Allowability of Foreign Tax Credit
If you are a resident Indian and you have earned some income in the foreign country, on which TDS has been deducted, then this article may helpful to you in understanding how can you take credit of the taxes paid outside India.
Let us take an example first, so that we can understand the content more precisely:
Rohit (A resident of India) is a software engineer and he has provided a technical service to a German company and he earned Fee of Rs. 5 Lac out of which payer deducts tax of Rs. 1 and remit Rs. 4 Lac to Rohit. Now, when Rohit will file his Income Tax Return in India, he has to include Rs. 5 lac in his Total Income and Tax will be calculated on whole amount and now he can set off tax paid outside India of Rs. 1 lac against his total Tax Liability in India
Understanding the Basis of Taxation:
There are two principles of charging Tax:
(i) Source Rule: – Country in which source of earing Income exist, such country has a right to tax the Income.
(ii) Residence Rule: Country of which such person is a Tax Resident, such country has a right to tax his global income
Understanding the Tax Treaty
Now there may be situation that an Indian resident has earned some Income in the foreign country and he has paid the taxes thereon in that country, and when that person will file his Income tax return on India, he has to include his foreign incomes too in his Income tax return which results in double taxation of foreign income as he already paid tax on such income in the foreign country.
Now, to overcome from this double taxation, countries agree to enter into an agreement wherein they negotiate that which country has a right to tax which income, so that burden of double taxation can be avoided. Such Agreements called Double Taxation Avoidance Agreements (DTAA) or Tax Treaties.
Relief mechanism under the DTAA
There are two ways of providing relief
(i) Exemption Method: Country of source exempts the charging of taxes and country of residence will charge tax on such foreign income.
(ii) Credit Method: Though the Tax will be charged by the source country but credit will be allowed in the Residence Country
Important Documents/Check Points
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