAs, India’s position is to allow tax credit only when taxes are actually paid in those jurisdictions.  Therefore, India does not promote tax sparing credit while many countries of the World extending this benefit to their tax residents.

 

Q: Whether underlining tax is available under the Indian Tax laws?

A: The underlining tax credit refers to the credit that may be given, in the Resident state, for the taxes paid on the underlying profits out of which dividend is paid by a company in the source state. This is usually applicable only to Companies and is a case of economic double taxation. Of the income. It is not covered under the definition of tax as per Section-2(43) of ITA. There is no specific Provision under Indian tax laws to provide credit of underlining tax. However, there are some DTAAs which provides credit of underlining tax e.g. India-Mauritius, India-USA etc.

 

Q: What are the methods of Credit of Foreign Tax?

A: Following are the methods of Credit of Foreign Tax:

 

  • Exemption Method adopts ‘income approach’ i.e. exclusive right of tax is given to any one of jurisdictions, residence or source, for each head of income are of two type, Full Exemption and Exemption with progression wherein EXEMPT income is included only for rate purposes.
  • Credit Method: adopts ‘tax approach’ meaning country of residence allowed tax credit for foreign tax paid are of two type…
  • Ordinary credit method: The amount of tax which must be credited may not exceed the tax that the Resident would pay in the residence state on the same foreign item of income.
  • Full credit method: The full credit of foreign tax is allowed with the domestic tax on foreign source income and balance of foreign tax shall either be adjusted against other domestic tax or refunded or carry forward.

 

Q: What is the procedure to claim credit of foreign tax in India?

A: Credit of the foreign tax shall be allowed on furnishing the following documents by tax payers, namely:

  • A statement of the income from the country or specified territory outside India offered for tax and of foreign tax paid on such income in Form No. 67 duly verified.
  • Certificate or statement specifying the nature of income and the amount of tax deducted therefrom or paid by the tax payer, from a) the tax authorities of the country or specified territory outside India; or b) from the person responsible for deduction of such tax; or c) signed by tax payer along with challan of foreign tax paid or proof of deduction of foreign tax.

 

The statement or certificate as mentioned above must be furnished on or before the due date of furnishing the tax return in India.

 

To Conclude – Foreign Tax Credit

The main purpose of foreign tax credit is to promote investment flow. An open approach may help to achieve the objectives of foreign tax credit. In this regard, at least carry forward of foreign tax credit may be a path breaking step.

(Disclaimer: This content is meant for our clients or professional friends only for stimulating discussion on the subject matter not to frame any commercial opinion. All efforts are made to compile correctly with no guarantee of extreme accuracy)

Please feel free to write on sanjay@dsrvindia.com or contact at: +91 9810116321

 

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