1 Background Most of the countries follow a mix of source and residence based concept of taxation i.e. a country seeks to tax the global income of a person who is a resident in that country as well as tax all the income which arises to a person (whether resident or nonresident) in its territory.
This leads to dual taxation of the same income, firstly in the country of source of income and secondly in the country of residence of the person earning income. Countries enter into Double Taxation Avoidance Agreements (‘DTAA ’), inter-alia, to eliminate this double taxation of the same income. Further, the tax which is paid in the source country by the person receiving income is either allowed as a credit by the country of residence while computing the tax payable therein or exempts such income from taxation. Additionally, most countries also provide for unilateral relief under their domestic law, which would aid in eliminating tax cascading where no DTAA exists.
Sections 90 and 90A of the Income-tax Act, 1961 (“the Act” or “ITA ”) provides for relief from double taxation of income in India if there exists a DTAA between India and a foreign country/specified territory. Typically, DTAA s entered into by India provide for availability of credits of foreign taxes with a view to afford relief from double taxation.
Similarly, section 91(1) of the Act provides for unilateral relief in respect of taxes paid on the income arising in a country with which India has not concluded a DTAA . This section provides for a credit on doubly taxed income, at the Indian rate of tax or the rate of tax of the other country, whichever is lower.
However, the Act did not specify any guidelines or rules outlining the manner and mechanism for computing the eligible tax credit as in line with Countries like USA, UK etc., resulting in avoidable litigation on various issues connected with claim for Foreign Tax Credit (FTC). In August 2013, Indian Government constituted Tax Administration Reform Commission (‘TAR C’) headed by Dr. Parthasarathi Shome, where one of the key recommendation by TAR C in its report was that Central Board of Direct Taxes (‘CBDT’) should come out with clear FTC (i.e., credit for the income tax paid by the taxpayer in another Country) guidelines in order to simplify the tax administration in India. This lead to the insertion of section 295(2)(ha) by the Finance Act, 2015 which empowered the CBDT to prescribe rules for granting relief under the Act in respect of foreign taxes paid.
Apart from the above, there are no provisions in the Act or the Rules that deal with the detailed aspects of the availability and claims for foreign tax credits. The First Report of the TAR C had recommended that the CBDT come out with clear guidelines in respect of availing FTC. Accordingly, the CBDT issued the draft FTC rules on 18 April 2016 and comments from stakeholders and general public were invited by 2nd May 2016.
2 Foreign Tax Credit Rules, 2016
After considering the comments received from the public, the CBDT has issued a Notification dated June 27th 2016 which amend the Income tax Rules 1962 to provide for a separate segment on Foreign Tax Credit Rules, 2016 (“Rules”). These rules clarify the nature and conditions for the availability of the FTC to the tax payers and provide guidance to claim FTC in India. The Rule 128(10) specifies reporting of carry backward of losses of the Current Year whereby it results in a refund of Foreign Tax for which credit had been claimed in any earlier previous year or years. The rules also provide guidelines for granting tax credit if and when the tax dispute in the foreign country is settled against the tax payer. The rules also provide that where income on which foreign taxes are paid is reflected in multiple years, the credit for FTC shall be allowed proportionately. The rules also provide for relaxation in documentation requirements and self certification supported by proof of payment of foreign taxes.
2.2 Analysis of the Rule
Salient features of Rule 128 are as follows:
2.2.1 Grant of FTC to residents:
FTC shall be allowed to a resident of India for the amount of any foreign tax paid by him, by way of deduction or otherwise.
2.2.2 Grant of FTC in the year of assessment of income:
i) FTC shall be allowed in the year in which the income (corresponding to the foreign tax paid) is offered to tax or assessed to tax in India.
ii) However, if the income (corresponding to the foreign tax paid) has been offered to tax in India in more than one year, FTC shall be allowed proportionate to the income offered in each of the years.
2.2.3 Meaning of foreign tax:
Foreign tax would mean the taxes covered under the applicable DTAA and, in other cases, the taxes covered under the double tax relief provisions of the ITA . As per Explanation (iv) to section 91 of the ITA (which grants unilateral FTC), income tax includes any excess profits tax or business profits tax charged on the profits.
2.2.4 Indian taxes for providing FTC:
i) FTC would be allowed against the amount of Indian income tax, as well as surcharge and cess payable under the ITA .
ii) No credit shall be allowed against any sum payable by way of interest, fee or penalty.
iii) In a case where minimum alternate tax (MAT ) or alternate minimum tax (AMT) is payable under the ITA , FTC shall be allowed against such MAT /AMT in the same manner as is allowable against normal tax payable under the ITA . However, where the amount of FTC available against MAT / AMT is in excess of FTC credit available against normal tax, MAT /AMT credit would be reduced to the extent of such excess [Refer Rule 128(7)].
2.2.5 Disputed foreign tax:
i) Where the foreign tax paid or any part thereof has been disputed in any manner by the taxpayer, such foreign tax would not qualify for FTC.
ii) However, FTC of such disputed foreign tax shall be allowed for the year in which such income is offered or assessed to tax in India if the taxpayer submits the following details within a period of six months from the end of the month in which the dispute is finally settled:
• Proof of settlement of dispute
• Proof of discharge of liability of such foreign tax
• Undertaking that no refund has been/shall be claimed by the taxpayer, directly or indirectly
2.2.6 Mechanism to compute FTC
i) Currency conversion rate: Foreign tax paid in foreign currency shall be converted into Indian currency by applying “telegraphic transfer buying rate” on the last day of the month immediately preceding the month in which such foreign tax was paid or deducted.
ii) Maximum credit: FTC shall be restricted to the lower of tax payable under the ITA on such income or the foreign tax paid on such income. Further, if the foreign tax paid exceeds the amount of tax payable under the DTAA , such excess shall be ignored.
iii) Source-by-source approach: FTC shall be computed separately for each source of income arising from a particular jurisdiction.
2.2.7 Documents to be furnished to claim FTC:
Mandatory documents to be furnished by a taxpayer to be eligible to claim FTC are as follows:
i) S tatement providing details of the foreign income, offered for tax for the tax year, and foreign tax paid or deducted thereon in prescribed form and
ii) Certificate or statement specifying the nature of income and the amount of tax deducted or paid thereon:
• From the tax authority of the concerned foreign jurisdiction or
• From the person responsible for with holding tax or
• Self-declaration from taxpayer, along with:
a) acknowledgement of online payment or bank counter foil or challan where for eign tax has been paid by the taxpayer
b) proof of deduction where tax been de ducted
Documents as prescribed need to be furnished on or before the due date of filing of return of income in India.
2.2.8 Details to be provided in the prescribed statement in Form No. 67 :
i) Name of the taxpayer
ii) PAN
iii) Address
iv) Assessment Year
v) Details of foreign income and FTC claimed which includes:
• Name of the country
• Source of income
• Foreign income and tax paid outside India
• Tax payable on such income in India
• Credit claimed under DTAA
• Credit claimed under double tax relief provisions of the ITA
vi) Refund of foreign tax claimed, if any, as a result of carry backward of losses providing details of the accounting year to which such loss pertains and the year in which the set off of such loss has been undertaken.
vii) If any foreign tax is in dispute, the nature and the amount of income in respect of which the tax is disputed and the amount of such disputed tax.
2.2.9. Carry backward of losses: Further, prescribed statement should also be furnished in case where there is carry backward of loss resulting in refund of foreign tax for which FTC was claimed in any of the earlier previous year(s) [Refer Rule 128(10)].
3 Open Issues :
Some of the issues which have not been dealt with in the FTC Rules are as under:
3.1 Underlying Tax Credit
The rule is silent on underlying tax credit on dividend income received by the Indian Companies from their overseas subsidiary/ associate company. It is to be noted that India have such beneficial clause in DTAA with USA, UK, Cyprus, Australia, Japan, Mauritius and Singapore subject to conditions. However, the Indian taxpayer may still claim such underlying tax credit based on Section 90(2) of the Act which allows the taxpayer to take benefit of provisions made in the DTAA to the extent such provision is beneficial to the tax payer.
3.2 Tax Sparing
Tax Sparing is a credit mechanism by which resident country allows credit for such taxes which would have been payable by the taxpayer in the source country but for such tax exemptions. In other words, credit for taxes spared by the country of source is given by the country of residence on deemed basis. DTAA s with many countries such as Mauritius, Israel, Bangladesh, Singapore, Spain etc., provides for tax sparing benefit in respect of tax holidays covered under the respective tax treaties. However, the FTC Rules are silent in respect of Tax Sparing Credit.
ecently Delhi ITAT bench in the case of Krishak Bharati Cooperative Ltd. [TS-117-ITAT-2016(DEL)] allowed FTC to the taxpayer (a co-operative society registered in India) under section 90 of the Act read with Article 25(4) of India-Oman DTAA in respect of dividend received from its Joint Venture company in Oman which was specifally tax exempt in Oman.
3.3 Carry Forward of FTC
Countries such as USA, Canada, Singapore, UK, Japan etc., allows carry forward of excess FTC for a limited period. Excess FTC can arise mainly on account of following two reasons:
• Effective tax rate in the foreign country on such income is higher than effective tax rate in the home country; or
• Ratio of high-tax income or the ratio of income earned from a high-tax rate country during a financial year is high.
However, Indian FTC Rules do not contain any provision for carry forward of such excess FTC. In absence of any mechanism to carry forward the FTC, it may lead to litigation between taxpayer and revenue.
3.4 Branch Profit Tax
Many Countries such as USA, Canada, France, Philippines, Indonesia etc., have additional branch profit tax where branches of foreign companies are taxed on profit after tax on repatriation of earning from the branch at the time of closure or termination of such branch in the foreign country. In some of the Countries, branch profit tax is as high as 30%.
As per the Act, any business profit of the branch of Indian Company is taxed under the head business income in the year of accrual, and no further tax is payable on receipt of such income from branch. Hence, in most cases where branch profit tax is paid by the taxpayer in the foreign country upon repatriation. is not eligible for FTC.
4 Concluding Remarks:
In the wake of significantly increased cross border transactions by Indian Companies, the FTC Rules were much awaited in India. The FTC Rules are expected to provide a uniform mechanism to grant FTC in India. It is also the intention of the present Government to provide certainty in taxation and reduce litigation. The FTC Rules aim to provide clear guidance in respect of some of the persisting issues in the computation of FTC Credit viz. Credit qua each source of Income, year of credit, availability of FTC against MAT etc.
The easing of documentation requirements for claiming FTC, allowance of FTC in respect of disputed tax settled subsequently and to some extent taking care of timing mismatches, is welcome and reflects an open-minded approach of the Government.
Though the claim of FTC in respect of disputed tax subsequently settled has been allowed, further clarity is required on the procedural aspects for claiming such credit, especially when the dispute is settled after the expiry of time limit for filing revised return of income under the Act.
The FTC rules as finalized also need to provide further clarity on certain other aspects e.g. calculation of underlying tax credits and tax sparing credits as envisaged by certain Indian DTAA s, eligibility to claim FTC in case of hybrid entities and in cases of mismatch in characterization of income.
Further, the FTC rules fall short of industry expectation that consistent with global practice, the taxpayer may be provided an option to claim credit on an aggregate basis by pooling all overseas tax payments, rather than adopt the source-by-source approach which typically results in increased compliance burden and leads to sub-optimal availability of credit. There are also expectations that the taxpayers are permitted grant of underlying tax credit, an option to carry forward or carry back excess FTC, ability or an option to claim deduction as an expenditure in respect of foreign tax which is not creditable against Indian tax etc.
Further, clarity has been provided on the availability of tax credit for State taxes paid in a foreign jurisdiction. It would also be interesting to see whether the restriction on MAT/AMT credit will come in conflict with the provisions of the Act or application of the relevant Tax Treaty.
The notified Rules require statement in Form 67 to be filed on or before the due date of filing return of income prescribed u/s. 139(1) of the Act, as a condition precedent for claiming FTC. The prima facie implication is that FTC will not be available if Form 67 is filed later at any stage, including with a revised return. This is likely to lead to disputes and litigation. Not only this appears to be unreasonable but also may be ultra vires the Act and the tax treaties which have no such condition envisaged for grant of FTC. The notified Rules will come into effect from April 1, 2017. Given that the notified Rules contain not only the procedure for claiming FTC, but also impacts the amount of credit, they may not apply to years prior to AY 2017-18.
Thus while some aspects have not been dealt with by the notified Rules, some clarity has been achieved and may lead to reduction in disputes and litigation surrounding FTC.
