Foreign Tax Credit – Act, Rules, Treaties, and Judicial Precedents – Road to Confusion Ahead
Today, if one were to discuss the various provisions of the Income-tax, 1961 one area which would elicit different responses would be the mechanism for computation of Foreign Tax Credit.
Central Board of Direct Tax (‘CBDT’) set up a Committee to suggest the methodology for grant of Foreign Tax Credit (FTC) after examining the various issues related to it. CBDT by Income Tax (18th Amendment) Rules 2016 inserted Rule 128 to Income Tax Rules, 1962 (‘the Rules’) providing the rules for grant of Foreign Tax Credit based on the report of the Committee.
Let’s analyze the Rules laid out by CBDT, certain recent judicial precedents and provisions of tax treaties entered in to by India on eligibility and mechanism for the claim of FTC.
As per the Rules
Taxpayer being a resident shall be allowed a credit for the amount, by way of deduction or otherwise of any foreign tax paid by him in a country or specified territory outside India.
FTC shall be available to the taxpayer in the year in which the income corresponding to such foreign tax has been offered/assessed to tax in India. FTC shall also be available
Where the income corresponding to foreign tax is offered to tax in more than one year, FTC shall be available across those years, in proportion to the income offered/assessed to tax in India.
Recent Judicial Precedent
The Hon’ble Karnataka High Court in the case of Wipro Limited v. DCIT allowed the claim of FTC of the taxpayer of credit of taxes on incomes were exempt from levy of tax under the Income-tax Act, 1961 (‘the Act’) by virtue of provisions of section 10A of the Act. The Hon’ble Court in coming to its conclusion relied upon the provisions of section 90(1)(a) of the Act, the provisions of the tax treaties and concluded as under:
Provisions of the Act
Relevant Treaty Provisions for Elimination of Double Taxation
The conclusion of the Hon’ble Court
90(1)(a)(i) of the Act dealing with incomes on which tax has been paid under the Act and under the corresponding Act in other country or specified jurisdiction
Article 23(3)(a) of India Canada Double Taxation Avoidance Agreement
Relief for taxes paid in Canada would be available in India only in the case where tax is payable on such income in India.
Further, the tax credit would be restricted to the extent of the proportion of Indian tax payable on such income
Section 90(1)(a)(ii) dealing with incomes which are chargeable to tax under the Act and under the corresponding law in the other country or specified territory
Article 25(2) of the India United States of America Double Taxation Avoidance Agreement
FTC would be available in India if such income has been taxed in the USA.
The tax liability of such income under the Act in the hands of the taxpayer on such income is irrelevant.
The tax credit in such a case is restricted to the tax liability on such income in India.
The Rules though state that FTC would be available only if incomes from a foreign country are offered to tax in India, accordingly it would appear that any incomes which are exempt from levy of tax in India, may not be eligible for the credit of taxes paid in the overseas country.
B. Mechanism of computing FTC
Under normal provisions of the Act
Rules provide that credit of FTC shall be the aggregate of the amounts of credit computed separately for each source of income arising from a particular country. Further, the credit allowable shall be the lower of the
tax payable under the Act on such income and
Foreign tax paid on such income.
Though the above Rule appears simple to implement, considering that under the regular provisions of the Act incomes are taxed at various rates and not a single rate of tax, there could be 2 methods of computing the FTC:
FTC should be computed by apportioning the entire tax liability in the ratio of doubly taxed income to the total income
FTC should be computed by apportioning the tax liability on a particular source of income in the ratio of doubly taxed income to the total income from such source
Under Minimum Alternate Tax (‘MAT’) or Alternate Minimum Tax (‘AMT’) provisions
In case where tax is payable under MAT or ‘AMT’, the rules provide that the same is to be computed in similar manner as done in case of normal provisions of the Act.
The issue of multiple rates of tax though would not arise in the case where tax is levied under MAT/AMT.
However, a key issue to address while computing credit under MAT/AMT provisions would be the methodology to be adopted in computing the doubly taxed income whether the same would mean the gross receipts or only the net taxable book profits from such source.
Recent judicial precedent
Recently, the Ahmadabad Bench of the Income-tax Appellate Tribunal (‘ITAT’) in the case of Elitecore Technologies Private Limited Vs. DCIT(ITA No. 623/Ahd/2015) while dealing with the claim of FTC in the case where the taxpayer was liable to tax under MAT provisions, has held that Net Income approach rather than gross income to be taken into account for the purpose of computing FTC.
The Honourable ITAT placed reliance on the UN Model Commentary and held that the gross receipts less any allowable deductions (specific or proportional) that are connected with such income are to be considered to ascertain the doubly taxed income.
MAT/AMT Credit to be carried forward
For the purposes of computing the MAT/AMT credit available to be carried forward in a year in which taxes are paid under MAT/AMT, the Rules provide that difference between the FTC available under the regular provisions of the Act and under MAT provisions would be ignored.
Amount (in INR)
Receipts from Foreign Country (Exempt fully under section 10AA) of the Act
Expenditure incurred/attributable on the above
Tax deducted on the same in Foreign Country
Taxable Income under normal provisions of the Act
Tax Liability on the same
Taxable book profits under section 115JB
Tax Liability on the same
In the above scenario, a taxpayer would generally be allowed to carry forward a sum of INR 66 (i.e 111 – 45) as MAT credit for the purpose of utilization in subsequent years.
However, by virtue of sub-rule 6, the taxpayer would be allowed to carry forward MAT credit of Rs. 10 as computed below:
Amount (in INR)
a. MAT Credit as computed above based on Provisions of the Act
b. Foreign tax credit available under MAT provisions
(Total Tax Liability * Doubly Taxed Income / Total Taxable Income)
(111 * 300/600) = 56
c. Foreign tax credit available under regular provisions of the Act
(Total Tax Liability * Doubly Taxed Income / Total Taxable Income)
( 45 * 0 / 150) = 0
Excess to be ignored (d = b-c)
MAT Credit allowed to be carried forward
The above Rule restricting the claim of carrying forward of MAT/AMT credit prima facie appear to be in conflict with the provisions of the Act as the provisions of the Act dealing with MAT/AMT credit do not provide for such restriction
Further, the powers bestowed upon the CBDT were only to notify the procedure for granting relief or deduction of any income-tax paid in any country or specified territory outside India against the tax payable under the Act and no powers have been bestowed on the CBDT for the purposes for computation of MAT/AMT credit.
Further, as the provisions of the tax treaties clearly provide for eligibility and mechanism, the Rules to the extent they are not beneficial to the taxpayers, a view could be taken that such Rules are not applicable to the taxpayers.
C. The eligible claim of FTC in excess of total tax liability under the Act
In case of domestic losses suffered by taxpayers, the tax payable under the Act would be lower than the foreign tax paid by the taxpayer. On applying the source wise formula prescribed in the Rules, FTC would be higher than the tax liability of taxpayer.
In such a scenario, the tax authorities would contend that the FTC should be restricted to the tax liability in India. The same has been upheld by the Mumbai Bench of the ITAT in the case of JCIT v. Digital Equipments India Limited (2005) 94 ITD 340 while dealing with a claim of FTC under the India- USA DTAA.
However, on a plain reading of the Rule, there appears to be no restriction on the claim of FTC in case the tax liability is lower than the eligible FTC. Further, a few tax treaties provide that an India would allow the entire taxes paid in the other country as credit in India.
The India Namibia Double Taxation Avoidance Agreement (‘DTAA’) provides that in India, double taxation would be eliminated as follows:
“Where a resident of India derives income or capital gains from Namibia, which, in accordance with the provisions of this Convention may be taxed in Namibia, then India shall allow as a deduction from the tax on the income of that resident an amount equal to the tax on income or capital gains paid in Namibia, whether directly or by deduction”
Now, in a case where the tax treaty clearly lays out that India would allow the entire amount of tax paid in the other country as credit in India, will the taxpayer be eligible for the refund of the FTC from the Government of India, remains a question which would surely have protracted litigation.
D. Treatment of unutilized FTC
The Rules do not cover the treatment of unutilized FTC. One view would be that the portion of unutilized FTC would be a sunk cost as the tax is a charge on profits/income and the payment of such taxes is made not with a view to earning such incomes.
Recently though, the Hon’ble Bombay High in the case of Reliance Infrastructure Limited v. CIT (IT No. 75 of 1998) had on occasion to deal with the claim made by the taxpayer in its favor by treating the unutilized foreign tax credit as an allowable expenditure.
The basis of the above decisions, one may take a view that the unutilized tax credit should be an allowable expenditure in the hands of the tax-payer.
However, say in case the incomes fall under any of the special income categories (i.e dividend income from foreign associate/subsidiary or royalty income taxable under the patent box regime) which are taxable at ‘gross’ basis and since the provisions of the Act clearly provide that no deduction of any expenditure or allowance would be provided for such incomes, the unutilized FTC would remain a sunk cost. However, in the case of capital gains, the unutilized FTC may be claimed towards cost incurred on the transfer of such assets.
With neither the eligibility nor the mechanism for computation of FTC clear and the treatment of unutilized FTC unclear from the Act and Rules, taxpayers by placing reliance on judicial precedents, would face resistance with tax officers and would invariably end up with protracted litigation.
While the CBDT sought to lay the roadmap for the computation of FTC bysetting up a Committee, it appears that it has racked up more issues than solving them.
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