If you are a resident of India, income earned by you anywhere in the world shall be taxable in India. In such cases, you would end up paying taxes on the same income twice. DTAA makes sure that a taxpayer is not doubly taxed for the income earned outside the country of residence. Since income may be taxed at source i.e. from the place it originated and is also usually taxable in the country of residence, the DTAA makes sure that the taxpayer is not adversely impacted. It allows the taxpayer to claim Foreign Tax Credit for the taxes paid outside India.
What is Foreign Tax Credit?
If you have paid taxes in one country, you can claim the credit of the tax paid in the country of your residence when both the countries have DTAA. There are two rules to it which are as follows:
- Source Rule: This rule holds that income is to be taxed in the country in which it arises irrespective of whether the income arises to a resident or non-resident.
- Residence Rule: This rule holds that the power to tax should rest with the country of residence.
If both rules apply simultaneously to an assessee there will be double taxation. Double taxation means taxing the same income twice in the hands of the assessee. Section 90 aims at handling scenarios where India has signed a DTAA with the other country. While Section 91 handles scenarios where India hasn’t signed any such agreements with another country.
Rule 128 of Income Tax Rules
With the introduction of Rule 128 and Form 67, most of the confusion around claiming tax credit has been resolved. Foreign Tax credit (FTC) in India is governed by Rule 128 of Income Tax Rules and Applicable from 01.04.2017. The rule covers the following conditions:
- Only a resident assessee will be eligible to claim FTC if any tax has been paid by him in a country or specified territory outside India.
- Grant of FTC shall be allowed only in the year in which the income corresponding to such tax has been offered to tax or assessed to tax in India.
- Income on which foreign tax has been paid or deducted is offered to tax. And credit proportionate to Income offered to tax in that year shall be allowed.
- Foreign Tax Credit will not be allowed in respect of any sum payable by way of interest or penalty.
- Where a DTAA has been entered between India and the foreign country, eligible foreign tax shall be the taxes covered under the respective DTAA.
- No credit shall be available in respect of any amount of foreign tax or part thereof which is disputed in any manner by the assessee.
- Provided that the credit of such disputed tax shall be allowed for the year in which such income is offered to tax or assessed to tax in India if the assessee within six months from the end of the month in which the dispute is finally settled, furnishes evidence of settlement of dispute and evidence to the effect that the liability for payment of such foreign tax has been discharged by him and furnishes an undertaking that no refund in respect of such amount has directly or indirectly been claimed or shall be claimed
- Further, the credit of foreign tax shall be the aggregate of the amounts of credit computed separately for each source of income arising from a particular country.
- The credit allowable shall be the lower of the tax payable under the Act on such income and the foreign tax paid on such income.
Documents required to claim Foreign Tax Credit
In order to claim FTC, the assessee shall be required to furnish the following documents. Such documents shall be furnished on or before the due date return of income under section 139(1) of the Act :
- Certificate or statement specifying the nature of income and the amount of tax deducted therefrom or paid by the assessee:
- from the tax authority of foreign country; or
- from the person responsible for deduction of such tax; or
- signed by the assessee:
- Provided that the statement furnished by the assessee in clause (3) above shall be valid if it is accompanied by:
- an acknowledgment of online payment or bank counterfoil, or challan for payment of tax where the payment has been made by the assessee;
- proof of deduction where the tax has been deducted.
- Form 67 to be filed on Income Tax Portal
- Form No. 67 shall also be furnished in the case where the carry backward of loss of the current year, results in a refund of foreign tax for which credit has been claimed in any earlier previous year or years.
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How to claim Tax Credit on Foreign Income?
If you are a Resident, income earned by you anywhere in the world has to be included in your total income.
- Convert income earned outside India into Indian currency as per the reference rates
Convert your income earned in foreign currency into Indian Rupees by using the State Bank of India telegraphic transfer buying rate (TTBR) of the last day of the month before the month in which income is due.
For example, for converting foreign income of May 2020, use the TTBR of the relevant currency for April 2020 and convert your foreign income into Indian Rupees.
- Now, include this income under the respective income head, for example, include salary income under the head ‘salaries’.
Treat this income as any other income which is earned by you locally. Basic exemption limit of INR 2,50,000 is allowed on your total income and remaining income is taxable as per income tax slab rates.
- If TDS has been deducted from your income you are allowed to take credit for such taxes.
For this purpose, reference has to be made to the relevant Double Tax Avoidance Agreement (DTAA) of the country where such income has been earned. India has entered into DTAAs with several countries. Further, the taxpayer is also allowed to take credit of TDS deducted.
- Obtain TRC Certificate
Taking the benefit of a DTAA involves obtaining a Tax Residency Certificate (TRC) that helps identify and certify your tax residency status to make sure the correct DTAA has been applied. This is in line with the tax laws in India.
- While taking TDS credit, make sure the correct DTAA is applied, so you can take credit for the foreign tax deducted.
Resident in India earning a foreign income should report such income and foreign assets in the Income Tax Return.
- The taxpayer should add details of foreign income i.e. income earned outside India in Schedule FSI of ITR
Enter the following details with respect to Foreign Income:
a. Country Code – Select the country in which income is earned
b. Taxpayer Identification Number
c. Income outside India – enter the amount of income earned outside India
d. Taxes paid outside India – tax paid on income earned outside India
e. Tax payable in India – tax payable in India on income earned outside India
f. Tax Relief available = tax paid outside India or tax payable in India whichever is lower
g. Relevant DTAA Article – enter details of the relevant article of DTAA under which the taxpayer claims the tax relief
- Once the taxpayer adds details of Foreign Income in Schedule FSI, the details in Schedule TR (Tax Relief) get populated.
The double taxation relief is reduced from the tax calculation.
There are two methods to claim DTAA tax relief – exemption method and tax credit method.
– By exemption method, income is taxed in one country and exempted in another.
– In the tax credit method, where the income is taxed in both countries, tax relief can be claimed in the country of residence.
You should file Form 67 before filing your tax returns. Further, you can prepare and submit Form 67 online on your Income Tax Portal. Once you login navigate to E-file > Select other Forms > Select Form 67 and assessment year from the drop-down
Only resident Indians can claim for the tax credits, only if they have paid taxes in another country.