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What is Foreign Tax Credit?

Updated on: 17 Feb, 2024 02:58 PM

The foreign tax credit is a type of tax relief facility introduced by governments worldwide. Under this facility, a resident taxpayer can claim a credit for the foreign income tax or the income tax paid on the income earned in a foreign country. This helps ensure that an individual pays taxes only once on a particular income and there is no double taxation. This article talks about tax on foreign income in India in detail and also addresses the question “Is foreign income taxable in India?”.

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 foreign tax credit, 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.

If you are someone with foreign income and don’t know how to disclose it in ITR or are confused about foreign income taxation, 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.

Procedure 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.

Foreign Tax Credit Calculation Example in India

If the tax paid in a foreign country amounts to Rs 100, and the income tax, surcharge, and cess payable in India total Rs 90, with an additional Rs 10 in interest under sections 234B and C, only Rs 90 of the foreign tax credit would be eligible. No credit can be applied against the interest under sections 234B/C amounting to Rs 10.

The computation of foreign tax credit involves aggregating the amounts separately calculated for each source of income from a specific country or specified territory. The credit is applied as follows:

  • The credit is capped at the lower of the tax payable under the Indian Income Tax Act on that income and the foreign tax paid on the same income.
  • The credit is determined by converting the currency of the foreign tax payment at the telegraphic transfer buying rate on the date when the tax was paid or deducted.

As a layman, it can be difficult to file Form 67 manually by yourself. Getting the assistance of a CA is the best way to ensure the details provided are correct and accurate and make sure that you get the credit without any hassle.

Frequently Asked Questions

Q- What are the documents required to Claim Foreign Tax Credit?

The assessee should furnish the following information to claim a foreign tax credit -

  • A certificate that specifies the nature of income and the tax paid or deducted.
  • Along with the certificate, the assessee must also submit proof of the payment or tax deducted.
  • The assessee must file Form 67 on the Income Tax Portal while filing the ITR.

Q- Which form is required to claim a foreign tax credit?

Every resident taxpayer is required to fill and furnish Form 67 to claim relief from the foreign tax credit. You must furnish accurate and complete details of your foreign income to benefit from FTC.

Q- What is the applicability of the Foreign Tax Credit in India?

Foreign Tax Credit applies to all Indian residents with a source of income that accrues in a foreign country. Any income earned outside India is taxable both in the country where it is accrued and in India. To avoid double taxation, the government has provided the benefit of FTC, wherein the taxpayer can claim a deduction on the tax paid.

Q- What is Rule 128 of the Income Tax Rules?

As per Rule 128, every Indian resident who pays tax outside the Indian territory for any income earned outside India can receive a credit for such tax paid in the resident country.

Q- How much foreign Income is tax-free as per the Indian Income Tax Act?

As per the IT Act, of 1961, any income up to INR 2,50,000 is exempt from income tax. The foreign income is treated as domestic income, and tax is levied as per the applicable slab rates.

Q- How are sections 90 and 91 related to FTC?

If there exists a DTAA between the two countries, the assessee can claim relief under section 90, and if there is no DTAA between the two countries, the assessee can claim relief under section 91 of the Income Tax Act.

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CA Abhishek Soni
CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.