Entering the world of international taxation? Imagine foreign tax credits as a handy tool to avoid paying taxes on the same income in both your home country and abroad. It’s like a financial strategy that prevents double taxation headaches for individuals and businesses dealing with global tax complexities. Let’s dive into the basics of Foreign Tax Credit in India, in this blog for a smoother journey through the world of international taxes.
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Meaning of Foreign Tax Credit
The concept of a foreign tax credit serves as a protective measure that ensures you do not have to pay taxes twice on a single income. This is the way it operates. Your home country provides acknowledgement for the foreign taxes you pay when you generate income in another country. By following this approach, you can prevent double taxation on your income from both nations. It serves as a method to promote fairness in global financial transactions and prevents individuals from being subject to paying taxes twice on their earned income.
Foreign Income Taxation Rule
The taxes will be levied on two basic criteria:
- Residence Rule: The determination of residency for tax purposes is governed by the residence rule in the realm of taxation, whereby a country determines whether an individual or their business is considered a resident. Put simply, if you reside in a particular country for a significant duration, that country may categorize you as a resident and enforce its tax regulations on your earnings. Determining your place of residence typically requires examining factors such as the duration of your stay in the country or other indicators specified in the tax regulations.
- Source Rule: Now, the source rule redirects attention to the origin of your earnings. It can be compared to stating that a nation has the authority to impose taxes on income generated within its territories. The source rule enables countries to govern and levy taxes on economic activities occurring within their territories.
Income Tax Rules such as Rule 128 of the Income Tax Act and Rule 115 of the Income Tax Rule are also related to foreign tax credits. Let us analyse a situation: Picture someone from India who possesses property in the United Kingdom and desires to put it on the market. This is what occurs regarding taxes, so below is a foreign tax credit example:
- In the UK, he is required to pay taxes on the earnings he obtains by selling the property, as per the regulation that dictates taxes be paid in the place where the income is generated (source rule).
- However, as he is a resident of India, the tax system of India applies the residence rule, which means that any income he earns globally is liable to be taxed in India. Therefore, when filing his income in India, he must incorporate the earnings gained from the sale of the property in the UK.
This situation may result in the same earnings being taxed twice, which ultimately diminishes the total amount of money he can retain. To prevent this from happening, governments establish agreements with one another, such as the Double Taxation Avoidance Agreement (DTAA). Its purpose is to guarantee that people do not encounter multiple taxations on their income, fostering an equitable and transparent tax framework for all individuals.
How do I avoid double taxation?
Double Taxation Avoidance Agreements (DTAA) are crucial for individuals dealing with income in multiple countries, so foreign tax credits in India can be managed like this:
- Section 90: This section empowers the Indian government to enter into agreements with other countries to avoid the burden of double taxation for its residents. In simpler terms, if you’re a taxpayer with income in both India and another country, Section 90 allows you to benefit from the terms of the DTAA between India and that specific country. This agreement outlines which country has the primary right to tax certain types of income, ensuring a fair and transparent taxation system.
- Section 91: Section 91 comes into play when there is no DTAA between India and a particular country. In such cases, it provides relief to Indian residents by allowing them to claim a tax credit for taxes paid in the foreign country. This prevents double taxation and aligns with the principle that income should be taxed only once, either in India or in a foreign country
How do I claim a foreign tax credit in India?
To claim FTC, it is necessary to submit Form 67 through the Income Tax Portal before the designated deadline for filing the ITR.
- A declaration of the calculation of earnings from the country, excluding India.
- A record of the foreign tax withheld, including evidence such as a challan or TDS receipt.
- A document or official record that outlines the type of earnings and the way taxes were subtracted, either by a foreign tax agency or by the entity responsible for deducting the taxes.
Other relevant details
- The FTC can be used to offset the tax, surcharge, and cess payment obligations as per Indian tax laws, but it cannot be applied towards interest, fees, or penalties, so people need to know how to use foreign tax credits.
- The FTC, which stands for Foreign Tax Credit, refers to the total sum of credit amounts that are calculated individually for every source of income that comes from a particular country.
- The FTC can be utilized to offset the tax, surcharge, and cess owed under Indian tax regulations; however, it cannot be used for fee, interest, or penalty payments.
- If there is a dispute regarding the foreign tax, the FTC will not be accessible.
- The FTC will be applicable in the year when the income is subjected to taxation in India.
- Foreign Tax Credit in India can be claimed for the tax payable under Section 115JB of the Income Tax Rules, which pertains to Minimum Alternate Tax.
- The Foreign Tax Credit (FTC) will be determined as the lesser amount between the tax payable on the income under Indian tax laws and the foreign tax that has been paid.
- To calculate the foreign tax credit calculation in India, you convert the currency in which the foreign tax was paid or deducted at the Telegraphic Transfer Buying Rate on the last day of the month, just before the month in which the tax was paid or deducted.
Final Words
In conclusion, the Foreign Tax Credit acts as a bridge in the international tax landscape, allowing taxpayers to offset taxes paid in a foreign jurisdiction against their domestic tax liabilities. This not only promotes fair taxation but also encourages global economic activity by removing the burden of double taxation. As businesses and individuals engage in an increasingly interconnected world, the Foreign Tax Credit stands as a valuable instrument in developing balanced and equitable taxation across borders.
