Foreign tax credit: Need for guidelines

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: Foreign tax credit (FTC) rules are an integral part of international tax provisions of tax legislations in most countries. Double taxation is a real risk when a country adopts the worldwide system of taxation (as is the case with India) under which the income of residents is subject to taxation regardless of source, because income sourced in another country is usually taxed there as well.

Under the FTC principle, the residence-country calculates its tax on the basis of the taxpayer's total income including the income from the source-country which may be taxed in that other country.

It then allows a deduction from its own tax for the tax paid in the other country. While India's tax treaties recognise this general principle, the treaties leave the application to domestic tax law provisions. Absence of specific FTC provisions in the domestic tax law could present certain technical as well as practical challenges as can be discerned from recent judicial decisions in the case of Wipro Limited v DCIT (96 TTJ 211) and in the case of JCIT v Digital Equipments India Ltd (DEIL) (93 TTJ 478).

Income exempt from tax in India

In Wipro's case, the US-source income was included by the company in its total income computed under the Act. As such, income was earned from software services activities, eligible deductions under section 10A of the Act were claimed in the tax return filed in India. Relying on the provisions of the India-US tax treaty, domestic tax law and Supreme Court's decision in the case of UOI v Azadi Bachao Andolan (263 ITR 705), the taxpayer argued that there is no requirement that the taxpayer should pay income-tax in both the countries on the same item income for the foreign taxes to be eligible as a credit in India. The treaty merely contains a "maximum deduction rule" which provides that India will allow a credit against Indian tax for US taxes paid up to the amount of the Indian tax on the income in respect of which US tax has been paid. While the tribunal did not specifically rule on the manner in which the limitation is to be applied, it directed the tax officer to grant FTC as per the applicable provisions of the treaty.