Paid tax abroad? Here’s how to claim foreign tax credit in India

Foreign tax credit, or FTC, is a key provision in international taxation that helps residents avoid double taxation. When a taxpayer earns income abroad and pays tax in a foreign country, FTC allows him to claim credit for this tax against the liability in his home country. This mechanism ensures that the same income is not taxed twice: once where it is earned and, again, where the taxpayer resides. FTC under Double Taxation Avoidance Agreement (DTAA) must be applied along with domestic tax laws.

The FTC mechanism in India is governed by Sections 90 and 91 of the Income Tax Act, 1961. Section 90 of the Income Tax Act allows India to enter into DTAAs with other countries to provide bilateral relief from double taxation, while Section 91 offers unilateral relief when no DTAA exists with the foreign country. Rule 128 of the Income Tax Rules, 1962, provides the mechanism for calculating and claiming FTC in India.

Claiming FTC under bilateral relief

• Exemption method
• Credit method

Under the tax exemption method, income is taxed only in the source country and is exempted from tax in the country of residence. In contrast, under the tax credit method, income is taxed in both countries as per their respective tax laws read with the DTAA, and the country of residence allows a credit for the tax paid in the source country.

The most common type of FTC claimed in India is under the bilateral relief method, with the ordinary credit method being predominantly used within this framework.

Here, we will explain the provisions, documentation requirements and challenges while claiming FTC under the ordinary credit method.

Key provisions relating to FTC

• Indian residents can claim FTC for foreign taxes paid/deducted on foreign income.
• FTC is allowed only against tax, surcharge, and cess, not on interest or penalty.
• FTC is allowed in the year that the income is taxed in India; if paid over multiple years, credit is given proportionately.
• FTC shall be the aggregate of the amounts of credit computed separately for each source of income arising from a particular country.
• FTC allowed is the lower of:
• i. Indian tax on foreign income, or
• ii. Foreign tax paid.
• FTC must be converted using the telegraphic transfer buying rate on the last day of the month immediately preceding the month in which such tax has been paid or deducted.

Documents needed

The taxpayer must furnish the following documents to claim FTC under Rule 128:

• Statement of income earned from the foreign country for the relevant previous year, along with details of foreign tax deducted/paid on such income, and must be furnished in Form 67.
• A certificate or statement must be provided that includes the nature of foreign income and the amount of tax deducted or paid. It can be obtained from:

• The foreign tax authority, or
• The person responsible for deducting the tax, or
• Signed by the assessee, accompanied by an acknowledgement of online payment/bank counter foil/challan in case of payment and proof of deduction where the tax has been deducted.

Form 67 must be submitted online on or before the end of the assessment year relevant to the previous year. If Form 67 is not submitted before the time limit, it will lead to non allowance of FTC in Section 143(1) intimation and may cause unnecessary litigation.

Lower-of-two rule

Let’s say you earned Rs.10 lakh from a client in Japan. The tax withheld in Japan is Rs.1.5 lakh (15% tax rate in Japan). In India, the same income attracts a tax of Rs.1 lakh (10% tax rate in India).

In this case, the taxpayer will get FTC of Rs.1 lakh, not Rs.1.5 lakh. You end up losing the excess tax of Rs.50,000 paid abroad since the tax rate is higher in the foreign country.

Litigation

Litigation concerning FTC often arises due to a mismatch in the timing of tax payments, varying interpretations between DTAAs and Indian tax laws, procedural lapses, and compliance issues.

Some of the major issues commonly subject to litigation are:

Ordinary vs full tax credit
Despite the existence of full credit method—where the entire foreign tax paid is allowed as credit regardless of Indian tax liability—India follows the ordinary credit method under Rule 128 of the Income Tax Rules. This method, also used in most tax treaties, limits foreign tax credit to the Indian tax payable on the foreign income.

Tax-exempt income in India
In some cases, income may be taxed in a foreign country, but is exempt under Indian tax laws, resulting in no tax payable in India. This raises the question of whether such income qualifies as ‘doubly taxed’ and is eligible for FTC.

Credit for state taxes
State taxes (say, US state taxes) are not covered by DTAAs, but Section 91 may allow FTC on state taxes where no treaty exists. Courts have had mixed views, with some rulings offering FTC even on state taxes.

Gross vs net basis
In many countries, certain types of income like interest, royalties, or fees are taxed on the gross amount. However, in India tax is charged on the net income after deducting related expenses.

While claiming FTC in India, the tax paid abroad is compared to the Indian tax calculated on net income (that is, after deducting expenses). As a result, the full amount of foreign tax paid may not always be eligible for credit in India.

End note

FTC is not merely a compliance requirement, but a crucial relief mechanism for Indian taxpayers with foreign income. However, significant ambiguity persists in FTC provisions under domestic tax laws and DTAAs. Taxpayers must thoroughly examine the laws of both the residence and source countries, along with relevant treaties before claiming FTC to mitigate litigation risk.

Source: The Economic Times