Most job seekers think of getting a high-paying job in a foreign country and living the life of their dreams. Are you one among them? But have you thought of taxation? Chances are that you will be liable to pay taxes in both countries, i.e., the country that you work in and the country that you are a resident of. To ease this burden, the government has entered many agreements with various countries that offer tax relief or, in simple terms, tax credits for the tax paid in such foreign countries. Check out this blog to learn more about the foreign tax credit and know if you are eligible to get the benefit of the same.
What is the meaning of a Foreign Tax Credit?
The taxation for any income can be based on two principles i.e., either the source principle or the resident principle. Accordingly, the income is taxed in the country where the income is earned, and generated (by a resident or a non-resident) under the source principle. On the other hand, income of any nature earned or received by a resident, whether in India or abroad, is taxable under the resident rule.
As per the provisions of the Income Tax Act, 1961, a taxpayer is eligible for relief from double taxation either under Section 90 or Section 91. Section 90 is used in relation to countries where India has a DTAA (Double Tax Avoidance Agreement) while Section 91 is in relation to countries where there is no DTAA.
These provisions govern the treatment of income that is taxable in the host country and the resident country both. Therefore, it removes the confusion of which country will be responsible to tax on the notified income. The other country in the equation will provide the tax credit on the tax already paid based on the provisions of the Act. However, there were many ambiguities in the execution of these provisions of the Act, therefore, the Income Tax Department introduced Rule 218 and Form 67.
Who is eligible to claim a foreign tax credit?
The foreign tax credit system, governed by Rule 128 of the Income Tax Act, has been introduced to facilitate easier claiming of foreign tax credits. Here are the rules for claiming foreign tax credits on foreign income:
|Resident Assessee||Only individuals or entities residing in India can claim credit for taxes paid in a foreign country or specified territory outside India.|
|Year of Taxation||The foreign tax credit can be claimed in the year when the income is subject to taxation in the resident country.|
|Proportionate Credit||Only a proportionate amount of income on which tax has been paid or levied can be allowed as a tax credit.|
|Exclusion of Certain Amounts||The foreign tax credit is not applicable to amounts paid as interest, fees, or penalties.|
|DTAA Coverage||If there is a Double Tax Avoidance Agreement (DTAA) between India and a foreign country, only the taxes covered under the DTAA will be eligible for the foreign tax credit.|
|Disputed Income||Any disputed income amount is not eligible for a foreign tax credit, except if the taxpayer provides evidence of dispute settlement within six months.|
|Calculation for Each Income Source||The credit for foreign tax is calculated separately for each source of income from each country.|
|Determining the Credit||The foreign tax credit is determined by comparing the tax payable in the resident country with the foreign tax paid, allowing the lower of the two amounts as the foreign tax credit.|
These rules aim to provide relief to taxpayers by allowing them to offset the taxes paid in foreign countries against their Indian tax liability, thereby avoiding double taxation.
How is a foreign tax credit available?
The process to claim the foreign tax credit is explained hereunder.
- The first step is to convert your foreign income into Indian Rupees (INR) using the Telegraphic Transfer Buying Rate (TTBR) on the last day of the month before the income is due.
- This foreign income is then treated as domestic income and classified under the appropriate income head, such as salaries, interest, dividends, etc. Any income exceeding the basic exemption limit of INR 2,50,000 is subject to taxation based on applicable rates.
- Taxpayers have to then refer to the Double Tax Avoidance Agreement (DTAA) of the source country and claim credit for the taxes deducted at the source (TDS) in the foreign country.
- Following this, taxpayers will have to obtain a Tax Residency Certificate (TRC) to establish their tax residency status and ensure the correct application of the DTAA provisions.
- Taxpayers will further have to provide the necessary details of their foreign income in Schedule FSI (Foreign Source Income) of the Income Tax Return (ITR) form to claim foreign tax relief. These details include:
- Country code of the source country
- Taxpayer Identification Number
- Amount of income earned outside India
- Tax paid in the foreign country (source country)
- Tax payable on foreign income in India according to applicable tax laws.
- Finally, taxpayers will have to determine the tax relief amount by comparing the tax paid in the foreign country with the tax payable in India. The amount that can be claimed as tax relief is the lower of the two amounts.
- Taxpayers will also have to mention the relevant article of the Double Tax Avoidance Agreement (DTAA) that applies to their situation, ensuring proper alignment with the provisions of the agreement.
How is Foreign Tax Credit beneficial?
Foreign Tax Credit is a beneficial provision that helps individuals and businesses mitigate the impact of double taxation when they earn income from foreign sources. It allows taxpayers to offset the taxes paid to a foreign government against their domestic tax liability. The various advantages of the foreign tax credit are mentioned hereunder.
- The Foreign Tax Credit benefit prevents double taxation, ensuring that income is not taxed by both the source country and the taxpayer’s home country.
- It encourages international trade and investment by reducing the tax burden on cross-border economic activities, facilitating global transactions and market expansion.
- This benefit helps preserve economic competitiveness by ensuring that businesses and individuals are not disadvantaged compared to counterparts in countries without similar provisions.
- Allowing taxpayers to use the foreign tax credit to reduce their domestic tax liability, improves cash flow and enhances profitability for those engaged in foreign income-earning activities.
- The Foreign Tax Credit promotes compliance and transparency by requiring accurate reporting and disclosure of foreign income, contributing to fair tax practices, and preventing tax evasion.
- It supports tax treaties and bilateral relations by honoring agreements, fostering cooperation between countries, and ensuring equitable treatment of taxpayers across borders.
- By simplifying tax compliance and eliminating the need for separate filings or refunds in multiple jurisdictions, the Foreign Tax Credit reduces administrative burdens, making the process more streamlined and efficient.
Foreign Tax Credit is one of the most crucial sections of the Income Tax Act as it allows taxpayers to reduce their tax liability and get relief from the burden of double taxation. However, it should be noted that FTC is applicable only on eligible income and cannot be applied to interest or penalties on such income. The introduction of Rule 128 and Form 67 has simplified the process of claiming Foreign Tax Credits providing more clarity and thereby making it more accessible to taxpayers across the country.
Form 67 is utilized by Indian residents to disclose foreign income in their Income Tax Return (ITR). It encompasses personal information, details of foreign income sources, provisions for claiming tax relief and deductions under DTAA, and a verification section. This form ensures compliance, enables foreign tax credit claims, and simplifies reporting of foreign income for Indian residents.
The options for receiving double tax relief are either through the Exemption Method or through Foreign Tax Credit Method.
The documents that need to be submitted for claiming Foreign Tax Credit are,
a. While filing the Income Tax Return (ITR), the taxpayer must complete Form 67 on the Income Tax Portal.
b. A document stating the type of income and the amount of tax paid or withheld.
c. In addition to the document mentioned above, the taxpayer needs to submit evidence of the payment or tax deduction
Yes. The basic exemption limit of Rs. 2,50,000 is also applicable to foreign income under the Income Tax Act, 1961.