Foreign Tax Credit - Draft Rules - Critical Analysis

Draft Rule for grant of Foreign Tax Credit (FTC) – Critical Analysis

Section 295(2)(ha) of Income Tax Act empower CBDT to notified rules providing for procedure for granting relief or deduction of Foreign tax u/s 90 or 90A or 91, against Income Tax payable under the Act.

CBDT has issued Draft Rules in connection with grant of Foreign tax Credit

The analysis of the Draft Rules is carried out in 3 parts:-

a)      Existing provisions of section 90 & 91 relating to Foreign Tax Credit and what these sections provide.

b)      The vacuum/lacuna, which proposed rule intends to supplement.

c)       The Contradiction between proposed rule and section 91.

Ø  Existing Provisions

The Provisions relating to grant of FTC is regulated by existing provisions of Income Tax Act, as under:-

1.       Double Taxation Avoidance Agreement (DTAA) entered  with other Countries u/s 90

2.       Section 91 in cases, where foreign tax relates to country with which India does not DTAA

DTAA entered into by India and Section 91 provides the methodology for Quantification of FTC as under:-

S.No.	Particulars	DTAA (In general)	Section 91
1.	Method	Credit Method	Credit Method
2.	Quantification of FTC	Foreign Tax paid by resident of India, will be allowed credit of such taxes against Indian tax payable on foreign source income, which is subjected to tax in foreign Country and India. The amount of FTC will be lower of foreign Tax paid or that proportion of Indian tax which Foreign source income bear to Total Income of Resident.	Foreign Tax paid by resident of India, will be allowed credit of such taxes, against Indian tax payable on doubly taxed income. The amount of FTC will be the lower of sum calculated by applying Indian rate of tax or rate of tax of foreign country, on doubly taxed income. (Refer Note)

Note:

1.       India rate of Tax – Amount of Indian Income Tax (before Relief u/s 91)/Total Income

2.       Rate of tax of foreign Country – Income Tax paid in Foreign Country/Income assessed in Foreign Country.

The difference in the operation of DTAA and section 91 with respect to quantification of FTC is illustrated as under:-

a)      Foreign Source Gross Income – Rs. 1,00,000

b)      Tax rate on Gross basis in Foreign Country – 15%

c)       Tax paid in foreign country – 15,000

d)      Net Expenses in India on such Foreign source Income – Rs. 40,000

e)      Net Income in India – Rs. 60,000

f)       Tax rate in India – 30%

S.No	Particulars	Relief under DTAA	Relief u/s 91
1.	Tax in India (A)	18,000	18,000
2.	Proportion of Foreign Income to Total Income (60,000 (net of Expenses)/60000)	100%
3.	Foreign Tax paid	15,000
4.	FTC (B) (Foreign tax is less than Indian tax)	15,000
5.	Foreign Tax on doubly taxed income by applying rate of tax of foreign Country – 15% of Rs. 60,000,since same is less than Indian rate tax of 30%.		9,000
6.	FTC (C )		9,000
7.	Net Indian Tax after FTC (A-B)/(A-C)	3,000	9,000

Thus where foreign tax is based on gross basis and Indian tax is applicable on net basis (net of expenses), the amount of Foreign tax available for credit will always be less than actual foreign taxes paid u/s 91.

Ø  Draft Rules

The draft rules proposes to abrogate the following ambiguities surrounding the FTC procedure:-

1.       Year in which FTC can be claimed – An assessee can claim FTC in the year in which foreign source income is offered for tax in India- Rule 1

2.       Taxes against which FTC can be claimed – The FTC will be available against the amount of tax, (Including MAT) surcharge & cess payable under Income Tax Act but not in respect of Interest, fee or penalty payable under the Act.- Rule 3 & 6

3.       Foreign Tax paid in Dispute – whether eligible for FTC – No credit will be available in respect of amount of foreign tax paid  , which is disputed by assessee – Rule 4

4.       Documents required for Claiming FTC – TDS Certificate from Foreign Payer, Bank acknowledgement (where foreign tax is paid by assessee himself) & declaration that foreign tax paid is not under dispute.- Rule 8

5.       Conversion of Foreign Taxes into INR – Conversion is to be done on Telegraphic Transfer buying rate on the date on which tax has been paid or deducted in foreign country.- Rule 5

6.       Computation of Foreign taxes – Individual basis or Aggregate basis – The draft rule suggest reckoning of Foreign taxes on Individual basis (Rule 5), elucidated as under:-

a)      Foreign Income in Country A – Rs. 1,00,000, Tax paid – Rs. 20,000

b)      Foreign Loss in Country B – Rs. 80,000

c)       Income in India – Rs. 1,80,000, tax rate in India – 30%

d)      Total Income in India – 2,00,000 (1,80,000+1,00,000-80,000)

e)      Total Tax in India @ 30% - Rs. 60,000

f)       Foreign Tax Credit

i)                    Aggregate Approach – Total Foreign Income is Rs. 20,000, which is 10% of Total Income (20,000/2,00,000). Foreign Tax Credit will be lower of Rs. 20,000 (Foreign Tax) or 10% of Rs. 60,000 (Indian tax) i.e 6,000. Thus FTC will be restricted to Rs. 6,000

ii)                   Individual Approach – Foreign Income of Country A – Rs. 1,00,000, which is 50% of Total Income. Foreign Tax Credit will be lower of Rs. 20,000 (Foreign tax) or 50% of Rs. 60,000 i.e Rs. 30,000. Thus FTC will be Rs. 20,000. No such working will be done for Country B, since no foreign tax is paid in Country B.

iii)                Thus Rule 5 advocates Individual approach for determination for foreign Taxes for credit purpose..

This rule seems to be in conformity with ratio laid down by Bombay High Court in CIT vs. Bombay Burmah Trading Corporation Ltd 259 ITR 423

Ø  Contradiction between Draft Rules & Section 91

1.       Rule 5 postulates that credit for foreign taxes shall be the lower of the tax payable under Income Tax Act on foreign source income and the foreign tax paid on such income.

2.       There seems to be incongruity between said rule and provision of section 91 as regard the quantification of FTC.

3.       Under section 91, the actual foreign tax paid is not compared with Indian tax on foreign source income to determine the lower amount to arrive at FTC. It is a Foreign Tax rate which is compare with Indian tax rate and lower of them is applied on foreign source Net income to determine the amount of FTC. The latter part makes difference, when an income is taxable on Gross basis in foreign country and on net basis in India, as exemplified above. Thus rule 5 needs to be modified to bring it in harmony with section 91 or else it should be restricted to the following only:-

a)      Determination of amount of Foreign Taxes for credit on Individual basis

b)      Conversion of Foreign Taxes into INR.

The draft rules should cover only those aspects of FTC procedure, which is not provided in the statue and quantification of FTC, which is already taken care by section 91, should not be embroil in the Procedure again.