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
- Person has to obtain tax deduction certificate from the Payer or any other document from which he can substantiate his claim of taxes paid outside India
- He has to file Form 67 wherein he has to provide the details of Incomes and Taxes paid outside India, under which article of DTAA tax has been paid etc.
- For the Convert of Foreign Tax in to Indian rupee he has to apply TT Buying rate set by SBI as on the Last Date of month immediately preceding the month in which tax is deducted
- Credit will only be allowed for Tax/Surcharge/Cess paid outside India and no credit will be allowed for any Interest or Penalty paid
- Full Credit will be allowed for the taxes paid in the country in a country with which India has a DTAA to extent of Indian Income Tax Liability. For Ex Total tax Lability in India Comes out to Rs. 5 Lac and taxes paid outside India is Rs. 6 lac then maximum credit will be allowed up to Rs. 5 lac Only and balance credit of Rs. 1 lac will be Lapse.
- If India does not have DTAA with the Country in which Income earned and taxes paid then relief will be granted u/s 91 as follows:
Lower of:
- Avg Indian Income Tax Rate
- Rate of Tax Deduction in Foreign
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The entire contents of this document have been prepared based on the relevant provisions and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness and reliability of the information provided, we assume no responsibility therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws. The user of the information agrees that the information is not a professional advice and is subject to change without notice. We assume no responsibility for the consequences of use of such information.
Author Bio
I was seeking clarification on which Income from Foreign Assets need to be offered to tax on ITR-2 and the resultant Tax Credit that should be availed. Appreciate your clarifications.
ITR-2 Instructions state that we need to report Foreign Income based on the relevant accounting period of the foreign country where assets are based i.e. for USA which follows January-December accounting period one should offer Income to Tax based on that accounting period; so for AY2021-22 does an assessee disclose Income earned from USA listed equity share income of dividends & capital gains from April 2020-December 2020 or does the assessee need to offer Income earned from April 2020-March 2021 the Indian financial year.
Also tax credit that should be claimed on ITR-2 would it be USA (January 2020-December 2020) or India (April 2020-March 2021).
Appreciate your views.