Foreign Tax Credit Rules – a welcome effort | CA Prakash Hegde and CA Raghavendra N.
Foreign Tax Credit Rules – a welcome effort
by CA Prakash Hegde and CA Raghavendra N.
Double Taxation Avoidance Agreements (‘DTAA’s) try to resolve the conflict of double taxation by stipulating the right of each of the parties (countries) to the DTAA to tax a particular source of income of a tax payer in most of the circumstances. Still, unintended double taxation can arise due to principles of residence based and source based taxation in different jurisdictions. In such circumstances, the need for obtaining foreign tax credit (‘FTC’) i.e. availing credit for taxes paid on the same income in foreign countries against taxes payable in the country of residence, arises. Usually, DTAAs themselves contain provisions for obtaining FTC by a resident tax payer.
In circumstances where a tax payer is subjected to taxation both in India and another country with which India does not have a DTAA, section 91 of the Income Tax Act, 1961 (‘Act’) comes to the relief of the tax payer as it allows such tax payer to claim FTC in India subject to certain conditions.
As the Act or the Income Tax Rules, 1962 (‘Rules’) did not contain detailed provisions relating to claim of FTC, many disputes arose between the tax payers and the income tax authorities with regard to the computation methods, amounts etc. The Tax Administrative Reforms Commission headed by Dr. Parthasarthy Shome had discussed the issues faced by resident taxpayers in availing FTC and recommended an action to ease the process. Keeping this in mind, to minimize disputes and to streamline the process, the Finance Minister, in his budget speech in 2015 had mentioned that the Central Board of Direct Taxes would be empowered to prescribe rules for grant of FTC. Accordingly, a new Rule 128 to the Rules, providing the rules / conditions for grant of FTC has been inserted with effect from 01 April 2017. These rules are the result of another effort by the government to simplify and reduce tax litigations.
Let us see the important provisions contained in this newly inserted Rule 128.
Year of availability: Sub-rule 1 provides that a resident assessee will be eligible to claim FTC where any tax has been paid by him in a country or specified territory outside India. Such FTC shall be allowed only in the year in which the income corresponding to such tax has been offered to tax or assessed to tax in India. The sub-rule also states that where income on which foreign tax has been paid or deducted, is offered to tax in more than one year, FTC shall be allowed across those years in the same proportion in which the income is offered to tax or assessed to tax in India.
Meaning of eligible foreign tax: Sub-rule 2 provides that where a DTAA has been entered in to between India and the foreign country, eligible foreign tax shall be the taxes covered under the respective DTAA. However, where no DTAA has been entered in to between India and the foreign country, eligible foreign tax shall mean the tax payable under the law in force in that country in the nature of income tax referred to in clause (iv) of the Explanation to section 91 of the Act.
Amount against which FTC is available: Sub-rule 3 provides that an assessee would be allowed to claim FTC against the amount of tax, surcharge and cess payable by such assessee in India under the Act. It further clarifies that claim of FTC will not be allowed in respect of interest, fee or penalty.
Sub-rule 6 provides that the credit of foreign tax shall be allowed against Minimum Alternate Tax (‘MAT’) / Alternate Minimum Tax (‘AMT’) in the same manner as is allowable against tax payable under the normal provisions of the Act. However, sub-rule 7 provides that where the amount of FTC available against the tax payable under the provisions of section 115JB or 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, such excess shall be ignored.
FTC for disputed tax: Sub-rule 4 provides that credit shall not be available in respect of any amount of foreign tax or part thereof which is disputed in any manner by the assessee. Credit for such disputed tax shall be allowed in 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 the evidences of the settlement of dispute, discharge of such disputed foreign tax and an undertaking that no refund in respect of such amount has directly or indirectly been claimed or shall be claimed.
Mode of computation: Sub-rule 5 provides that FTC shall be the aggregate of the amounts of credit computed separately for each source of income arising from each country. Further, the credit allowable shall be the lower of the tax payable under the Act on such income and the foreign tax paid on such income. Proviso to clause (i) of sub-rule 5 clarifies that where foreign tax paid exceeds tax payable in accordance with DTAA, such excess shall be ignored.
Accordingly, a separate calculation is to be made for each and every stream of income arising from each and every foreign country. The aggregate of such different FTC amounts shall be the total amount of FTC allowable from the tax payable in India.
Documents required to claim FTC: Under sub-rule 8, for claiming FTC, an assessee has to furnish the following documents: –
- a statement in Form No. 67
- 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 foreign country; or
- from the person, responsible for deduction of such tax; or
- a statement signed by the assessee if it is accompanied by:
- an acknowledgment 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.
Such documents shall be furnished on or before the due date return of income under section 139(1) of the Act.
Form No. 67 shall also be furnished in a case where the carry forward of loss of the current year results in refund of foreign tax for which credit has been claimed in any earlier previous year or years.
As provided in sub-rule 1 of Rule 128, FTC shall be allowed by a resident of India if the foreign tax has been ‘paid’ in a foreign country (or specified territory) and the corresponding income is ‘offered to tax’ or ‘assessed to tax’ in India.
In a recent landmark decision in the case of Wipro Ltd. v. Dy. CIT [2015] 62 taxmann.com 26 (which was rendered before the introduction of Rule 128) the Karnataka High Court (‘HC’) had held that FTC for federal tax paid in USA should be allowed under the Double Taxation Avoidance Agreement (‘DTAA’) between India and USA even if that income is exempt in India under section 10A of the Income Tax Act, 1961 (‘the Act’). The logic behind the decision of the HC was that the income derived by a unit eligible to claim exemption under section 10A of the Income Tax Act, 1961 (‘the Act’) is chargeable to tax under section 4 of the Act and therefore, covered under the scope of total income prescribed in section 5 of the Act. But no tax is charged because of the exemption granted under section 10A of the Act for a limited period of 10 years. Merely because the exemption has been granted, it cannot be considered that the assessee is not liable to tax as the said exemption granted had the effect of suspending the collection of tax only for a period of 10 years and therefore, the assessee’s case is falling under section 90(1)(a)(ii) of the Act. India-USA DTAA does not speak about any tax being paid in India as a condition precedent for claiming the FTC.
It may be noted that the terms ‘offered to tax’ or ‘assessed to tax’ in sub-rule 1 of Rule 128 are subject to interpretations, which may open up another set of litigation on this matter.
The other important aspect to be noted in this context is that different countries follow different periods as their tax years. For e.g. US, Canada and many European countries follow calendar year (i.e. from January to December) as their tax year whereas Australia follows July to June as its tax year. Therefore, income offered to tax in such countries in their tax year may have to be distributed over two tax years in India. To address such a situation, the sub-rule provides that FTC shall be allowed in proportion to the income offered to tax in India in a particular year.
It should also be noted that the year in which a particular income is taxed in India and in a foreign country could be different as the trigger for taxation of the same could be different under the tax laws of different countries. However, sub-rule 1 makes it abundantly clear that the year in which FTC is available in India for the taxes paid in the foreign country is the year in which the corresponding income is offered to tax or assessed to tax in India. But a catch lies here as the term used in the sub-rule is ‘foreign tax paid’. In many countries, the tax payer has to file his tax return computing the tax liability. However, the actual tax payment has to be made only after the tax authorities complete the assessment. Therefore, there could be a time gap between filing of the tax return and the payment of taxes. Under the provisions of this sub-rule, FTC is allowed only for the foreign tax paid!
Sub-rule 2 specifies the meaning of ‘foreign tax’ paid in a foreign country against which FTC would be available in India. It states that where India has entered into a DTAA with that country, foreign tax shall be the taxes covered under that DTAA. Where no DTAA has been entered in to, foreign tax shall mean tax payable under the law in force in that country on the profits (referred to in clause (iv) of the Explanation to section 91).
In this context too, it would be relevant to refer to the decision of the Karnataka High Court (‘HC’) in Wipro Ltd. v. Dy.CIT supra in which the HC has ruled that even though state taxes are not covered in the DTAAs which India has entered into between USA / Canada, the assesse is eligible to claim FTC for State taxes paid in USA / Canada in accordance with section 91 of the Income Tax Act.
Sub-rule 3 has clarified that FTC is not available against amount of interest, fee or penalty. This may reduce ambiguity amongst Indian taxpayers and could reduce litigation.
Sub-rule 5 states that FTC shall be computed separately for each source of income arising from each country. This approach will complicate the FTC computation where the foreign taxes are computed after allowing certain lump sum deduction (not specifically related to a source of income) under foreign tax laws. In such a situation, one has to pro-rate the deduction to each source of income to arrive at the foreign taxes on such income.
Though sub-rule 6 provides that FTC can also be claimed in respect of taxes in the nature of MAT / AMT, there is absence of further clarity since there could be mismatch in the base on which income tax is payable under MAT / AMT and taxes paid in the foreign country. If FTC available is higher than the MAT / AMT credit, the lower amount shall be considered.
Few situations not addressed in the new Rule
There may be a situation where the foreign tax authorities may enhance the amount of tax payable by an assessee in their country. As a result, the assessee may have to pay the enhanced amount of tax subsequent to the last date for filing a revised return in India for the year in which he has offered that income to tax. In such a situation, though legitimately he is entitled for a higher amount of FTC, he may not be able to claim the same as the newly inserted Rule has not addressed this situation.
There are many residents of India who are employees of Indian employers and are eligible for FTC for the taxes paid in a foreign country on their salary. If such FTC is considered by their Indian employers at the time of deduction of tax on their salary (under section 192), it would have been convenient as otherwise, these employees have to claim the FTC in their return and wait until they receive the refund from the income tax authorities. This leads to cash-flow issues for such employees. However, the newly inserted Rule has not addressed this situation as well.
One of the aspects which the Rules lack to address is the claim of FTC on the enhanced tax liability of the tax payer by the Assessing Officer during the assessment proceedings. Where an Assessing Officer, based on the assessment proceedings, makes any addition to the tax payer’s income resulting in an increase in tax liability, the question would arise if the FTC claimed by the tax payer in his tax return would also be enhanced, in light of increase in tax liability. This issue has not been addressed in the Rules.
Many countries including USA allow the assessees to carry forward the unutilized foreign tax paid to be set off appropriately in the future. Without this, the assessee’s will permanently lose the unutilised foreign tax paid. But the newly introduced Rule has not allowed such carry forward.
Conclusion
Despite few shortcomings in the newly inserted FTC provisions as noted above, it may be viewed that these provisions have addressed some of the very important aspects of FTC and have brought clarity which can help reduce litigation.