Double Taxation Agreement and Receipt of Foreign Tax Credit in India

In India, taxpayers paying foreign income tax in other countries can avail certain foreign tax credit through exemptions or deductions in India.

With globalization, migration, and increased cross border transaction there has been a rise in issues of double taxation of incomes. To address these issues, double taxation agreements (DTAAs) allow that taxes paid in a foreign country can receive credits in the domicile jurisdiction. Even still, receiving foreign tax credits against remunerations taxed in foreign countries has long been a disputed matter in India. However, tax tribunals have been trying to decide the matter conclusively in India.
 
What are DTAAs and Foreign Tax Credits?

In order to prevent issues of double taxation of income, governments enter into double taxation avoidance agreements (DTAAs) to grant relief to tax payer for incomes on which they may pay income tax in both countries. They might also provide further incentives to promote trade and foreign investment between countries.

India allows DTAAs under section 90 of the Income Tax Act ad has entered into DTAAs with most major tax jurisdictions. DTAAs helps provide tax certainty to taxpayers and also encourages foreign investment into India. India has entered into DTAAs with most major tax jurisdictions.
Under DTAAs, depending on the specific clauses usually taxpayers will be allowed a credit against taxes they may have paid in other jurisdiction. Further, under section 91 of the Income Tax Act, a credit or deduction may also be provided for taxes paid by taxpayers in countries that do not have DTAAs with India.

There are three main ways that the foreign tax credit can be availed:
  • Exemption Method: Under this method, when a resident of one country derives income that is also taxable in other jurisdiction, then under the provisions of the appropriate tax treaty, the residential country will have to exempt the income that is taxed in the foreign country. The exemption allowable will be determined as per the treaty rules or according to the proportionate method as compared to the applicable rate in the residential country.
  • Credit Method: Under this method, if any taxes are paid in the foreign jurisdiction that amount will be an allowable expenditure from the taxable income in the country that the taxpayer is a resident.
 
Rulings by ITAT: The following are some of the major principles held by the tax tribunals in India in regard to availing foreign tax credit.
 
1. Foreign Tax Credit has to be calculated on the net income and not gross receipts:
The Ahmedabad bench of the income tax tribunal in the case of Virmati Software & Telecommunication, decided on the method of computation for deciding the foreign tax credit proportionately on the income tax paid in foreign jurisdictions when the tax rate is lower than India. In this specific case, the documents detailing expenses incurred by the taxpayer in relation to gross receipts had not been provided to the assessing officers. Hence, they had to determine the proportionate amount that could be claimed.

The tribunal held that as per section 91 of the Income Tax Act, the amount of tax should be divided by the whole income to determine the rate of tax in the foreign jurisdiction. The whole of income will mean all income incurred, after deducting eligible expenses. When determining these income gross receipts should not be included, it has to be decided on the net income. Only profit should be considered when determining the income and it has to be compared against the tax rate in India.

This proportionate determination is done when the taxpayer hasn’t provided details of expenses incurred outside India; hence the assessing officers will be required to determine the proportionate tax credit. This case provided clarity on what basis the credit will be calculated on. Previously, there have been several contentions that the proportionate credit will be calculated on the gross receipts of the tax payer and not net income.
 
2. Availing foreign credit when there is no DTAA:
Generally, if a taxpayer pays foreign tax in a jurisdiction that does not have a DTAA with India, then the taxpayer will be allowed a tax relief under section 91 of the Income Tax Act.

A ruling by the Delhi ITAT also clarified certain other rules in reference to situations with regard to the application of section 91:
  • The treaty benefits for US can be claimed for both federal and state taxes, even if India has not entered into an agreement with that particular state.
  • Section 91 is not restricted only to countries with which India has no double taxation treaty. In the event that the treatment under section 91 is more beneficial than the treatment under section 90, then that benefit can be availed.
  • The benefit of section 91 can also be availed by resident but not ordinarily residents of India. Resident but not ordinarily residents of India are taxed in India both on the Indian and global income. However, the ITAT clarified that they are not excluded by section 91 and can receive foreign credit against any tax paid globally.
 
3. Can the tax paid be availed as a deduction under section 40:

According to section 40(a) (ii), the tax credit or any relief provided by double taxation treaties or under section 91 of the Income Tax Act cannot claim such tax paid outside India as a deduction in India. It is deemed that this expense is not allowable as a relief is already being provided under the treaty or under section 91.

However, the Bombay High Court has also clarified in the case of Reliance Industries vs. CIT (2017) that if the foreign tax paid cannot be availed as credit or deduction in India under section 90 or 91 of the Income Tax Act then, it will be allowed as a business expenditure under section 40. If the benefit of section 90 or 91 isn’t available, then the tax paid in the foreign jurisdiction will not be considered a ‘tax’ within the meaning of section 40 of the Income Tax Act.
 
4. Availing foreign tax credit for remuneration earned by individuals in UK:

In a case decided by the Delhi ITAT in December of 2020, the tribunal held that even residents and ordinary residents that pay foreign tax (in this case UK) then they may also avail the benefit of a foreign tax credit. Provided, that the double taxation treaty allows for this treatment.

In this case, the assesse Kapil Dev Ranwan was a resident of India that was on assignment in the UK. He was liable to pay tax on the income incurred in the UK during his posting and he claimed the foreign tax credit on it on his return to India. However, this was denied by the tax authorities on the ground that the taxpayer was stayed in the UK less than 183 days and was a resident in India.

The tribunal however held that the taxpayer was eligible for tax credit on the taxes paid in the UK since the income was taxable both in India and the UK.
 
How to avail Foreign Tax Credit in India?

Section 128 of the Income Tax Act lays down that the resident of India can avail a foreign tax credit against a foreign income tax paid, as a deduction or otherwise, in the year that such income becomes taxable in India. The foreign will be applicable for incomes covered by way of section 90 or 91 of the Income Tax Act.

The credit will be available against the tax, surcharge and any cess paid but not for any interest, fee or penalty. To avail the foreign tax credit, the taxpayers should do the following:
  • Furnish the statement of income for the income taxed in the foreign jurisdiction, along with the tax deducted from such income in Form 67 before the appropriate due date.
  • A certificate from the tax authority in the foreign country specifying the income and foreign tax paid on it, signed by the assessee.
  • A certificate from the person responsible for making the tax deduction that is also signed by the assessee.
  • The proof of the deduction of tax or an acknowledgement of such deduction by way of certificate or receipt of online payment.