How to claim Foreign Tax Credit?

Important Keyword: DTAA, Foreign tax credit, Income Tax, Income Tax for NRI.

How to claim Foreign Tax Credit?

If you’re a resident of India, income earned worldwide is subject to taxation in India. This scenario could lead to double taxation of the same income. Double Taxation Avoidance Agreements (DTAA) aim to prevent this by ensuring that taxpayers are not taxed twice for income earned outside their country of residence.

Income may be taxed at its source, i.e., where it originated, and also in the taxpayer’s country of residence. DTAA ensures that taxpayers are not unfairly affected by this arrangement. It enables taxpayers to claim Foreign Tax Credit for taxes paid outside India, thereby alleviating the burden of double taxation. This mechanism ensures that income is taxed fairly, regardless of its source or location, promoting international tax equity and facilitating cross-border transactions.

What is Foreign Tax Credit?

When you’ve paid taxes in one country and seek to claim credit for the tax paid in your country of residence, provided both countries have a Double Taxation Avoidance Agreement (DTAA), there are two rules governing this:

1. Source Rule: This principle dictates that income should be taxed in the country where it originates, regardless of whether the recipient is a resident or non-resident.
2. Residence Rule: This principle stipulates that the authority to tax income should primarily belong to the country where the taxpayer resides.

If both rules apply simultaneously to a taxpayer, it could result in double taxation. Double taxation occurs when the same income is taxed twice in the hands of the taxpayer.

Section 90 of the Income Tax Act addresses situations where India has entered into a DTAA with another country. It provides mechanisms to mitigate the impact of double taxation by allowing taxpayers to claim relief or credit for taxes paid in the foreign country.

On the other hand, Section 91 deals with scenarios where India has not signed any DTAA with another country. In such cases, unilateral relief measures are applied to prevent double taxation and ensure fair taxation of income.

Rule 128 of Income Tax Rules

The introduction of Rule 128 and Form 67 has significantly clarified the process of claiming Foreign Tax Credit (FTC) in India. Effective from April 1, 2017, Rule 128 of the Income Tax Rules governs the eligibility and conditions for claiming FTC. Here’s an overview of the key provisions:

1. Eligibility: Only a resident assessee can claim FTC if they have paid tax in a country or specified territory outside India.
2. Timing of Credit: FTC can be claimed in the year in which the corresponding income is offered or assessed to tax in India.
3. Proportionate Credit: Credit is allowed proportionate to the income offered to tax in that year.
4. Exclusions: FTC is not allowed for sums payable as interest or penalty.
5. DTAA Consideration: If a Double Tax Avoidance Agreement (DTAA) is in place between India and the foreign country, eligible foreign tax refers to the taxes covered by the respective DTAA.
6. Disputed Tax: No credit is available for disputed foreign tax. However, if the dispute is settled within six months from the end of the relevant month, and evidence of settlement and tax payment is provided, credit may be allowed.
7. Source-wise Credit: The credit of foreign tax is computed separately for each source of income from a particular country.
8. Limitation: The credit allowable is capped at the lower of the tax payable under Indian law on such income and the foreign tax paid on such income.

These provisions ensure clarity and fairness in the computation and claiming of Foreign Tax Credit in India, minimizing the possibility of double taxation and providing relief to taxpayers with income sourced abroad.

Documents required to claim Foreign Tax Credit

To claim Foreign Tax Credit (FTC), the assessee must provide certain documents, which should be furnished on or before the due date of the income tax return under section 139(1) of the Income Tax Act. These documents include:

1. Certificate or statement specifying the nature of income and the amount of tax deducted or paid. This statement can be obtained from:
   • The tax authority of the foreign country.
   • The person responsible for deducting the tax.
   • Alternatively, the assessee can provide a statement signed by themselves.
   The statement furnished directly by the assessee should be accompanied by:
   • An acknowledgment of online payment or bank counterfoil, or challan for payment of tax if the payment was made by the assessee.
   • Proof of deduction if tax has been deducted.
2. Form 67 should be filed on the Income Tax Portal. This form is also required in cases where the carry backward of loss in the current year results in a refund of foreign tax for which credit has been claimed in any earlier previous year or years.

By furnishing these documents and completing the necessary formalities, the assessee can successfully claim Foreign Tax Credit, ensuring that they do not suffer double taxation on their income earned abroad.

How to claim Tax Credit on Foreign Income?

If you’re a resident, any income earned worldwide must be included in your total income. Here’s how to go about it:

1. Convert Foreign Income: Convert income earned outside India into Indian currency using the State Bank of India’s Telegraphic Transfer Buying Rate (TTBR) of the last day of the month before the month in which the income is due.
2. Include Income Under Respective Head: Include this converted income under the relevant income head, such as salary income under the head ‘salaries’.
3. Taxation: Treat this income like any other local income. The basic exemption limit of INR 2,50,000 is applicable to your total income, and the remaining income is taxable as per the income tax slab rates.
4. Claim TDS Credit: If Tax Deducted at Source (TDS) has been deducted from your income, you’re allowed to claim credit for such taxes. Reference the relevant Double Tax Avoidance Agreement (DTAA) for the country where the income was earned to ensure correct application.
5. Obtain TRC Certificate: Obtain a Tax Residency Certificate (TRC) to certify your tax residency status and ensure the correct DTAA is applied.
6. Reporting Foreign Income: Report foreign income and assets in the Income Tax Return. Include details of foreign income in Schedule FSI of the ITR.
7. Details Required: Enter the following details for foreign income in Schedule FSI:
   • Country Code
   • Taxpayer Identification Number
   • Income outside India
   • Taxes paid outside India
   • Tax payable in India
   • Tax Relief available
   • Relevant DTAA Article
8. Tax Relief Calculation: Once foreign income details are added, the tax relief details in Schedule TR (Tax Relief) are populated. Double taxation relief is then deducted from the tax calculation.

By following these steps and accurately reporting foreign income, residents in India can ensure compliance with tax laws and claim any eligible relief under DTAA to avoid double taxation.

Read More: Relief under section 90, 90A and 91

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Official Income Tax Return filing website: https://incometaxindia.gov.in/