How to Claim Credit on Foreign Tax Paid

Introduction

Foreign Tax Credit (FTC) is a non-refundable tax credit for income tax payments made to a foreign government as a result of foreign income tax withholdings. The assessee may claim relief for taxes paid on income earned in a foreign country that is also taxed in his or her home country.

The objective of this article is to provide a brief understanding of the concept of double taxation relief under Indian Income Tax Laws in the case of an individual.

Important Definitions

1. Source Country: The country from which an individual receives or is deemed to receive income.
2. Country of Residence: The country in which the individual is considered to be a resident in that fiscal year based on his period of stay under the respective Income Tax laws.
3. Double Taxation Avoidance Agreements (DTAAs): Tax treaties concluded between countries to eliminate or relieve certain income subject to double taxation. These tax treaties are of two types: (a) Comprehensive agreements; (b) Limited treaties. Limited treaties are those which are limited to certain types of income only, whereas comprehensive DTAAs are those which cover almost all types of income covered by any model convention. Many a time, such treaties also cover wealth tax, gift tax, etc. (It shall be noted that each country forms a separate DTAA with another country for providing the double taxation relief.)

Application of DTAA

Where an assessee is a resident and an ordinary resident (ROR) in India, the global income earned shall be taxable in India as per Income Tax rules. That is, in case the assessee is a ROR and has a source of income from another country which is taxed both in the source country and in India, it shall give rise to double taxation.

However, in this case, he will pay the income taxes on the income earned from the source country based on the two basic rules, namely (i) the source rule and (ii) the residence rule. The source rule holds that income is to be taxed in the country in which it originates, irrespective of whether the income accrues to a resident or a non-resident, whereas the residence rule stipulates that the power to tax should rest with the country in which the assessee resides.

In case where both the above said rules apply to an assessee as per the income tax rules, both in the source country and in the country of residence, the income earned in the source country shall also be taxable in the country of residence. (Here, the country of residence is referred to India.) In such cases, rules under DTAA shall be implied for providing double taxation relief.

Relief under DTAA

The relief provided under the DTAA can be of two types: (a) Bilateral Relief; and (b) Unilateral Relief.

Bilateral Relief

Under this method, the Government of both countries enters into an agreement to provide relief against double taxation by mutually working out the basis on which the relief is granted. Bilateral relief may be granted in either one of the following methods:

• Exemption Method: Where the particular income is taxed in only one of the two countries.
• Tax Credit Method: – Where the income is taxable in both countries in accordance with their respective tax laws and the DTAA of country of residence of the tax payer, however, allows him credit for the tax charged there on in the country of the source.

India provides bilateral relief to its residents u/s 90 and 90A of the Income Tax Act, 1961. Section 90 deals with agreements with foreign countries or specified territories, whereas Section 90A deals with double taxation relief to be extended to agreements (between specified associations) adopted by the Central Government.

Unilateral Relief

This method provides for relief of certain amount by the home country even where no mutual agreement has been entered into by the two countries. India provides unilateral relief to its residents u/s 91 of the Income Tax Act, 1961.

Double Taxation relief under section 90 of the Income Tax Act, 1961

The DTAA provides that where any income of a resident or an ordinary resident of India is taxed in another country, such income shall be included in his total income chargeable to tax in India in accordance with the provisions of the Act.

In this case, based on the DTAA between the foreign country and India, an individual can claim a FTC for such taxes paid abroad in proportion to the income chargeable to tax in India when filing income tax returns.

Double Taxation relief under section 91 of the Income Tax Act, 1961

Section 91 provides that in the case of income derived by a resident and an ordinary resident from countries with which India does not have a DTAA. The FTC eligible for relief under this section is the tax amount calculated on double taxed income at the Indian rate of income tax or the rate of income tax in such country, whichever is lower.

Other important rules for claiming FTC

The following are some rules and regulations concerning the FTC:

1. Where income on which foreign tax has been paid or withheld is offered for tax in more than one year, the FTC shall be allowed across those years in the same proportion in which the income is offered for tax or assessed for tax in India.
2. The FTC may be applied to the amount of tax, surcharge, or cess payable under the Act, but not to any sum payable as interest, fee, or penalty. However, if the foreign tax amount is disputed, the credit shall be eligible for FTC only on the final settlement and upon furnishing the evidence of settlement of dispute.
3. FTC is available on income taxes computed under Section 115JB (Minimum alternate tax).

Tax credits, in general, are non-refundable in India, including the FTC. Also, in case there exists a refund of foreign taxes withheld by the foreign country as per their tax laws, the refunded tax amount under the foreign income tax laws cannot be claimed as FTC in India.

 Documents Required for FTC Claim

In order to claim FTC, the taxpayer is required to file the following documents on or before the due date of the filing of the return:

1. A statement of

• Foreign income taxed in the foreign country.

• Foreign tax deducted or paid on such income in Form No. 67

1. Certificate or statement specifying the nature of income and the amount of tax deducted there from or paid by the taxpayer.
2. Proof of payment of taxes outside India (such as the Income Tax return filed for the respective year)

Form 67 is a mandatory document for claiming FTC. It is a statement that provides the details of income earned in a foreign country. It also furnishes details of the tax either paid by the taxpayer or deducted from their income. Please keep in mind that under Section 139(1) of the Income Tax Act of 1961, Form 67 is provided before or on the due date for submitting an income tax return.

This article has been written by Parkave B, an intern with V Ramaratnam and Company, Chartered Accountants. To know more about claiming Foreign Tax Credit (FTC), you may reach out to V Ramaratnam and Company, Tax Consultants in Chennai.