All about Foreign Tax Credit

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All about Foreign Tax Credit

Introduction:

 

Corporate India today serves global needs and brings in overseas income which is chargeable to Indian tax net as a resident of India. Flip side of this paves way for claim for taxes paid at foreign jurisdiction based on the source of income. Without clear guidelines on the credit mechanism, there were uncertainty on determination of quantum of credit eligibility, which had led to lots of litigation. The attempt which CBDT has made to settle the dust by notifying rules for foreign tax credit was come into force from 1.4.2017.

 

Types of Double Taxation:

  • Jurisdictional Double Taxation:
  • When same person taxed in two or more different countries for the same income due to dual residence or based on residence in one country and source in another.

 

  • Economic Double Taxation:
  • When two different taxpayers taxed on same income in two or more countries.

 

  • Eg: Dividend Distribution tax on Dividend, Transfer Pricing etc.

Elimination of Double Taxation Relief:


  • Section 90/90A
    : (Bilateral Relief)
  • When the Governments of two countries enter into an agreement to provide relief against double taxation by jointly working out the system to grant it. In India, bilateral relief is provided under Section 90 and 90A of the Income-tax Act, 1961.

 

  • As per Section 90(2) assesse can opt DTAA or Income tax Act whichever is more beneficial to the assessee. (Normally first read the Income Tax Act then read DTAA)

 

  • As per Section 90(4) an assesseeshall not be entitled to claim any relief under such agreement unless a certificate of his being a resident in any country outside India or specified territory outside India, as the case may be, is obtained by him from the Government of that country or specified territory.

 

Note: India and Taiwan have DTAA under section 90A and India have balance treaties with other countries are under section 90.

  • Section 91: (Unilateral Relief)
  • The relief provided by home country irrespective of any agreement with the country concerned.
  • This kind of relief exists because bilateral agreements might not be sufficient to meet all the cases.
  • In India, Section 91 of the Income Tax Act, 1961 provides such relief. In other words, where Section 90 does not apply for relief under Section 91 will be available.
  • Unilateral relief is only available in respect to doubly taxed income that is part of income which is included in assessee’s total income.

Example of Unilateral Relief:

Particulars India Income (Including USA Income of Rs 6,00,000/-) USA Income
Income 10,00,000 6,00,000
Tax 2,00,000 1,50,000
Rate 20% 25%
Relief 6,00,000*20% = 1,20,000

Methods of Bilateral Relief

 

 

  • Meaning of Exemption Method:
  • Under this method, the residence country exempts from tax the income arising in the source country.

 

  • Income would be chargeable to tax only in sourcecountry.

 

  • Full Exemption method – Completely ignore the State Sincome

 

  • Exemption with progression – Consider State S income only for tax ratepurposes.

 

Example of Full Exemption Method:

 

XYZ resident of India earns Rs.20,000 Income in USA and Tax rate in USA is 40% and paid tax in USA Rs. 8,000 and the Income earns in India Rs. 80,000 and Average Tax rate in India is 30% (If consider only India Income) and 35% (If consider global Income). Therefore in India Income Rs. 80,000 taxable @ 30% i.e. 80,000*30% = Rs. 24,000.

 

Example of Progressive Exemption Method:

XYZ resident of India earns Rs. 20,000 Income in USA and Tax rate in USA is 40% and paid tax in USA Rs. 8,000 and the Income earns in India Rs. 80,000 and Average Tax rate in India is 30% (If consider only India Income) and 35% (If consider both India & USA Income). Therefore in India Income Rs. 80,000 taxable @ 35% i.e. 80,000*35%= Rs. 28,000.

 

  • Meaning of Full & Ordinary Credit Method:
  • Where a resident of a Contracting State derives income or owns capital may be taxed in the other Contracting State, the firstmentioned State shall allow:

 

  1. as a deduction from the tax on the income of that resident, an amount equal to the income tax paid in that other State;

 

  1. b) as a deduction from the tax on the capital of that resident, an amount equal to the capital tax paid in that other State.

 

 

  • Such deduction in either case shall not, however, exceed that part of the income tax or capital tax, as computed before the deduction is given, which is attributable, as the case may be, to the income or the capital which may be taxed in that other State.

 

  • Full Credit method – Full credit for taxes paid in State S.

 

  • Ordinary credit method – State R allows deduction restricted to that part of tax payable in State R which is appropriate to the income earned in State S.

 

  • Typically, Indian treaties have adopted ordinary credit method.

 

  • Full credit method is rarely adopted by jurisdictions as it could result in refund of tax liability paid in State S by State R.

Examples of Full Credit Method:

Particulars Case A Case B
Income in State Residence 1,60,000 1,60,000
Income in State Source 40,000 40,000
Tax Rate in Residence Country 22% 22%
Tax Rate in Source Country 15% 40%
Tax Payable in Residence State 44,000 44,000
Tax Payable in Source State 6,000 16,000
Tax Credit 6,000 16,000

Examples of Ordinary Credit Method:

Particulars Case A Case B
Income in State Residence 1,60,000 1,60,000
Income in State Source 40,000 40,000
Tax Rate in Residence Country 22% 22%
Tax Rate in Source Country 15% 40%
Tax Payable in Residence State 44,000 44,000
Tax Payable in Source State (A) 6,000 16,000
Tax in Residence State on Income from Source state (22%*40,000) (B) 8,800 8,800
Tax Credit [Lower (A) or (B)] 6,000 8,800
  • Meaning of Underlying Tax Credit:
  • Grant of credit by Residence country of not only with held tax on dividends, but also for corporate tax paid on the underlying profits out of which the dividend has been paid by the company in Country S.

 

  • Underlying tax Credit is for Avoidance of Economic DoubleTaxation.

 

Example of Underlying Tax Credit:

An Indian Co. has subsidiary in USA who is paying dividendRs 80,000 to Holding Indian Co and Details are as follows:

Particulars Amount
Profits of Subsidiary Co. 2,00,000
Income Tax Paid by Subsidiary Co. @ 20% 40,000
Amount paid as Dividend to Holding Co. 1,60,000
Withholding tax on Dividend @ 10% 16,000
Income of Holding Co. (Including Div. Income) 3,00,000
Tax on Holding Co. Income @ 30% 90,000
Underlying Tax Credit 40,000
Credit for Withholding Tax deducted by Subsidiary Co. 16,000
Balance Tax Payable in India by Holding Co. 34,000

 

  • Tax Sparing Credit Method:
  • It is an extension of the normal and regular tax credit to taxes that are spared by the source countryi.e. for given or reduced due to rebates/tax incentives. Simply stated, credit for taxes forgone by the source State.

 

  • Providing investment incentives and thus, stimulate investments and economic development.

 

  • This Method exist only in India Mauritius DTAA.

 

Example of Tax sparing Credit Method:

A Inc. has subsidiary B Ltd in India and subsidiary B Ltd exports 100 percent of its production and claim 10B benefit and B Ltd Earn profit of Rs 5,00,000 and details are as follows:

 

 

Particulars Amount
Income Earned by B Ltd 5,00,000
Exemption under Section 10B 5,00,000
Amount Paid as Dividend to A. Inc. 5,00,000
Withholding Tax @ 10% on dividend 50,000
Underlying Credit to A Inc.
Credit of Withholding Tax to A. Inc. 50,000
Tax Sparing (5,00,000 *30% Tax Rate in India) 1,50,000
Total Credit Available 1,80,000

Rule 128 of Income Tax Rules 1962

  • Foreign Tax Means:
  1. In respect of a country or specified territory outside India with which India has entered into an agreement for the relief or avoidance of double taxation of income in terms of section 90 or section 90A, the tax covered under the said agreement;
  1. In respect of any other country or specified territory outside India, the tax payable under the law in force in that country or specified territory in the nature of income-tax referred to in clause (iv) of the Explanation to section 91.

Clause (iv) of Explanation to Section 91.

The expression “income-tax” in relation to any country includes any excess profits tax or business profits tax charged on the profits by the Government of any part of that country or a local authority in that country.

  • Foreign Tax paid in a country or specified territory outside India by way of deduction or otherwise, then credit Available in the year in which income corresponding to such tax has been offered to tax or assessed to tax in India.
  • Foreign Tax Credit Available proportionately if Income offered in more than one year.
  • Foreign Tax Credit Available against amount of tax, surcharge and cess payable under the Act.
  • Foreign Tax Credit not Available against amount payable of Interest, Fees or penalty.
  • Foreign Tax credit is allowed against MAT under section 115JB/115JC.
  • No credit shall be available in respect of any amount of foreign tax or part thereof which is disputed in any manner by the assessee:

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

  • Aggregate of amount computed separately for each source of income arising from a country.
  • The credit shall be the lower of the tax payable under the Act on such income and the foreign tax paid on such income.
  • If foreign tax paid > Tax payable under DTAA, such excess isto be ignored.
  • The credit shall be determined by conversion of the currency of payment of foreign tax at the telegraphic transfer buying rate on the last day of the month immediately preceding the month in which such tax has been paid or deducted.

Telegraphic transfer buying rate’ shall have the same meaning as assigned to it in Explanation to rule 26.

  • Where the amount of foreign tax credit available against the tax payable under the provisions of section 115JB or section 115JC exceeds the amount of tax credit available against the normal provisions, then while computing the amount of credit under section 115JAA or section 115JD in respect of the taxes paid under section 115JB or section 115JC, as the case may be, such excess shall be ignored.
  • Foreign Tax Credit allowed if following documents furnished by assessee.
  1. a statement of income from the country or specified territory outside India offered for tax for the previous year and of foreign tax deducted or paid on such income in Form No.67 and verified in the manner specified therein;
  1. certificate or statement specifying the nature of income and the amount of tax deducted therefrom or paid by the assessee,—
  • From the tax authority of the country or the specified territory outside India; or
  • From the person responsible for deduction of such tax; or
  • Signed by the Assessee.

Providedthat the statement furnished by the assessee in clause (iii) shall be valid if it is accompanied by,—

  • An acknowledgement of online payment or bank counter foil or challan for payment of tax where the payment has been made by the assessee;
  • Proof of deduction where the tax has been deducted.
  • The statement in Form No.67 and the certificate or the statement referred above shall be furnished on or before the due date specified for furnishing the return of income under sub-section (1) of section 139, in the manner specified for furnishing such return of income.

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