Cross Boarder Transaction – Minimization of Impact of withholding Tax deducted in Foreign Country

 

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.

 

Taxation under Section 115BAC of Income Tax Act

 

Taxation for Individual/HUF (Resident or Non-resident) Opting for taxation under Section 115BAC

 

a)      Concessional Tax rates

Total Income	Tax rate
Upto Rs. 2,50,000	NIL
From Rs 2,50,001 to Rs 5,00,000	5%
From Rs 5,00,001 to Rs 7,50,000	10%
From Rs 7,50,001 to Rs 10,00,000	15%
From Rs 10,00,001 to Rs 12,50,000	20%
From Rs 12,50,001 to Rs 15,00,000	25%
Above 15,00,000	30%

 

b)      Conditions to be full-filled for availing option u/s 115BAC

 

Particulars	Individual, not having income from business or profession. (Employee)	Individual or HUF,  having income from Business or Profession
How to avail Option  u/s 115BAC	In order to avail option for any assessment year, Assessee needs to file FORM 10-IE, before due date of filing ITR.	i.     In order to avail option for any assessment year, Assessee needs to file FORM 10-IE, before due date of filing ITR.  ii.     Option once exercised for any AY, will continue to apply for subsequent AY mandatorily. iii.     Assessee can withdraw the option and once he do it, then this option cannot be avail again. He can avail the option again, if he ceased to carry on the business.
Deductions/  exemption not Allowed	i.     Leave travel concession/allowance ii.     House Rent Allowance iii.     Allowances specified u/s 10(14). However Travel allowance, transfer allowance and Conveyance allowance is allowed as a deduction. iv.     Free food provided by an employer through paid voucher, having value upto Rs. 50/meal. v.     Daily allowance /constituency allowance received by MP/MLA vi.     Standard Deduction from Salary and deduction on account of Entertainment allowance and Professional tax. vii.     Interest on Housing loan on self-occupied Property viii.     No standard deduction from Family pension. ix.     Deduction under chapter VIA, other than employer contribution to NPS x.     Exemption of Rs. 1500 on account of clubbing of Minor Income	i.     Interest on Housing loan on self-occupied Property  ii.     Exemption to units in SEZ iii.     Additional Depreciation. iv.     The depreciation on any block of assets, where depreciation rate is more than 40%, will be restricted to 40% only.  v.     Investment in new plant or machinery in notified backward areas in certain States (Section 32AD) vi.     Tea /Coffee/ Rubber Development account Section 33AB vii.     Specific expenditure on scientific expenditure- Section 35 viii.     Deduction in respect of expenditure on specified business- Section 35AD ix.     No standard deduction from family pension  x.     Deduction under chapter VIA, other than deduction in respect of new employee u/s 80JJAA xi.     Exemption of Rs. 1500 on account of clubbing of Minor Income
Losses Set-off Provisions , when option u/s 115BAC is exercised	a)  Bought forward Loss under the head  “PGBP” and “Capital Gain”, if attributable to deductions not allowable u/s 115BAC, will NOT be set-off  and will lapse forever b)  Other Bought forward loss under the head  “PGBP” and “Capital Gain”, can be set-off, if any and can be further carried forward, if any c)   Bought forward unabsorbed ADDITIONAL depreciation CANNOT be set-off and will lapse forever. d)  Bought forward unabsorbed depreciation (NORMAL),  can be set-off and further carried forward, if any. e)  Loss under the head “Income from House property” i) Bought forward loss on account of self-occupied property, CANNOT be set-off against income from house property and such loss will lapse forever. ii)      Bought forward loss on account of Let out property, CAN be set-off against income from house property and such loss can be carried forward, if not set-off. iii)    Current Year Loss CANNOT be set-off against any other income and such loss will lapse forever. Refer Example below
Others		If option for section 115BAC is availed for AY 2021-22, the WDV of block of Assets as at 1-4-2020, shall be increased by bought forward unabsorbed ADDITIONAL DEPRECIATION disallowed as above If Option is exercised after AY 2021-22, then above benefit of increasing WDV of Block of Assets is not available.

 

 

c)       Other Points- The following special income will continue to be taxable at special rates mentioned in respective sections

i)                    Short Term Capital Gains u/s 111A

ii)                   Long term Capital Gains u/s 112

iii)                 Long term capital gains u/s 112A

iv)                 Tax on winning from lotteries etc. us/ 115BB

v)                  Tax on unexplained credit, unexplained investment etc. u/s 115BBE

vi)                 Tax on income from patent u/s 115BBF

 

 

Example

1.       Mr. A is working as an employee in PY 20-21 and as at 31/3/2020, he was entitled to carried forward the following Losses from business, which was stopped in FY 19-20.

a)      Business Loss (Not due to deductions not allowed u/s 115BAC) – Rs. 5,00,000

b)      Bought forward unabsorbed Additional Depreciation – Rs. 3,00,000

c)       Bought forward unabsorbed Normal Depreciation – Rs. 1,00,000

 

If Mr. A avail option for taxation u/s 115BAC, the following consequences will prevail

i)                    He can continue to carry business loss of Rs. 5 lacs and can set-off such business loss , if starts business in future  within the time frame within which such loss is allowed to set-off.

ii)                   Bought forward unabsorbed Additional depreciation of Rs. 3 lacs will lapse forever.

iii)                 He can continue to carry unabsorbed Normal Depreciation of Rs. 1 lakh and can set-off such depreciation, if starts business in future.

 

2.       Mr. A is having bought forward loss under the head ‘Income from House Property”  ,on account of self-occupied property ,to the extent of Rs. 1,60,000 as at 31-03-2020. He has Income from house property in PY 20-21 – Rs.1,70,000. If Mr. A opts for taxation u/s 115BAC in PY 20-21, he cannot set-off of Rs. 1,60,000 against income of Rs. 1,70,000 and such loss will lapse forever, even if he does not opt for taxation in subsequent PY 21-22.