The key reasons which leads to double taxation for an individual are:
(i) Source based taxation, under which the income is subject to tax in the country where the source of such income exists i.e. where the services are rendered.
(ii) Residence based taxation, under which the income is taxed on the basis of the residential status of the employee.
The domestic tax laws as well as double taxation avoidance agreement (tax treaty) entered into by a country generally provide relief to a taxpayer from such double taxation by way of exemption or tax credits. Under the Indian domestic tax laws i.e. the Income Tax Act, 1961 (the Act), Section 90 and 91 have been incorporated to provide relief with respect to income which has suffered tax burden in India as well as in a foreign jurisdiction.
Section 90 of the Act allows taxpayers to claim credit of foreign taxes paid in overseas countries as per the provisions of the tax treaties entered by India with such other country. A taxpayer can choose to be governed either by provisions of the tax treaty or by the domestic tax law to the extent more beneficial to him. As per details available on income tax website, till date, India has entered into tax treaties with 98 countries. However, in case where no tax treaty exists between India and other foreign jurisdiction, Section 91 allows for unilateral relief in India for taxes paid in such foreign jurisdiction.
The tax treaties specify the methods to eliminate double taxation and such methods are different and unique in its own sense in each tax treaty. Certain tax treaties provide relief by exempting the doubly taxed income while others may provide credit of taxes paid in the source country while computing taxes in the resident country.
Under the tax credit method, the resident country retains the right to tax the foreign income and allows credit for the taxes paid in source country. The resident country would determine the resident’s worldwide income (including foreign sourced income) and compute the tax liability thereon. From the tax liability so computed, credit is granted, subject to certain limits, of the foreign taxes paid on such foreign sourced income.
Now a common question that arises while allowing the credit of taxes in India is that what all taxes are eligible to be included while computing the foreign tax credit (FTC) in India. While, section 91 allows for a unilateral tax relief for taxes paid including state taxes and other local levies in such country, an issue arises in cases where tax treaty exists between India and other foreign jurisdiction and such tax treaty do not include state taxes or other local levies in the definition of taxes eligible for FTC example India-US tax treaty.
The question of doubt arises in those countries where the federal structure requires taxpayers to pay federal income tax as well as state income tax and other local levies. It is pertinent to note here that the income-tax in relation to any country includes income tax paid not only to the federal government, but also the income tax charged by any part of that country including a state or a local authority.
In light of the restricted definition of tax, the issue of claim of credit for the state taxes and local levies has been widely disputed in India. Some of the tribunals and courts have ruled in favour of the taxpayers by holding that since the taxpayer is not allowed to claim a deduction of state taxes paid as an expense, non-granting of credit as well for such state taxes would lead to double taxation. Further, the courts have also ruled that beneficial provisions in domestic tax law should not be denied merely because a corresponding provision in the tax treaty is less beneficial.
On the other hand, the tax department generally contends that where certain type of tax is not specifically covered by the tax treaty, the same should not be allowed as a credit. It is also argued that the provisions dealing with credit under the tax treaty and the unilateral relief mechanism under the domestic law are mutually exclusive provisions which operate under different circumstances since the unilateral credit mechanism provisions operates only when there is no tax treaty with India.
Given the magnitude and the significance attached to the issue for a deputationist, the government should provide necessary clarification to avoid unnecessary litigation on this account. However, until any such clarification comes, one should evaluate the provisions of the relevant tax treaty and available jurisprudence thereon carefully.
1.What are the documents required to claim FTC in India?
The taxpayers shall be required to furnish the following documents on or before the due date of furnishing his tax return
a. A statement of foreign income offered to tax and the foreign tax deducted or paid on such income in prescribed form and
b. Certificate or statement specifying the nature of income 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.
2.What rate of exchange is considered for conversion of FTC?
Telegraphic transfer buying rate adopted by the State Bank of India on the last day of the month immediately preceding the month in which such tax has been paid or deducted is to be considered for conversion of taxes paid outside India to determine the eligible amount of FTC.
Akhil Chandna and Pooja Lara contributed to this article.
Vikas Vasal is national leader tax at Grant Thornton India LLP