The scale of how much outbound investment has been made from India is reflected in the $22,319 million invested between April 2015 and March 2016. The FDI equity inflow for the same period is $39,328 million—the investments being made by Indians outside India is more than half of the inflow that the country is receiving!

The government is also keen on getting a portion of the profits from such outbound investments back to India. The introduction of beneficial provisions like Section 115BBD of the Income-Tax Act, which provides for a preferential rate of 15% on dividends received by Indian companies as opposed to the 30% rate, are steps in the right direction.

While the above provision was introduced to encourage Indian MNCs to bring the foreign income back to India, it is equally important to provide a precise legislative framework which offers total clarity on the taxability of income streams that can potentially be earned from outbound investments. The government has taken a very transparent and pragmatic approach in providing such a legislative framework with the Place of Effective Management (PoEM), taxation of foreign sourced dividends, country-by-country reporting, and now, the draft rules for granting foreign tax credit (FTC).

The draft rules provide for grant of credit in the year in which the corresponding income has been offered for taxation. More clarity is needed on how the FTC is granted under a situation of mismatch in accounting systems, i.e., where taxes are paid in the subsequent years in the foreign country (on a cash basis) and the income is offered for taxation in India (on an accrual basis).

‘Foreign tax’ has been defined as the taxes covered under the double tax avoidance agreements (DTAA), for countries and specified territories with whom India has such accords. Where such agreements don’t exist, the definition takes colour from the domestic tax law, which includes “excess profits tax or business profits tax charged by the government of any part of that country or a local authority in that country”. There is an anomaly in this: Since state taxes and local taxes are not specifically covered in some of the DTAAs, such credit may not be available for taxes paid in countries with which India has a DTAA. However, the state and local taxes could be creditable for countries with whom India doesn’t have a DTAA.

Further, while clarity on the meaning of ‘foreign tax’ is welcome, the norms should also provide clarity on certain other DTAA-related aspects, like calculation of underlying tax credit and tax-sparing credit as covered by certain DTAAs of India.

With respect to computation, it is mentioned that the credit has to be computed separately for each source of income arising within a particular country/territory. This country-by-country, source-by-source approach will result in sub-optimal availability of credit.

In today’s globalised world, where cross-border transactions have become a daily affair, the same income could be earned from different countries and different types of income could be earned from the same country. Even so, different types of incomes could be earned from different countries. All this could lead to a situation where there can be a mismatch in characterisation of income. A credit-pooling mechanism may enable businesses to effectively utilise the taxes paid globally and avoid double taxation on worldwide profits. Singapore is one such country which allows for credit pooling.

The draft rules also ask for documents that have to be mandatorily furnished by the taxpayer for claiming FTC certificate from the tax authority/deductor, specifying the income and amount of tax, acknowledgement of online tax payment, and a declaration that the FTC is not disputed.

It is also proposed in the draft rules that the FTC shall be available against income tax, surcharge and cess payable under the I-T Act as per normal provisions as well as under MAT/ AMT provisions. However, it cannot be claimed if the amount of foreign tax is disputed in any manner. The rules don’t cover in what situations a foreign tax could be considered ‘under dispute’ and the recourse mechanism in case the dispute is settled later.

The much-awaited rules on FTC aim to provide guidance on some persisting issues. However, despite the relevant guidance, the draft rules are far from being comprehensive and fall short of expectations of Indian MNCs. There were expectations that these MNCs will be permitted grant of underlying tax credit, an option to carry back or carry forward excess FTC, the ability or the option to claim deduction as an expenditure in respect of foreign tax which is not creditable against Indian tax, etc.

Since India has introduced PoEM, final FTC rules should provide a mechanism for claim of FTC by foreign companies having PoEM in India. Taking a step further, it should be clarified if underlying tax credits could be provided in the case of multi-layer structures which could be subjected to double taxation in India due to PoEM of multiple entities being in India.

The draft rules, consistent with the intention of the present government to provide certainty on taxation and reduce litigation, have definitely achieved the objective of addressing some of the key issues. In spite of this achievement, there are many untouched aspects which need to be dealt with before the notification of the final rules.

Raju Kumar

With contributions from Vaibhav Luthra, senior tax professional, EY

The author is partner (Tax), EY.

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