Rules for Grant of Foreign Tax Credit in India

Rules for Grant of Foreign Tax Credit in India

Central Board of Direct Taxes (CBDT) has, vide Notification no. 54/2016 dated 27th June 2016, notified Rules for grant of Foreign Tax Credit (FTC). The said rules are applicable from Assessment Year 2017-18 onwards. Earlier, the CBDT had released draft FTC rules on 18th April 2016 for public comments and on the basis of comments received, the final rules are notified. The Rules provide clarity on the mechanism of obtaining foreign tax credit in India, of foreign taxes paid. The intended beneficiaries of the Rules are Indian residents that earn foreign sourced income.

The CBDT has now made it easier for Indian-resident taxpayers, including large Indian companies having overseas operations, to claim credit for the taxes borne by them abroad.

Credit of foreign taxes (referred to as foreign tax credit, or FTC) was already allowed under tax treaties with other countries and the Income Tax Act, but the absence of specific rules often led to litigation. Denial of FTC by tax authorities also resulted in double taxation on the same income in the hands of Indian-resident taxpayers. FTC eliminates double taxation on the same income.

To illustrate: A parent company headquartered in India earns interest on debt given to its foreign subsidiary and is subject to a 10% withholding tax. The Indian company will pay tax in India on its global income (including the foreign source interest income). The new rules will make it easier for it to claim an FTC for the 10% tax withheld in foreign subsidiary.

Applicability

These rules are applicable for a Resident taxpayer and the rules provides that a resident taxpayer can claim a credit for foreign taxes paid in

(a) a treaty jurisdiction i.e. a country/ specified territory with which India has a double taxation avoidance agreement or an exchange of information agreement, and

(b) in any other country where income tax includes excess profits tax or business profits tax charged by the central or local authority in that country

To claim a credit, two requirements envisaged are

1. the foreign tax must have been paid, and
2. credit may be claimed for the year in which the corresponding income is offered to tax in India

FTC in respect of financial year mismatch

The rules provide that FTC shall be allowed, in respect of the amount of any foreign tax paid outside India, by way of deduction or otherwise in the year in which the income corresponding to such tax has been offered/ assessed to tax in India.

Where income on which foreign tax has been paid or deducted, is offered to tax in more than one year, credit of foreign tax shall be allowed across those years in the same proportion in which the income is offered to tax or assessed to tax in India.

for eg. In the US, taxes could be paid on a calendar year basis (Jan- Dec), as opposed to India where taxes are paid on a financial year basis (Apr – March). In such cases, the Rules provide that where income is taxable across two years, credit shall be proportionately distributed across those years based on when income is offered to tax in India.

Foreign Taxes Covered

The rules provide that foreign tax credit shall be available in respect of following foreign taxes:

• In respect of a country with which India has a Double Taxation Avoidance Agreement, the tax covered under such agreement, and
• In respect of other countries, the tax payable as per the laws of that country in the nature of income tax.

Clause (iv) of Explanation to Section 91 of the Act provides that 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.

Thus as mentioned above, FTC would not be available for taxes not covered by the relevant tax treaty, such as state taxes paid in the US or branch profits' taxes paid overseas. Besides, the tax credit would be restricted to the rate of tax payable under the tax treaty, even if the actual tax paid as well as the Indian tax payable is higher. So, if excess taxes have been withheld by the foreign payer out of abundant precaution, or on account of their local laws, tax credit would be available only for tax payable under the treaty terms. For example, the US levies a higher rate of withholding of 30% if a foreign entity (say, an Indian company) does not have a tax identification number. In such cases, credit in India would be available only to the extent of applicable rate prescribed under the tax treaty.

Indian Taxes Covered

The rule clarifies that FTC shall be available against tax, surcharge and education cess.

Also, FTC shall not be available in respect of any interest, fee or penalty.

This is in line with judicial precedents in the context of tax treaties, which have held tax relief to be available in respect of surcharge and education cess, in addition to regular income taxes on the basis that these taxes are “substantially similar” to income taxes. This reduces the ambiguity amongst taxpayers on the eligible taxes, and should reduce long drawn litigation on this subject.

Credit in respect of Disputed Taxes

The Rules provide that no credit shall be available for any amount of foreign tax which is disputed in any manner by the taxpayer. Therefore, a tax credit is not applicable in a situation where foreign tax was paid by the taxpayer on demand during scrutiny by the foreign tax authorities, but such taxes have been disputed by the taxpayer, under appeal proceedings.

However, in respect of disputed foreign tax, FTC shall be allowed if the assessee within six months from the end of the month in which the dispute is finally settled furnishes the following:

• Evidence of settlement of dispute; and
• Evidence to the effect that the liability for payment of such foreign tax has been discharged by him; and
• An undertaking that no refund in respect of such amount has directly or indirectly been claimed or shall be claimed.

The move to provide credit for 'disputed foreign taxes' upon final settlement of dispute is a welcome relief. However, the procedure for allowing such credit, especially when the assessments are time-barred needs to be prescribed.

Also, depending on the tax administrative efficiency of the concerned foreign jurisdiction, it may take several years for the final dispute to be resolved. This time gap may lead to an undesirable situation where taxes have been doubly paid in India and a foreign jurisdiction for a long duration for a transaction which was, in the first place not taxable.

1. Computation of Foreign Tax Credit
2. FTC shall be aggregate of the amounts of credit computed separately for each source of income arising from a particular country or specified territory.
3. FTC shall be lower of tax payable under the Act on such income and foreign tax paid on such income. Where the foreign tax paid on doubly taxed income exceeds the tax payable on such income as per DTAA, then such excess shall be ignored while computing the foreign tax credit.
4. FTC shall be determined by converting the foreign currency at the Telegraphic Transfer (TT) Buying rate as on the date of payment/ deduction of such foreign tax.

Certain jurisdictions such as Singapore follow a credit pooling system where tax credits are not divided into various heads. This mechanism enables businesses to effectively utilize tax credits and avoid double taxation due to characterization issues. However, the Indian system seems to follow the more traditional form of credit – segregated on the basis of income sources.

Foreign tax Credit against MAT

The Rules further provide that

• FTC shall also be allowed against the tax payable under MAT (section 115JB or 115JC of the Act) in the same manner as is allowable against the tax payable under the normal provisions of the Act.
• Where FTC available against tax payable under section 115JB or 115JC of the Act, is in excess of the FTC available against the tax payable under the normal provisions, then such excess shall be ignored while computing the amount of MAT credit available under section 115JAA or 115JC of the Act.

However, the Rules are unclear on how the computation mechanism would work in such a case, as there may be a mismatch in the source of income tax - between MAT and taxes paid in the foreign country.

How to Claim Foreign Tax Credit-Documents Required

Taxpayers will have to furnish the following documentary evidence for availing the credit:

• Certificate from the concerned tax authority of the foreign country specifying the nature of income and amount of tax deducted/ paid by the taxpayer. In case of foreign tax deduction, certificate of tax deducted may be furnished,
• Acknowledgement/ challan/ slip/ bank counterfoil in respect of tax paid by the taxpayer, and
• A declaration that the amount of foreign tax, in respect of which credit is being claimed, is not in dispute.
• Form No. 67 will be required to be filed for claiming FTC.
• Form No. 67 shall also be furnished in a case where the carry backward of loss of the current year results in refund of foreign tax for which credit has been claimed in any previous year or years.

The required documents shall be filed on or before the due date of filing the return of income.

Conclusion

The Rules are a welcome relief to global Indian businesses earning significant income abroad specifically the clarity on timing mismatches across jurisdictions, foreign exchange fluctuation, disputed foreign income and ease in documentation requirements. Also, clarity on grant of FTC against the MAT liability is a big positive.

However, there are several points that still need to be addressed – such as ability to claim underlying tax credit for dividend distribution taxes, buyback taxes and tax sparing which are unique to the Indian tax system.

The author can also be reached at ca.guptarohit@gmail.com