In today’s globalized economy, individuals and businesses often find themselves engaging in transactions across international borders. While this presents numerous opportunities, it also introduces complexities, particularly when it comes to taxes. Since, different countries have different tax laws, they levy taxes according to their domestic tax laws and in some cases, the taxpayer ends up paying double tax on the same income, once in their home jurisdiction and once in foreign jurisdiction.
In order to mitigate such situations, these countries enter into Double tax avoidance agreements (DTAA) with each other (India has DTAA with 90+ countries). Additionally, if there is no DTAA in India and another county they can claim FTC as per Indian Income tax Act. These agreements facilitate the taxpayer by allowing them to pay tax on certain incomes in only one country. This is done by way of Foreign Tax Credit (FTC), a mechanism designed to alleviate double taxation for those subject to taxes in both their home country and a foreign jurisdiction.
So, what exactly is a Foreign Tax Credit?
The Foreign Tax Credit is a provision in tax law that allows taxpayers to offset the taxes they have paid to foreign governments against their domestic tax liabilities. In essence, it prevents the same income from being taxed twice, once by the country where it was earned and again by the taxpayer's home country. This credit is available to both individuals and businesses having incomes in countries which have mutual DTAA allowing availment of tax credit.
Let us understand this case with the help of an example, Suppose Mr. Akshay is employed in U.S from Apr’21 to Jun’23 and in Jul’23, he relocates to India where he got a new job. Now, for financial year 23-24, he has stayed in India for 9 months implying him a resident status in India for FY 23-24.
Now, for FY 23-24, his global income will be taxable in India including his U.S Salary. Since, this salary is earned in U.S, he has to pay tax on this salary in U.S as well. In such cases, in order to avoid double tax, he can claim foreign tax credit of the taxes paid on salary in U.S with Indian tax authorities.
In such cases, residents can claim credit for the amount of tax deducted in the foreign state by filing Form 67 with the income tax department. Residents must submit Form 67 before the due date of Income Tax Returns (ITR) filing to claim credit for such taxes.
By understanding how the credit works and implementing effective tax planning strategies, taxpayers can minimize their overall tax liabilities and maximize their returns on global investments.
Understanding FTC in India from legal point of view:
Sections 90 (India has DTAA with 90+ countries) and section 91 (an individual is eligible to claim tax relief if a DTAA is absent between India and another country) of Income Tax Act, under these sections, if the taxpayer is a resident of India, and he has paid taxes outside India, he can claim a credit of such foreign taxes paid against his tax payable in India.
Rules for claiming FTC have been notified, which have helped clear out ambiguity around claiming of FTC, some of which have been briefly captured here under:
- FTC is allowed in the year in which the income corresponding to such tax has been offered or assessed to tax in India;
- FTC shall be lower of, tax payable on such income under the Indian tax laws and the foreign tax paid;
- FTC shall be available against the amount of tax, surcharge and cess payable under the Indian tax laws but not against interest, fee or penalty;
- FTC shall not be available if the foreign tax is a disputed one;
- FTC is available even on tax payable under Section 115JD (Alternate Minimum Tax);
- FTC shall be the aggregate of the amounts of credit computed separately for each source of income arising from a particular country;
- FTC shall be determined by conversion of the currency of payment of the foreign tax at a specified rate
Documents required to claim FTC
In order to claim FTC, the taxpayer is required to furnish the following documents on or before the due date of filing of return:
- A statement of foreign income offered to tax & foreign tax deducted or paid on such income – This is mostly available in the tax return of the foreign country
- Salary Slips of the foreign employer
- Proof of payment of taxes outside India (Something like Form 1042S (Withholding certificate if from U.S)
