Analysis of draft rules for grant of Foreign Tax Credit

[CA Paras Dawar]

Computation of Foreign Tax Credit (‘FTC’) in case of assessee’s with cross border tax payments has been a major hassle for tax professionals. Absence of well-defined set of rules, coupled with few judicial precedents had resulted in diversified practices. The proposed draft rules regarding grant of relief under section 90/90A/91 of the Income Tax Act, 1961 (‘Act’) will help provide much needed clarity in an area which was until now marked by diverse interpretations. This will help reduce the hassle in claiming credit on tax paid in other countries and help achieve the Government’s vision for non-adversarial tax regime.

1.    Eligibility to claim FTC

A resident assessee will be eligible to claim FTC if any tax has been paid by him in a country or specified territory outside India. Grant of FTC shall be allowed only in the year in which the income corresponding to such tax has been offered to tax or assessed to tax in India.

This may create certain complicacies where there is a mismatch in timing of taxation of a particular stream of income in India and foreign country in accordance with their respective tax laws.

For example: Income X is chargeable to tax in India in FY 2016-17 and in foreign country in FY 2017-18. Here, since the income is taxable in FY 2017-18 in foreign country, there may be cases where foreign tax is paid by the end of FY 2017-18. Since, draft rule provides for grant of FTC in the year in which income was offered to tax in India, taking credit of foreign tax in India in FY 2016-17 may prove to be a challenge since the basic condition for grant of FTC (payment of foreign tax) has not materialised up to the date of filing of return in India for FY 2016-17. 

A clarification on aforementioned issue from while bringing out the final rules is essential.

2.    Eligible Foreign Taxes on which relief is allowed

Where a Double Taxation Avoidance Agreement (‘DTAA’) has been entered between India and the foreign country, eligible foreign tax shall be the taxes covered under the respective DTAA.

However, where no DTAA has been entered between India and the foreign country, eligible foreign tax shall mean the tax payable under the law in force in that country in the nature of income-tax referred to in clause (iv) of the Explanation to section 91 of the Act. 

3.    Grant of FTC 

Assessee would be allowed to claim FTC against the amount of tax, surcharge and cess payable by such assessee in India under the Act. However, it has been clarified that claim of FTC will not be allowed in respect of any sum payable by way of interest or penalty. 

The draft rule propose that no credit shall be available in respect of any amount of foreign tax which is disputed in any manner by the assessee. This will create an embargo on grant of credit of foreign tax which was paid by the assessee as a tax demand computed by tax authorities of foreign country on assessment and where such tax demand has been disputed by the assessee by way of an appeal in the said foreign jurisdiction. However, the said rule requires greater clarification in case of a situation where the dispute in relation to foreign tax is settled by the competent foreign authority and the assessee chooses not to appeal any further.

4.    Manner of calculating FTC

The draft rule propose that credit of foreign tax shall be the aggregate of the amounts of credit computed separately for each source of income arising from a particular country. Further, the credit allowable shall be the lower of the tax payable under the Act on such income and the foreign tax paid on such income.

In simpler words, a separate calculation would be required to be made on each and every stream of income arising from each and every foreign country individually in accordance with the manner prescribed in next paragraph. The aggregate of such different FTCs computed from each and every stream of income above from foreign countries shall be the credit of foreign tax paid allowable from the tax payable in India. 

For the above purpose, FTC from each and every stream of income arising from each and every foreign country shall be lower of:

i.   the tax payable under the Act on such each and every stream of income, or
ii.  the foreign tax paid on such each and every stream of income

Further, the credit shall be determined by conversion of the currency of payment of foreign tax at the telegraphic transfer buying rate on the date on which such tax has been paid or deducted.

The above rule throws light in an area which was until now marked by divergent practices due to absence of any specific law. Having said that, the requirement of calculating the FTC separately on each and every stream of income from a foreign country would make the entire calculation process complex and convoluted. 

Simplification of proposed rule is indispensable to Government’s object of making India a tax friendly economy. The Indian Tax Authorities may instead of proposing calculation of FTC separately on each stream of income from a foreign country, consider allowing calculation of FTC on combined income (from all streams of income) from the respective foreign country for the purpose of calculation of lower of tax payable in India and the foreign tax paid.

5.    FTC where MAT/AMT is payable

One of the most welcome proposal in the draft rule is grant of FTC where tax is payable under the provisions of section 115JB or 115JC of the Act. The draft rule provide that the credit of foreign tax shall be allowed against MAT/AMT in the same manner as is allowable against tax payable under the normal provisions of the Act.

However, the said provision has come with a rider that where the amount of FTC available against the tax payable under the provisions of section 115JB or 115JC exceeds the amount of tax credit available against the normal provisions, then while computing the amount of credit under section 115JAA or section 115JD in respect of the taxes paid under section 115JB or section 115JC, as the case may be, such excess shall be ignored. The said provision is clarificatory and will obviate taking claim of excess FTC twice, first, directly upon payment of taxes when being paid under MAT and second, indirectly by means of MAT credit against future tax liabilities.

6.    Documents required to be furnished

For claiming FTC, assessee shall be required to furnish following documents :-

i.  Certificate from the tax authority of foreign country specifying the nature of foreign income and the amount of foreign tax deducted/paid thereon. 

However, in a case where the foreign tax is deducted at source, the assessee may furnish a certificate of tax deducted from the person responsible for deduction of such tax. 

The said rule may create hardships for assessee’s as they would now be required to go to tax authorities of foreign country for demanding a certificate specifying nature of foreign income and the amount of foreign tax deducted/paid thereon. The Income Tax Authorities must consider rationalising the said provision as requirement of certificate from tax authority of foreign country may not be practically possible in every cases.
 
ii.  Acknowledgement of online tax payment or bank counter foil or slip or challan for tax payment where the payment of foreign tax has been made by the assessee; and

iii.  A declaration that amount of foreign tax in respect of which credit is being claimed is not under any dispute. 

Conclusion

The proposed rules are a welcome step towards providing clarity on various issues related to grant of credit of taxes paid outside India. There exist few provisions which require greater clarification or which create unnecessary hardships on assessee. However, we hope that such provisions would be appropriately dealt while bringing out the final rules. 

(The author is a practicing Chartered Accountant based in Delhi and can be reached at [email protected]) 

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