Foreign Tax Credit Overview And Related Issues

The era of globalization and digitalization has brought a revolution in the way businesses are conducted, bringing the economies/geographies closer. While the businesses are evolving, the tax challenges relating to the right to tax the income between the Source and Residence Country are equally evolving.

Tax Treaties play a very crucial role to ensure that the taxes on income are distributed between the sovereigns while eliminating/ minimizing double taxation in the hands of the person earning the income. In this article, we are giving an overview of the regulations relating to the claim of Foreign Tax Credit (FTC) in India and the related tax issues.

Foreign Tax Credit

FTC is allowed to be a resident of India in respect of the tax paid by him in a source country or specified territory outside India either by deduction or otherwise.

FTC is allowed in the year in which the corresponding income has been offered to tax in India. Where the income is offered to tax in multiple years, FTC is allowed on a proportionate basis corresponding to the income offered in relevant years.

The key provisions relating to FTC in the IncomeTax Act, 1961 (ITA) read with the rules thereunder¹ are as follows:

1. FTC is allowed in respect of tax paid outside India irrespective of whether India has entered into a Double Taxation Avoidance Agreement (DTA) with such country or specified territories or not. Where DTA is entered, the FTC is allowed for the taxes covered under the DTA. The provision of the DTA has an overriding effect over the provisions in ITA to the extent they are more beneficial. In case of no DTA, the FTC claim may be considered as per the provisions of section 91 of the ITA.
2. FTC is restricted to the amount of tax payable in India on the corresponding income. Excess foreign tax paid over the taxes payable in India will not be allowed as credit. FTC can be claimed only against the tax, surcharge, and cess payable on the corresponding income in India. As such, it cannot be claimed against any interest or penalty payable under the provisions of the ITA.
3. FTC is allowed where the taxes are payable in India on the corresponding income under the normal provisions of ITA as well as where Minimum Alternate Tax (MAT) is payable. Where the FTC is claimed against MAT, the excess of FTC over the FTC allowable against tax payable under the normal provisions of ITA will be ignored while computing the MAT credit carried forward.
4. For claiming the FTC, the taxpayer is required to file the prescribed form - Form 67 by the end of the relevant assessment year in which the corresponding income is offered to tax and where the return of income has been furnished within the due date of filing an original tax return or belated tax return. The form is required to be filed online and needs to be accompanied by the relevant proofs substantiating the payment of taxes in a foreign country.

Over the years, there have been various issues relating to the eligibility to claim FTC, the amount that can be claimed as a credit, relating to filing of Form 67, which we have covered in the ensuing paragraphs.

i. Eligible persons for claiming FTC in India

The taxpayer is eligible to claim the FTC paid in the source country in the country of residence. Where a taxpayer qualifies as a tax resident in both the countries i.e., in the Source and Residence country, then his tax residency is determined by the tie-breaker rule provided in the DTA or may be determined by the competent authorities as specified in the DTA.

In India, a person who qualifies as a "tax resident" is further categorized as Resident and Ordinarily Resident (ROR) or Resident but not ordinarily resident (RNOR), depending on their number of days of stay in India. Irrespective of the residential status, i.e., ROR or RNOR, the taxpayer should be eligible to claim credit for the taxes paid in the source country once he qualifies as Resident. Reference in this regard can be made to the decision of the Hon'ble Delhi Tribunal in the case of Aditya Khanna² wherein it was held that RNOR is also eligible to claim FTC in India in respect of taxes paid abroad on doubly taxed income.

ii. Relief against State Taxes

In certain countries (for example the USA), income taxes are levied by the State as well as the Central Government. The eligibility to claim FTC for State taxes is a subject matter of dispute, especially where there is a DTA with that respective Country and the taxes under the DTA do not cover state taxes.

For instance, in the USA, the tax is levied by the Federal Government as well as State Government. The DTA between India and USA covers only federal taxes. A question arises whether the state taxes paid in the USA can be claimed as FTC.

The Karnataka High Court, in the case of Wipro Ltd³ , has held that where DTA does not cover taxes like state taxes payable on income, FTC can be availed under Section 91 of the ITA. The DTA between India and USA does not cover state taxes payable in the USA. The High Court held that taxes on income paid to the state of a country like the USA should be allowed as a credit under section 91 of the ITA.

The Mumbai Tribunal, in the case of Tata Sons Ltd⁴ has held that Section 91 of ITA does not discriminate between State and Federal taxes and, in effect, provides for both types of Income-taxes to be considered for the purpose of tax credits against Indian Income-tax liability. Hence, the taxpayer is, in principle entitled, to tax credits in respect of the State as well as Central tax payable outside India.

The Ahmedabad Tribunal, in the case of Dr. Rajiv I. Modi5 allowed credit for state taxes paid in the USA.

As such, the judiciary has held that FTC is eligible for both State as well as Central taxes.

iii. Allowability of FTC where income is exempt from tax in India

Where an income is subject to profit-linked deduction and no tax is payable in India, a question arises whether the taxpayer shall be eligible to claim FTC in respect of such income. Here the language of the DTA Article on the elimination of Double taxation is very important.

In this context, the decision of the Karnataka HC in the case of Wipro Ltd (supra) is relevant. The taxpayer had claimed a deduction under Section 10A of the ITA and claimed FTC for the taxes paid in USA and Canada. The FTC claim was disputed as to whether the taxpayer is eligible to claim FTC where there is no tax paid on the income in India. The Hon'ble HC held that the income is chargeable to tax and is includible in the total income of the taxpayer, but no tax is paid because of the deduction/ exemption given under Section 10A of the ITA for a period of 10 years. The said deduction/ exemption granted under the statute has the effect of suspending the collection of income tax for a period of 10 years. It does not make the said income not leviable to income tax. Merely because the deduction/ exemption has been granted, it cannot be assumed that the taxpayer is not liable to tax, and therefore, the assessee is eligible for FTC under Section 90(i)(a)(ii) of the ITA.

Further, the Hon'ble HC held that the income derived by an Indian resident, which is taxable in the USA (directly or by deductions), would get FTC in India for the entire amount of income tax paid in the USA under India-USA DTA.

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Footnotes

1. Section 90, 91 of the Income tax Act, 1961(ITA) read with Rule 128 of the Income tax Rules 1962.

2. [2019] 105 taxmann.com 323

3. [2015] 62 taxmann.com 26, [2016] 382 ITR 179

4. [2011] 10 taxmann.com 87 (Mum.)

5. [2017] 86 taxmann.com 253

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.