Introduction
In an increasingly globalized world, individuals and businesses engage in cross-border transactions, leading to tax obligations in multiple jurisdictions. India, like many other countries, has provisions to avoid double taxation on income earned abroad. One such provision is the Foreign Tax Credit (FTC) mechanism, which allows taxpayers to offset taxes paid in foreign jurisdictions against their Indian tax liability.
The concept of FTC is a significant aspect of international taxation, particularly for individuals and businesses engaged in cross-border transactions. In India, the foreign tax credit mechanism allows taxpayers to claim a credit against their Indian tax liability for the taxes paid in a foreign country on the same income that is also subject to tax in India. The idea behind FTC is to prevent double taxation on the same income, ensuring that taxpayers are not taxed twice on the same earnings, once in the foreign country where the income is earned and again in India.
What is FTC?
FTC is a mechanism that prevents double taxation on the same income in both the taxpayer’s home country and the foreign country where the income was earned. In the Indian context, it allows taxpayers to claim a credit for taxes paid abroad against their Indian tax liability.
Suppose Mr. Ramana is an Indian resident but earns interest income in the United States. The source state, i.e., The US will withhold a percentage of the amount as tax. In addition, Mr. Ramana will also have to pay taxes on his U.S. Income in India. This will result in double taxation on the same income. FTC is a facility that helps people like Mr. Ramana avoid paying double tax on the same income.
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Importance of Foreign Tax Credit in India
Prevents Double Taxation: One of the primary reasons for introducing the foreign tax credit mechanism in India is to prevent double taxation of the same income. Without FTC, taxpayers earning income abroad would be subject to tax in both the foreign country and in India, leading to double taxation and reducing the incentive for cross-border trade and investment.
Promotes International Trade and Investment: By providing relief from double taxation, foreign tax credit encourages cross-border trade and investment by making it more attractive for Indian taxpayers to conduct business overseas. This promotes economic growth, fosters international business relationships, and enhances India’s position in the global economy.
Avoids Tax Evasion and Tax Avoidance: The availability of foreign tax credit in India helps in combating tax evasion and tax avoidance practices by ensuring that taxpayers accurately report their foreign income and pay the appropriate taxes, thereby contributing to the overall integrity of the tax system.
Encourages Compliance and Transparency: Foreign tax credit requires taxpayers to maintain proper documentation and comply with relevant tax laws and regulations, promoting transparency and accountability in tax reporting and compliance.
The concept of FTC in India
As per the tax laws of India, sections 90 and 91 of the Income Tax Act, 1961 deals with the concept of FTC. Section 90 discusses claiming of FTC in a case where India has entered into a Double Taxation Avoidance Agreement (DTAA) with another country and such DTAA provides for claiming of such FTC while Section 91 deals with claiming of FTC in scenarios where India has not entered into a DTAA with the country where the income arises for a taxpayer. Under these sections, if the taxpayer is a resident of India, and he has paid taxes outside India, he can claim a credit of such foreign taxes paid against his tax payable in India.
Rules for claiming FTC have been notified under Rule 128 w.e.f 1.4.2017 which have helped clear out ambiguity around claiming of FTC, some of which have been briefly captured here under.
- Only residents of India can claim FTC for taxes paid in foreign countries or specified territories.
- FTC can only be claimed in the year when the foreign income is taxed in India.
- FTC is limited to the proportion of income on which tax is paid or levied abroad.
- FTC cannot be claimed on interest, fees, or penalties paid abroad.
- If a Double Tax Avoidance Agreement (DTAA) exists between countries, only taxes covered by the agreement are eligible for FTC.
- Disputed income amounts are not eligible for FTC unless resolved within six months with evidence of dispute settlement and no outstanding tax liabilities.
- FTC is calculated separately for each source of income from each country.
- The lower of the resident country’s tax payable and foreign tax paid is allowed as FTC.
- FTC is available for income tax on foreign income under section 115JB (minimum alternate tax).
- FTC amount is determined by converting the foreign tax payment currency at the telegraphic transfer buying rate on the last day of the preceding month.
Steps to Claim Foreign Tax Credit for Indian Residents with Foreign Income:
- Convert Foreign Income to INR: Convert foreign income into Indian Rupees using the Telegraphic Transfer Buying Rate (TTBR) on the last day of the preceding month.
- Classify Income: Classify foreign income into relevant categories such as salaries, interest, dividends, etc., and ensure it does not exceed the basic exemption limit of INR 2,50,000.
- Claim TDS Credit: Refer to the DTAA with the source country and claim credit for any Tax Deducted at Source (TDS) in the foreign country.
- Obtain TRC Certificate: Obtain a TRC to establish tax residency status and ensure eligibility for DTAA benefits.
- Fill Schedule FSI: Enter details of foreign income in Schedule FSI of the Income Tax Return (ITR), including country code, taxpayer identification number, income amount, tax paid in the source country, and tax payable in India.
- Calculate Tax Relief: Calculate foreign tax relief as the lower of tax paid in the foreign country or tax payable in India, per applicable tax rates.
- Provide DTAA Details: Specify the relevant article of the DTAA applicable to the foreign income.
By following these steps, Indian residents with foreign income can effectively claim a Foreign Tax Credit and avoid double taxation.
Case Law on Foreign Tax Credit (FTC)
Facts
In the case involving M/s Krishak Bharti Cooperative Limited, an Indian cooperative society engaged in fertilizer manufacturing, the company formed a Joint Venture (JV) with Oman Oil Company to establish Oman Fertilizer Company SAOC (‘OMIFCO’ or ‘JV entity’) in Oman, duly registered under Omani laws.
During the assessment proceedings, the Assessing Officer taxed the dividend income received by the Assessee from the JV entity under the provisions of the Income Tax Act, 1961. However, the Assessee claimed a tax credit for the tax payable in Oman on such dividend income, relying on Article 25(4) of the Indian-Oman DTAA. Importantly, no tax was actually paid by the Assessee in Oman due to an exemption under Article 28(bis) of the Oman Tax Laws, as clarified by a letter dated December 11, 2000.
Subsequently, the Principal Commissioner of Income Tax (PCIT) issued an order under Section 263 of the Act, denying the FTC on the grounds that the Assessee wasn’t covered under the exemption, and since tax was theoretically payable on the dividend income in Oman, Article 25 of the DTAA wasn’t applicable.
In response, the Assessee challenged the PCIT’s order before the Income-tax Appellate Tribunal (ITAT), which ruled in favor of the Assessee, finding the PCIT’s order jurisdictionally flawed and legally untenable. This decision was upheld by the Hon’ble Delhi High Court, affirming the Assessee’s right to claim the tax credit as per the provisions of the India-Oman DTAA.
The matter was subsequently brought before the Hon’ble Supreme Court, which, in its order dated September 15, 2023, upheld the decision of the Hon’ble Delhi High Court.
Judgement
In its deliberation, the Hon’ble Supreme Court meticulously analyzed the relevant clauses of the DTAA, notably scrutinizing Article 7 (Business Profits), Article 11 (Dividends), and Article 25 (Avoidance of Double Taxation). Additionally, the Court took into consideration the provisions outlined in Article 8(bis) of the Omani Tax Laws.
The Supreme Court observed that as per Article 25(2) of the DTAA, India is mandated to allow a deduction equivalent to the income tax paid by the Assessee in Oman, whether directly or by deduction. Moreover, Article 25(4) of the DTAA explicitly clarifies that the tax payable should encompass the tax that would have been due if not for the tax incentives provided under the tax laws to promote development.
The Apex Court affirmed that the term ‘incentive’ lacks definition under both the Indian Income Tax Act and the Omani tax laws. In this context, the Court reviewed the Clarification/Exemption letter issued by the Secretary General of Taxation to Oman Oil Company SAOC.
Accordingly, since dividends distributed by all companies (including tax-exempt entities) would be exempt from income tax in the hands of recipients, the dividend earned by the Assessee from the JV entity would similarly be exempt under Article 8(bis), receiving equivalent tax treatment in India as in Oman under Article 25 of the DTAA. This is particularly pertinent given that the Assessee’s investment in the project through the establishment of a Permanent Establishment (PE) in Oman contributes to economic development within Oman.
The Supreme Court examined whether the dividend income earned by the Assessee, though exempted under Omani tax laws, was taxable, ultimately concluding that the Assessee was entitled to the benefits of the India-Oman DTAA.
Conclusion: Foreign Tax Credit serves as a vital tool for taxpayers engaged in cross-border transactions, ensuring they are not taxed twice on the same income. By adhering to the prescribed rules and procedures, individuals and businesses can effectively claim FTC, fostering international trade, encouraging compliance, and promoting economic growth. The insightful case law discussed underscores the significance of FTC in providing relief from double taxation and upholding the principles of fairness and equity in international taxation.
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