Cross Boarder Transaction – Minimization of Impact of withholding Tax deducted in Foreign Country
In view of integration of Indian economy with rest of world, the cross broader transaction has become norm of the day. In order to maximize the state revenue, every country is strategizing the novel ways to levy and collect tax on such transaction. In view of wafer thing margin in competitive scenario, it is imperative for Indian counterpart to do proper planning for withholding tax deducted in the foreign country, otherwise same will be dead loss for the for the Indian entity. In this piece, I will delve upon how an Indian entity can minimize the impact of such foreign withholding taxes.
In India, the foreign taxation is governed by the Interplay of Income Tax Act, 1961 and Double Taxation Avoidance agreement (DTAA), which Indian has entered into with various countries. Among other things, DTAA governs the following:-
a) It allocates the taxing right on income accruing in cross boarder transaction to both or either countries
b) It provides mechanism for avoidance of double taxation, where the both the states has taxing right on such Income
c) Resolution of cases, where taxation is not in accordance with DTAA, though Mutual agreement Process (MAP).
Before proceeding further, I would like to succinctly apprise provision of section 5, which provide that for an Indian resident, his global income is taxable in India. Thus Income earned aboard is taxable in India, even though taxes have been paid outside India. In ensuing discussion, I am touching upon the cases, whereby the impact of foreign taxes can be minimized.
To better understand the captioned subject, withholding taxes deducted in foreign country can be divided into 3 categories
a) Withholding taxes deducted by foreign country as per taxing rights allocated under DTAA
b) Withholding taxes deducted by foreign country, with which Indian does not have DTAA
c) Withholding taxes deducted by foreign country in excess of rights allocated by DTAA
v Withholding taxes deducted by foreign country as per taxing right allocated under DTAA
1. In case foreign country has deducted tax as per allocated rights, then DTAA also mandated the resident Country (India, as recipient is resident of India) to give assessee, credit of taxes deducted/paid in foreign country against Indian tax liability. As a result thereof, Indian assessee can reduce his Indian income tax liability for taxes paid in foreign country in prescribed manner.
2. The credit of foreign taxes is limited to the lower of the following:-
a) Taxes paid in foreign country or
b) Indian taxes attributable to Foreign Income on average basis
3. India has issued detailed rules and procedure to enable assessee to claim credit for foreign taxes deducted/paid as per DTAA.
v Withholding taxes deducted by foreign country, with which Indian does not have DTAA.
1. Section 91 of the Income Tax Act, governs the provisions relating to avoidance of double taxation, where Indian resident has paid taxes in foreign country, with which India does not have DTAA. In such case double taxation avoidance is done through credit of foreign taxes against Indian tax liability in prescribed manner. The main pre-requisite for obtaining such advantage is to establish that concerned income has accrued or arise in the foreign country in which tax has been deducted. If foreign country has deducted taxes, even though income has not accrued in said foreign country, then section 91 is no benefit to Indian resident. For example, Indian resident has supplied goods to foreign country, as per terms the ownership of the goods is transferred in India, then under general law, no income has accrued outside India. But in such case, there is possibility that foreign buyer may deduct withholding tax under the force of his foreign country legislation. This aspect will vary on case to case basis
2. The credit of foreign taxes will be lower of the following
a) Sum calculated by applying Indian rate (Calculated on average basis) of tax on Foreign Income or
b) Sum calculated by applying rate of tax of foreign country on foreign Income
The difference in the operation of DTAA and section 91, with reference to credit of foreign taxes, exemplified is 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. |
Foreign Tax Credit (FTC) (B) (Foreign tax is less than Indian tax) |
15,000 |
|
|
5. |
Foreign Tax on foreign 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 |
Important point
If on aggregate basis, the Indian Total Income in ZERO or negative figure, then foreign taxes paid will be total loss to assessee, as no credit will be allowed against India tax liability, which is NIL. Such taxes can also not be claimed as business deduction in view of provision of section 40a(ii)
v Withholding taxes deducted by foreign country in excess of rights allocated by DTAA or in case income does not accrue in foreign country.
1. In such scenario, Indian assessee will not be able to claim the credit of foreign taxes paid against Indian Tax liability
2. The recourse available to Indian assessee is to file an Income Tax return in foreign country and claimed refund of taxes so deducted in foreign country.
3. In case, where foreign Taxation authority declined to give refund, the Indian assessee can trigger the Mutual agreement process (MAP) under DTAA, whereby it can approach to Indian Government (Indian Competent Authority)through filing of FORM 34F. If Indian Assessee application is accepted by Indian Competent Authority, then Indian Government will approach to foreign Competent Authority for resolution of matter. If through this process also, matter remains unresolved, the foreign taxes will be loss to an Indian entity
Thus In cross broader transaction, Indian entity should properly plan how it can minimize the impact of foreign taxes, otherwise it will be a loss to the assessee.
