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.

 

Residential Status of Individual - Section 6 of Income Tax Act, 1961

 

Residential Status of an Individual

 

Finance Act 2020 has heralded a momentous variation in determination of Residential status of an Individual, which was hitherto exclusively based on an Individual stay in India.

By virtue of amendment in section 6, residential status of an individual (From Assessment year 21-22 and onwards) inter-alia, is made contingent upon citizenship of an Individual, Total Income and his residential status in other country.

Ø  The residential status of an individual will be determined as under;-

a)      Not being Citizen of India and person of Indian Origin

Particulars	Stay in India in PY (Days)	Stay in Indian in Preceding 4 PY (Days)	Total Income, other than income from  foreign Source, in PY	Remarks
Normal Stay in India	182 days or more	Any number of Days	Any Amount	Resident. Section  6(1)(a)
Normal Stay in India	60 days or more	365 days or more	Any Amount	Resident. Section  6(1)(c)

 

b)      Citizen of India

Particulars	Stay in India in PY (Days)	Stay in Indian in Preceding 4 PY (Days)	Total Income, other than income from foreign Source, in PY	Remarks
Normal Stay in India	182 days or more	Any number of Days	Any Amount	Resident. Section  6(1)(a)
Normal Stay in India	60 days or more	365 days or more	Any Amount	Resident. Section  6(1)(c)
Normal Stay in India	Less than 60 Days	Any number of Days	Exceeding 15 lacs	Resident but not ordinary Resident, if he is not resident of any other country. Section 6(1A)
Leaves India as member of crew of an Indian ship or for employment outside India	182 days or more	Any number of Days	Any Amount	Resident. Clause (a) to Explanation 1 to section 6(1)
Leaves India as member of crew of an Indian ship or for employment outside India	Less than 182 days	Any number of Days	Exceeding 15 lacs	Resident but not ordinary Resident, if he is not resident of any other country. Section 6(1A)
Individual stays outside India and comes on visit to India	182 days or more	Any number of Days	Any Amount	Resident. Clause (b) to Explanation 1 to section 6(1)
Individual stays outside India and comes on visit to India	120 days or more	365 days or more	Exceeding 15 lacs	Resident but not ordinary Resident. Clause (b) to Explanation 1 to section 6(1)
Individual stays outside India and comes on visit to India	120 days or more but less than 182 days	Less than 365 days	Exceeding 15 lacs	Resident but not ordinary Resident, if he is not resident of any other country. Section 6(1A)
Individual stays outside India and comes on visit to India	Less than 120 days	Any number of Days	Exceeding 15 lacs	Resident but not ordinary Resident, if he is not resident of any other country. Section 6(1A)

 

c)       Person of Indian Origin

Particulars	Stay in India in PY (Days)	Stay in Indian in Preceding 4 PY (Days)	Total Income, other than income from foreign Source, in PY	Remarks
Normal Stay in India	182 days or more	Any number of Days	Any Amount	Resident. Section  6(1)(a)
Normal Stay in India	60 days or more	365 days or more	Any Amount	Resident. Section  6(1)(c)
Who stays outside India and comes on visit to India	182 days or more	Any number of Days	Any Amount	Resident. Clause (a) to Explanation 1 to section 6(1)
Who stays outside India and comes on visit to India	120 days or more	365 days or more	Exceeding 15 lacs	Resident but not ordinary Resident. Clause (b) to Explanation 1 to section 6(1)

 

 

Ø  Determination of Total Income, other than Income from foreign source

 

1.       Explanation, after Section 6(5) defines Income from foreign source , as Income which  accrue outside India (except Income derived from a business controlled in or a profession set up in India) and which is not deemed to accrue or arise in India

2.       Ignoring the technicalities associated with determination of Total Income, which is dealt at point no. 3, the Total Income, in literal sense,  for purpose of section 6 will be computed in following manner,  exemplified by way of illustration as under:-

a)      Domestic Income – Rs. 10,00,000 (A)

b)      Income from foreign Sources

i)                    Income from business (in foreign Country) controlled in India – Rs. 3,00,000 (B)

ii)                   Other foreign source Income – Rs. 12,00,000 (C)

c)       Total Income for the purpose of Section 6 = A+B, i.e. Rs. 13,00,000

3.       Present amendment in section has created situation of Catch-22 for Individual, enunciated as under

a)      Section 5 – Total Income of Individual is based on Residential Status

b)      Section 6 – Residential Status of Indian Citizen is also dependent upon Total Income

c)       Example – Suppose Mr. X , an Indian Citizen has following income particulars for PY 20-21

i)                    Stay in India in FY 20-21- 40 days and he is not treated as resident of any other foreign country.

ii)                   Income accrued in India – Rs. 6,00,000

iii)                 Income accrued from foreign business, controlled in India – Rs. 9,10,000

d)      In above example,  following consequences emerges

i)                    Rs. 9,10,000 is taxable in the hands of Mr. X, when he is treated as “Resident but not ordinarily resident”

ii)                   Under amended section 6(1A), he is treated as “Resident but not ordinarily resident” when his total income exceeds Rs. 15 lacs and calculation of total income is dependent upon residential status.

iii)                Thus total income cannot be computed till residential status is determined (As per section 5) and residential status cannot be finalized, till total income is calculated (section 6)- Catch 22 situation

 

e)      In view of above, in my humble submission, we need to resort to intention behind enactment of said legislation i.e. Heydon’s Rule of Interpretation of Statue. The amendment was done to tax the High income individual, who are managing their stay in India in such a way that, they are not resident of India (Non-resident) and hence their income from business carried outside India, but controlled from India, remains out of taxation purview. To determine, High Income individual, a benchmark of 15 lacs is fixed under law. Thus, the “total income” as envisaged in section 6 should be determined in literal sense ignoring the residential status. Post determination of “Total Income”, residential status be determined as per amended section 6.