Foreign tax credit: Some Income rules fail to deal with complications

By: |
Updated: July 25, 2016 7:25:25 AM

A foreign tax credit (FTC) is allowed to a taxpayer by his/her country of residence to mitigate the impact of double taxation.

FTC would be available against tax, surcharge and cess payable under the Income-tax Act, 1961, including minimum alternate tax (MAT), but not in respect of interest, a fee or penalty. (PTI)FTC would be available against tax, surcharge and cess payable under the Income-tax Act, 1961, including minimum alternate tax (MAT), but not in respect of interest, a fee or penalty. (PTI)

A foreign tax credit (FTC) is allowed to a taxpayer by his/her country of residence to mitigate the impact of double taxation. In the Indian context, the statute provides relief from double taxation both under the domestic tax law and under double taxation avoidance treaties that India has entered into. However, due to the absence of rules and regulations, disputes have often arisen in the past on the computation of FTCs.

Based on the recommendations of the Tax Administration Reforms Commission, the Central Board of Direct Taxes (CBDT) has notified FTC rules for the computation and claim of taxes paid by resident taxpayers in overseas countries. CBDT had earlier released draft rules for granting of FTC and sought suggestions from various stakeholders. The rules that have now been released shall come into effect from April 1, 2017.

Credit is allowed on foreign tax paid to the extent of tax payable in India on such income. FTC would be available against tax, surcharge and cess payable under the Income-tax Act, 1961, including minimum alternate tax (MAT), but not in respect of interest, a fee or penalty. To claim FTC, taxpayers have to submit proof of the tax paid or deducted at source in the foreign country. The claim would be accompanied by a self-certified form in the prescribed format before the due date for filing of return of income. For the calculation of FTC, the conversion would need to be done using the exchange rate as on the last day of the month immediately preceding the month in which the foreign tax was paid or deducted.

Although CBDT has taken cognisance of industry recommendations on various points, it appears that a few have missed their attention.

FTC is available in the year income corresponding to such foreign tax is assessed in India. Accordingly, where income corresponding to foreign tax is offered to tax in more than one year, FTC would be allowed in those respective years. This would certainly help in ironing out the differences arising due to different financial years followed in different jurisdictions, but would not completely address the issue that was raised. It was expected that the final rules would allow the carry forward and set-off of tax credit. This would have helped companies to utilise FTC entirely regardless of differences in computational provisions (like different depreciation rates, accrual versus cash system); however, this point seems to have been overlooked.

In the case of disputed demands, FTC would only be allowed once the dispute in a foreign jurisdiction is settled subject to furnishing of evidence of the final settlement of such dispute. Since a detailed procedure has not been prescribed in this regard, the claim of such FTC may pose practical difficulties, especially where a dispute involving a foreign jurisdiction drags on for a number of years (due to which the time limit for revising tax returns in India would expire and the assessment proceedings would be concluded). Detailed guidelines on this aspect may be issued to ensure that such practical difficulties are addressed.

The credit of foreign taxes is to be aggregated for each source of income arising from a particular country. The above approach may lead to undue hardship. Due to different tax rates in various countries for each source of income, credit of foreign taxes paid in an overseas country may not be entirely utilised even though the aggregate taxes paid in India on such total income may be higher. The industry had recommended that foreign tax be clubbed and seen together against the aggregate taxes payable in India on such incomes. This recommendation has not found favour. In addition, the final rules do not deal with complications arising in the case of re-characterisation of income. (For example, if applying thin capitalisation rules, the source country treats the interest payment as dividend distribution and thereby subjects such interest to the withholding tax rate applicable to dividends).

While FTC has been allowed against MAT, for the purpose of subsequent MAT credit such excess FTC over normal profits apparently has to be ignored. The complete benefit of foreign tax will seemingly not be passed on if the companies are taxable under the MAT regime. Clarity on this aspect was expected in the final rules; however, this aspect has not been addressed.

Apart from the above, the rules were also expected to clarify the availability of FTC in some complicated non-routine situations. Guidance would have been useful to avoid unnecessary disputes in cases like where a foreign company is considered a resident due to provisions of place of effective management or where taxes are not covered by a treaty like branch remittance tax or triangular cases.

The FTC rules are a welcome step towards bringing uniformity and reducing litigation, and they will provide significant relief to resident taxpayers having foreign operations and income on which taxes are being paid in overseas countries. Further, relaxation of the requirement of obtaining a certificate from foreign tax authorities, as provided for in the draft rules, indicates a practical approach to FTC claims in India.

However, with the aim of providing an effective remedy to the taxpayer and facilitating easy claim of FTC, the final rules could have considered a few of the suggestions discussed above and issued detailed guidelines on the same.

(With contribution from Shailendra Gupta, associate director and Diksha, assistant manager-direct tax, PwC )

The author is partner, direct tax,

PwC. Views are personal

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Switch to Hindi Edition