Introduction: The world has become a global village, be it for Economic or any other activities and has become a norm, excluding exceptional circumstances like COVID-19 which has put some breaks but only for a limited time.
This has resulted in Cross border economic activities and generation of worldwide income. Once the Income accrues, income tax silently follows. This makes each one of us to know about Taxation from that perspective, Double Taxation avoidance, and availment of Foreign Tax Credit. A brief article without much of the technicalities has been presented for a basic understanding of the subject.
It is a common practice for the industries to depute skilled employees to their client sites, and income accrues to such employees both in India as well as the country to which they have been deputed. Hence it even applies to individual salaried class also which has to be kept in mind. It will be the sole responsibility of such individuals to take care of proper declaration of income and taxes before the tax authorities. This also has been dealt upon herewith.
How Double Taxation arises:
Taxation is based on two main aspects -
a) Residential Status - The Residents of a Country are taxed by that Country in which the subjects hold residency and their world wide income will be taxable in such country.
b) Source of Income – The States will tax the income which originates from that state, irrespective of the Residential status of the subject earning that income.
When anyone satisfies both the condition, in such situations, there will be double taxation on the same income in both the countries.
Since it is a well accepted maxim that no income should be taxed twice, The Income Tax Act will generally provide relief from such double taxation and such relief is country specific. In addition to the above, there will be Double Taxation Avoidance Agreement (DTAA) legislations to provide relief from such double taxation.
It is important to note that The Foreign Tax Credit (FTC) mechanism as specified in the DTAAs has to be applied in conjunction with the domestic tax laws.
In India, the FTC mechanism is at present governed by Section 90 and Section 91 of the Income-tax Act, 1961. The applicability of these sections is depicted by way of the following Chart:
Income Earned Outside India - Resident Non Resident
DTAA Avilable (Bilateral) - Apply Provisions of Sec.90/90A - Not Taxable
DTAA Not Avilable (Unilateral) - Apply Provisions of Sec 91
The relief from Double taxation is provided in two ways:
1. Unilateral Relief – wherein in there is no tax treaty between India and other foreign jurisdiction and is governed by Section 91 of the Income Tax Act, 1961
2. Bilateral relief – wherein the Governments of two countries have entered into an agreement (DTAA) to provide relief against double taxation. This is governed by Section 90 and 90A of the Income-tax Act, 1961.
Provisions contained in Sec.91: (Where there is no DTAA)
If any person who is resident in India in any previous year has any income that accrued or arose during that previous year outside India (which is not deemed to accrue or arise in India), and has paid taxes on such income in the country of Source, which has no agreement under section 90 with India, for the relief or avoidance of double taxation, income-tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal. There is no clarity as to what constitute Tax, only federal tax or state Taxes are also deductible. This is a debatable issue. Provisions of this Section do not discriminate between the taxes levied by the Federal Governments and State Governments.
Provisions containing Section 90 (Where DTAA exists)
FTC can be availed by following any one of the following suitable methods:
One way is the exemption route, where the Resident Country exempts from taxing such income which suffers double taxation, being the income taxed in the source country. Again Resident country may allow
a) Full exemption, in which case the income earned in the source state is not at all considered in the Resident country. Or...
b) Exemption with progression, where the resident country takes into consideration the income earned in the source country for the purpose of determining the amount of tax on the remaining income.
The other way is Credit method, wherein the Resident country takes into account income earned in the Source State as taxable income and provides credit for taxes paid in the Source State.
a) Credit granted may be full credit wherein the Resident Country allows deduction of the Total amount of Tax paid in the Source Country or
b) Ordinary Credit wherein the Resident state gives deduction of the total amount of tax paid in the Source state from the tax liability arising in the Resident state. But the deduction is restricted to the extent of the tax liability arises in the Resident state.
In case where bilateral agreement has been entered u/s 90 with a foreign country then the assessee has an option either to be taxed as per the DTAA or as per the normal provisions of Income Tax Act 1961, whichever is more favorable to assessee.
Documents required to claim FTC in India
- A statement of Income including the foreign income earned and the foreign tax deducted or paid on such income in Form 67 to be filed before the due date of filing the Income Tax Return; and
- Statement specifying the nature of income earned and foreign tax deducted or paid from the tax authority of the foreign country or from the person responsible for deduction of such tax or signed by the taxpayer accompanied by proof of tax payment or proof of deduction.
Rate of exchange to be adopted for conversion of foreign exchange:
TT buying rate SBI as on the last day of the month immediately preceding the month in which such tax has been paid/deducted is to be considered for conversion.
Methodology of Computation of Relief under Section 90/90A
– Compute the global income in accordance with the provision of the Income-tax Act,1961
- Compute tax on such global income as per the slab rates applicable;
- Compute average rate of tax (i.e. Global income divided by amount of tax);
- Compute an amount by multiplying Foreign income with such average rate of tax;
- Compute Tax paid in Foreign country
The amount of relief shall be lower of the above two
Eg., A has an income earned in India of Rs. 3,00,000/-, and earned from US an amount equivalent to Rs.1,00,000. The tax paid in foreign country amounts to Rs. 20,000.
- Global income is Rs.4,00,000/-
- Tax Rs. 15,000/- (First Slab at 10%)
- Average tax 15,000/4,00,000*100 - 3.75%
- Tax to be foreign income in India at 3.75% on Rs.1,00,000 is Rs.3,750/-
- Tax paid Rs. 10,000/-
- Relief available is Rs. 3,750/-
Methodology of Computation of Relief under Section 91
- Compute tax payable in India
- Compute lower of Indian rate of tax and rate of tax in Foreign country
- Multiply the rate obtained in Step above by the doubly taxed income
- Relief will be the amount as computed in the Step above
Eg: A has a foreign income of Rs. 1,00,000/-, which has been subjected to double Tax. Tax rate applicable in India is 15%. Tax rate in Foreign country is 10%.
The relief shall be:
1. Tax payable in India will be Rs. 15,000/- (1,00,000*15%)
2. Lower of Indian rate of tax (15%) and rate of tax in Foreign country (10%) is 10%.
3. The relief will be Rs. 10,000/- (1,00,000*10%)