Foreign Tax Credit - Taxation of Foreign Source Income

What Is the Foreign Tax Credit?

Foreign Tax Credit (FTC) is a mechanism that allows residents who have paid taxes on their foreign income in another country to offset or reduce their Indian tax liability. The primary purpose of foreign tax credits is to prevent double taxation of the same income by both the country where the income was earned (foreign country) and the taxpayer's home country. To claim the FTC, taxpayers must accurately report their foreign income and the corresponding foreign taxes paid in their Indian tax return. Specific forms and disclosures may be required as per the guidelines provided by the Indian tax authorities.

How Foreign Tax Credit Works?

A resident taxpayer is subject to income tax on the money earned in the foreign country i.e., in both the countries, country of residence and the source country. The foreign tax credit allows the taxpayer to claim a deduction of the tax already paid in the foreign country. Let’s understand this with an example.

Suppose Mr. A. is an Indian resident but earns interest income in the United States. The source state, i.e., the US will withhold a percentage of the amount as tax. In addition, Mr. A will also have to pay taxes on his U.S. income in India. This will result in double taxation on the same income. Foreign Tax Credit (FTC) is a facility that helps people like Mr.A avoid paying double tax on the same income.

To claim the tax on foreign income India, the taxpayer has to furnish Form 67 while filing the ITR by the specified due date. Form 67 is used to declare the foreign income and also get an estimate of the taxation on foreign income India.

If you are someone with foreign income in India and don’t know how to disclose it in ITR or are confused about the taxation of foreign income, look no further, as Tax2win provides easy remote CA assistance for all your needs. Connect with a Tax Expert today.

How is Residential Status Determined in India?

You would be a resident Indian if you have fulfilled the below-mentioned conditions –

• You have stayed in India for 182 days or more in one financial year
• You have stayed in India for 60 days in the last financial year and 365 days or more in the last four financial years preceding the last financial year.

You would be a resident ordinarily resident (ROR) if you fulfill the following two additional conditions -

• Income received or accrued in India
• Income deemed to be received or accrued in India.

However, if you are a resident and resident ordinarily resident (ROR), you would have to pay income tax on the income that you earn in India as well as income that you earn internationally. The resident person has to report if there is any property or assets in the name of the assessee or if he/ she is a beneficial owner of the property or asset in the return of income. Do you know how to file income tax in such cases?

Eligibility for Foreign Tax Credit

Introducing Rule 128 and Form 67 has made it easier to claim foreign tax credits. Rule 128 is the Foreign Tax Credit Rule in India that governs Foreign Tax Credit. Following are the rules for claiming foreign tax credit on foreign income tax -

• Only a resident assessee can claim the credit on the tax paid in a foreign country (foreign income tax) or specified territory outside India.
• FTC is allowed only in the year when the income is levied to tax in the resident country. In other words, the taxpayer can claim a foreign tax credit in the year in which the foreign income is taxed in India.
• Only a proportion of the income on which tax is paid or levied can be allowed as a tax credit.
• The foreign tax credit is not allowed on the money paid as interest, fee, or penalty.
• If there is a DTAA (Double Tax Avoidance Agreement) between the countries in question, only the taxes covered under the DTAA will be eligible for Foreign Tax Credit.
• Any disputed income amount will not be eligible for a foreign tax credit.
• The credit of such disputed tax can be allowed if the assessee furnishes the evidence of the dispute settlement within the next six months. The assessee should not have any outstanding liability regarding the foreign tax, and no deduction should have been claimed.
• The credit of foreign tax is calculated separately by taking the aggregate of the credit for each source of income from each country.
• The lower the tax payable in the resident country and the foreign tax paid is allowed as the foreign tax credit.
• Foreign tax credit is available on the income tax on foreign income under section 115JB (minimum alternate tax).
• The foreign tax credit amount is determined by converting the currency of payment of the foreign tax at the TTBR (telegraphic transfer buying rate) on the last day of the month preceding the month in which the tax is supposed to be paid.

How to Claim Foreign Tax Credit in India?

If you are an Indian resident having a foreign source of income, here are the steps you must follow to claim a Foreign Tax Credit -

• Convert your Foreign Income into INR - First, you need to convert your foreign income into INR using the Telegraphic Transfer Buying Rate (TTBR) on the last day of the month preceding the month in which the income is due.
• Classify Into Relevant Head - Treat the foreign income as the domestic income and classify it into the relevant income head, like salaries, interest, dividends, etc. Any income exceeding 2,50,000 (basic exemption limit) is taxable per the applicable rates.
• Claim Credit for the TDS Deducted - Refer to the DTAA of the source country and claim credit for the TDS deducted in the source country.
• Get a TRC Certificate - To benefit from DTAA, you must get a Tax Residency Certificate (TRC). It clarifies your tax residency status to ensure the application of the correct DTAA.
• Fill in the Details of Foreign Income in Schedule FSI of the ITR - Fill in the following details to claim foreign tax relief -
  1. Country code of the source country
  2. Taxpayer Identification Number
  3. Amount of income earned outside India
  4. Tax paid outside India, i.e., the source country
  5. Tax payable on foreign income in India as per applicable tax laws.
  6. Enter the tax relief amount - lower of the tax paid in a foreign country or tax payable in India.
  7. The relevant article of the DTAA.

Documents Required for Claiming Foreign Tax Credit

• A certificate or statement describing the nature of income and the amount of tax deducted or paid by the assessee can be obtained from the following sources:
  • The foreign country's tax authority.
  • The person responsible for deducting such tax.
  • Signed by the assessee.
• However, the statement provided by the assessee mentioned in point 1 above is valid only if it is accompanied by:
  • An acknowledgment of online payment, bank counterfoil, or challan for the payment of tax, if the payment was made by the assessee.
  • Proof of deduction, where the tax has been deducted.
• Form 67 must be submitted using the Income Tax Portal.
• Form No. 67 must also be filed if the carryback of the current year's loss resulted in a refund of foreign tax for which credit was claimed in any previous year or years.

Foreign Income Reporting for Indian Taxpayers

• Resident Indians: All income earned from foreign sources must be reported in Schedule FSI of ITR Form 2.
• Non-Resident Indians (NRIs): Income generated outside India generally doesn't need to be reported in an Indian tax return (ITR). However, there's an exception.

Reporting Foreign Income with Tax Implications in India

There's a specific situation where NRIs must report their foreign income in an Indian ITR:

• Taxable in Both Countries and Tax Relief Claimed: If the foreign income is taxable in both India and another country, and the NRI claims tax relief in India, they must file Schedule FSI and Schedule TR.