Background:
With globalization, International Trade is growing at a rapid pace. There are several aspects which the parties to a transaction consider while transacting international trade. One of them being Income tax. Clarity with regard to the Income tax exposure in the Resident Country and the other Country is of paramount importance to the parties to survive and be competitive in today’s world. Countries of the world fully acknowledge the above fact and have therefore devised ways to ensure clarity with regard to taxing rights over a particular transaction. However, in certain circumstances it may be the case that the tax is levied twice on a particular stream of income which gives rise to “Double Taxation”.
There are two types of Double Taxation, namely:
- Economic Double Taxation and
- Juridical Double Taxation
Economic Double Taxation occurs where two different persons are subjected to tax in respect of the same amount of income or capital. It may arise, for example, where an amount is paid by person A to person B which is treated as taxable income of B while not being allowed as deduction in the hands of A.
Juridical Double Taxation occurs as a result of imposition of comparable taxes by two (or more) Countries on the same tax payer in respect of the same income for identical periods. Juridical Double Taxation may, inter alia, occur in the following circumstances:
- Where two Countries subject the same person to tax on his or her worldwide income. This would take place if both the Countries under their respective domestic regulations treat the taxpayer as their resident.
- Where the two Countries (Country R and Country S) subject the same person, not being a resident of either Country, to tax on income derived from, or capital owned in, one of the Country. This may happen, for example where the non-resident has a permanent establishment in Country R through which he earns interest from Country S.
- Where a resident of Country R derives income from, or owns capital in, Country S and both the Countries levy tax on such income or capital.
The tax structure of a developing country like India is an important factor in deciding its growth potential. For example, it can act as a stimulant for inflow of foreign fund, foreign technology, exports, etc. Accordingly, it makes prudent sense to devise means to avoid double taxation. A very important means of avoiding double taxation is by entering into a Double Tax Avoidance Agreement (DTAA) between the two transacting countries. Many tax related problems arising out of typical characteristics of international trade are solved or settled by DTAA. For example, the types of Juridical Double Taxation explained above can be mitigated, respectively by:
- Determining residential status of a tax payer (article 4 of DTAA)
- Applying mutual agreement procedure
- Laying down ways of eliminating double taxation (Article 23 of DTAA provides for Exemption method and credit method)
India - FTC Developments:
The Indian Tax Laws (ITL) provide for relief from juridical double taxation of income of Indian residents through a double taxation avoidance agreement (DTAA) or, in the absence of a DTAA, through unilateral relief as specified in the ITL. The mechanism provided in the DTAA/ITL provides the broad parameters and, presently, there are no specific rules available in respect of the framework/manner for granting FTC in India. In 2015, the ITL was amended to empower the CBDT to make rules in this behalf.
The Indian Income-tax Act, 1961 (the Act) under clause (ha) of sub-section (2) of section 295 provides that the Central Board of Direct Taxes (CBDT) may prescribe rules specifying the procedure for the granting of relief or deduction, as the case may be, of any income-tax paid in any country or specified territory outside India, under section 90 or section 90A or section 91, against the income-tax payable under the Act.
In 2013, a Committee was set up by CBDT to suggest the methodology for grant of Foreign Tax Credit (FTC) after examining the various issues related to it. After due consideration of the issues raised by various stakeholders, the Committee submitted its report. The draft rules for grant of Foreign Tax Credit are uploaded on the website of the Department at www.incometaxindia.gov.in for comments from stakeholders and general public.
Draft FTC rules :
- FTC to Residents in the year of assessment of income: An assesse being a resident shall be allowed a credit for the amount of any foreign tax paid by him in a country or specified territory outside India, by way of deduction or otherwise, in the year in which the income (corresponding to the foreign tax paid) corresponding to such tax has been offered to tax or assessed to tax in India, in the manner and to the extent as specified in this rule.
- Foreign tax - Defined: 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 Act. Where the foreign tax paid has been disputed in any manner by the taxpayer, such foreign tax would not qualify for FTC.
- FTC set off to be allowed against Tax, Surcharge and cess: FTC would be allowed against the amount of Indian income tax, as well as surcharge and cess payable under the ITL. No credit shall be allowed against any sum payable by way of interest, fee or penalty.
- Computation of FTC:
- Conversion rate: Foreign tax paid in foreign currency shall be converted into Indian currency by applying “telegraphic transfer buying rate” on the date when such foreign tax was paid or deducted.
- Maximum credit: FTC shall be restricted to the lower of tax payable under the ITL on such income or the foreign tax paid on such income
- Source-by-source approach: FTC shall be computed separately for each source of income arising from a particular jurisdiction.
- MAT or AMT: In a case where minimum alternate tax (MAT) or alternate minimum tax (AMT) is payable under the Act, FTC shall be allowed against such MAT/AMT in the same manner as is allowable against normal tax payable under the ITL. However, Where the amount of foreign tax credit 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.
- Documentation to be furnished for claiming FTC:
- Certificate from the tax authority of a country or specified territory outside India specifying the nature of income and the amount of tax deducted therefrom or paid by the assessee. 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;
(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.
Concluding thoughts:
Though this is a significant development and should be looked at as a positive move from the CBDT/Government, the FTC rules to be finalized, may need to provide further clarity on the certain other aspects, illustratively, calculation of underlying tax credit and tax sparing credit, option to carry forward excess FTC as envisaged by certain DTAAs of India. Further, the source-by-source approach would typically result in increased compliance burden and leads to sub-optimal availability of credit.
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