Do you know, there are two principles to tax income. One is Residence Based Taxation and other is Source Based Taxation.
As per Residence based Taxation, the country taxes persons based on their “residential status”.
Source Based Taxation gives importance to the source (country) from where income is generated. There may be individuals/entities whose “residence” is in one country but their business is actually carried on in another country and their income is earned in the latter country.
Every country has its own taxation rules. Some countries follow Resident based taxation, some follow Source based taxation and some follow both.
Can you think, it can create problems for taxpayer?
Suppose Mr. A is a resident of India. He has total income of Rs. 10,00,000 from India. He has given some services to a company based in USA, from which he receives professional income of Rs. 2,00,000. The USA Company, has made payment after deducting tax at source in, accordance with USA tax laws, let’s say Rs. 20,000.
Mr A, being resident in India, will have to offer his global income, i.e. income earned anywhere in the world to tax in India. Accordingly, his taxable income in India would be Rs. 12,00,000 (10,00,000+2,00,000). Considering, 30% slab rate, Mr. A’s tax liability would be Rs. 3,60,000. Would Mr. A be required to pay tax of Rs. 60,000 on Rs. 2,00,000 as per Indian Law, for which he has already paid tax of Rs. 20,000, or can he claim credit of such tax paid ?
When an income, which is taxed in its Source country, i.e. the country from where such income originates and such income is offered for tax again by the recipient of such income, in his country of residence, there is Double Taxation.
To prevent Double Taxation, different countries enter into Double Taxation Avoidance Agreements (“DTAA”) with each other. India has also entered into DTAAs with various countries around the world.
Where India has entered into DTAA with a country, relief is granted as per the relevant DTAA, in accordance with Section 90 of the Income Tax Act, 1961 (“ITA”) and where no such agreement has been entered relief is granted as per Section 91 of ITA.
Under various DTAAs, different methods of providing credit have been prescribed which are as under:-
a. Exemption Method: In this method right of taxation is given to either Source State or to the Resident State. So, only one country can tax a person.
b. Credit Method: In this method credit is allowed for the tax paid by a taxpayer in the Source State by way of reduction from the tax payable in the Resident State. DTAA between India and USA provides Credit Method.
|Income in India||1,50,000|
|Income in foreign country, i.e. USA||1,00,000|
|Tax Rate in India||30%|
|Tax in foreign Country||25%|
|Total Tax in India||75,000|
|Credit Method – Relief of Tax paid in Foreign Country (25% of 1,00,000)||(25,000)|
|Net Tax Liability in India||50,000|
c. Deduction Method: In this method, the tax paid in the Source State is allowed as an deduction, similar to expenses incurred, in the Resident State.
Section 91 of ITA also provides for Credit Method.
Credit Method is majorly divided into Full Credit Method and Ordinary Credit Method.
Under Full Credit Method, credit of the entire amount of tax paid outside India is available.
However, in Ordinary Credit Method, credit is available only to the extent to which tax is collected on such income in the Resident Country.
Ordinary Credit can be understood with the following example:-
|Income in India||1,50,000|
|Income in Foreign Country||1,00,000|
|Tax Rate in India||30%|
|Tax in Foreign Country||35%|
|Indian Tax on global Income||(A)||75,000|
|Indian Tax on Foreign Income||(B)||30,000|
|Foreign tax on Foreign Income||(C)||35,000|
|Relief as per Ordinary credit Method – lower of (B) and (C)||(D)||30,000|
|Tax Payable in India (A) – (D)||(E)||45,000|
Section 91 also follows ordinary credit method.
Apart from this, attention is also drawn towards Rule 128, of the Income Tax Rules 1962 in relation to Foreign Tax Credit (“FTC”).
As per Rule 128, FTC shall be allowed subject to following conditions:-
(a) a statement of income from the country or specified territory outsides India offered for tax for the previous year and of foreign tax deducted or paid on such income in Form No.67 and verified in the manner specified therein;
(b) certificate or statement specifying the nature of income and the amount of tax deducted therefrom or paid by the assessee,—
a. from the tax authority of the country or the specified territory outside India; or
b. from the person responsible for deduction of such tax; or
c. signed by the assessee:
Provided that the statement furnished by the assessee in clause (c) shall be valid if it is accompanied by,—
(A) an acknowledgement of online payment or bank counter foil or challan for payment of tax where the payment has been made by the assessee;
(B) Proof of deduction where the tax has been deducted.”
There is no double taxation on the same income, as a result of the DTAA which India has entered with various countries and also in accordance with Section 91 of the ITA. However, one has to take into account the method under which credit of tax paid, outside India, would be available while paying taxes in India. Also, the tax payer needs to comply with the requirements as prescribed under Rule 128 of the Income Tax Rules.