Seminar on foreign tax credit

Seminar on foreign

tax credit

Ishita Bhaumik and Ramya S Nayak | 04th June 2016

0

Agenda

• Introduction

• Types of double taxation

• Methods to eliminate double taxation

• Economic double taxation

• Juridical double taxation

• Draft CBDT circular in claiming FTC

• Issues in claiming FTC

© 2015 Deloitte Haskins & Sells LLP 1

Introduction

2

Why does double taxation arise

• Many countries adopt a combination of the above taxation concepts

• Thus, double taxation arises when the same income is taxed twice – once in the

country of residence as well as in the country of source-

‒ “May be taxed” scenarios

‒ Interest taxation- restrictive taxation in the source state

3

Scope of taxation

Source based

taxation

Residence based

taxation

Citizen based

taxation

Types of double taxation

4

Types of double taxation

5

• Same income taxed in the hands

of two different persons

• E.g. – Corporate profit taxed in

the hands of the Company and

dividend out of such profits taxed

in the hands of shareholder

• Same income taxed in the

hands of same person in

two different countries

• E.g. – Royalty income

received from India by a

resident of US

Types of double

taxation

Economic

double taxation

Juridical double

taxation

Methods to eliminate

double taxation

6

Overview

Methods to eliminate double taxation

7

Types of double

taxation

Economic double

taxation

Juridical double

taxation

Underlying tax

creditUnilateral Bilateral

Exemption

method

Article 23A

Credit method

Article 23B

Economic double taxation

8

Underlying tax credit (UTC)


• UTC refers to credit that may be given, in Country R, for tax paid on the underlying

profits out of which the dividend is paid by a company in Country S

• E.g. a Company resident in India declares dividend to its foreign shareholder company.

The foreign company receiving dividend then gets credit for corporate tax paid on such

profits by the Indian Company out of which dividend is declared

• There are no provisions in domestic tax laws in India which allow credit for underlying

taxes paid by overseas subsidiaries of Indian Companies

• Thus, application of concept of UTC can arise only if there is a specific provision to that

effect in the tax treaty

• Few countries which allow UTC provisions are - China, Australia, Ireland, Japan,

Malaysia, Mauritius, Singapore, Spain, UK, United Mexican States, USA

• However UTC is available in India only under the DTAAs with Singapore and Mauritius

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Wordings example: India- Singapore DTAA

Where a resident of India derives income which, in accordance with the provisions of this

Agreement, may be taxed in Singapore, India shall allow as a deduction from the tax on the

income of that resident an amount equal to the Singapore tax paid, whether directly or by

deduction. Where the income is a dividend paid by a company which is a resident of

Singapore to a company which is a resident of India and which owns directly or

indirectly not less than 25 per cent of the share capital of the company paying the

dividend, the deduction shall take into account the Singapore tax paid in respect of

the profits out of which the dividend is paid. Such deduction in either case shall not,

however, exceed that part of the tax (as computed before the deduction is given) which is

attributable to the income which may be taxed in Singapore.

10



Wordings example: India- Mauritius DTAA

In the case of a dividend paid by a company which is a resident of Mauritius to a company

which is a resident of India and which owns at least 10 per cent of the shares of the

company paying the dividend, the credit shall take into account in addition to any Mauritius

tax for which credit may be allowed under the provisions of sub-paragraph (a) of this

paragraph the Mauritius tax payable by the company in respect of the profits out of

which such dividend is paid

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Juridical double taxation

12

Unilateral and bilateral tax credit


13

• Refers to relief provided to resident tax

payer under its domestic law

• E.g. – Section 91 of Indian Income-tax

Act provides for unilateral relief in

respect of income which has suffered

tax both in India and in country with

which no tax treaty exists

• Where two countries negotiate an

agreement for providing double taxation

relief, such relief is known as bilateral

relief

• These agreements provide for the right

to a country to tax an item of income or a

taxable person and also provide for the

manner, mode and quantum of tax relief

to be allowed to doubly taxed income

Juridical double

taxation

Unilateral Bilateral

Unilateral tax credit

method

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Unilateral tax treaty


1. If any person who is resident in India in any previous year proves that, in respect of his

income which accrued or arose during that previous year outside India (and which is

not deemed to accrue or arise in India), he has paid in any country with which there is

no agreement under section 90 for the relief or avoidance of double taxation, income-

tax, by deduction or otherwise, under the law in force in that country, he shall be

entitled to the deduction from the Indian income-tax payable by him of a sum

calculated on such doubly taxed income at the Indian rate of tax or the rate of tax of

the said country, whichever is the lower, or at the Indian rate of tax if both the rates are

equal.

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Non-treaty country example- Hong Kong

Unilateral tax treaty


3. If any non-resident person is assessed on his share in the income of a registered firm

assessed as resident in India in any previous year and such share includes any

income accruing or arising outside India during that previous year (and which is not

deemed to accrue or arise in India) in a country with which there is no agreement

under section 90 for the relief or avoidance of double taxation and he proves that he

has paid income-tax by deduction or otherwise under the law in force in that country in

respect of the income so included he shall be entitled to a deduction from the Indian

income-tax payable by him of a sum calculated on such doubly taxed income so

included at the Indian rate of tax or the rate of tax of the said country, whichever is the

lower, or at the Indian rate of tax if both the rates are equal.

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Bilateral tax credit method

17

Bilateral tax credit


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• Under this method, foreign

income is exempt from tax in the

country of residence

• Two types of exemption method –

‒ Full exemption

‒ Exemption with Progression

• Country of residence would determine the resident’s

worldwide income (including the foreign sourced

income) and compute the tax liability thereon

• From the tax liability computed above, Country of

residence would grant a deduction in respect of foreign

tax paid on the foreign sourced income

• Types of credit method –

‒ Full Credit

‒ Ordinary Credit

‒ Tax Sparing credit

Bilateral tax

credit

Credit methodExemption

method

Types of exemption & credit method elaborated in coming slides



Article 23B of OECD-Credit method

• Where a resident of a Contracting State derives income or owns capital which, in accordance with

the provisions of this Convention, may be taxed in the other Contracting State, the first-mentioned

State shall allow:

‒ as a deduction from the tax on the income of that resident, an amount equal to the income

tax paid in that other State;

‒ as a deduction from the tax on the capital of that resident, an amount equal to the capital

tax paid in that other State.

• Such deduction in either case shall not, however, exceed that part of the income tax or capital tax,

as computed before the deduction is given, which is attributable, as the case may be, to the

income or the capital which may be taxed in that other State.

• Where in accordance with any provision of the Convention income derived or capital owned by a

resident of a Contracting State is exempt from tax in that State, such State may nevertheless, in

calculating the amount of tax on the remaining income or capital of such resident, take into account

the exempted income or capital.

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Article 23A of OECD-Exemption method

• Where a resident of a Contracting State derives income or owns capital which, in accordance with the provisions

of this Convention, may be taxed in the other Contracting State, the first-mentioned State shall, subject to the

provisions of paragraphs 2 and 3, exempt such income or capital from tax.

• Where a resident of a Contracting State derives items of income which, in accordance with the provisions of

Articles 10 and 11, may be taxed in the other Contracting State, the first-mentioned State shall allow as a

deduction from the tax on the income of that resident an amount equal to the tax paid in that other State. Such

deduction shall not, however, exceed that part of the tax, as computed before the deduction is given, which is

attributable to such items of income derived from that other State

• Where in accordance with any provision of the Convention income derived or capital owned by a resident of a

Contracting State is exempt from tax in that State, such State may nevertheless, in calculating the amount of tax

on the remaining income or capital of such resident, take into account the exempted income or capital.

• The provisions of paragraph 1 shall not apply to income derived or capital owned by a resident of a Contracting

State where the other Contracting State applies the provisions of this Convention to exempt such income or

capital from tax or applies the provisions of paragraph 2 of Article 10 or 11 to such income.

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Credit method

21

Credit Method – Full credit method


• Country of residence allows deduction of total amount of tax paid in Country of Source

on income which may be taxed in Country Source

• This method ensures that the tax payer gets full credit for the taxes paid in Country of

Source and has to pay only the difference between Country of Residence tax and

Country of Source tax

• Accordingly, total tax liability for the tax payer is the higher of the taxes as per country of

source and taxes as per country of residence

• E.g. India Nambia DTAA

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Wordings example: India- Nambia DTAA

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.

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Illustration

24

Particulars No tax credit Full tax credit

Gross income doubly taxed 100,000 100,000

Less: cost attributable to such income 50,000 50,000

Net taxable income 50,000 50,000

Withholding Tax rate in country of source 10% 10%

Taxes withheld on gross income 10,000 10,000

Tax rate in India 30% 30%

Taxes to be paid in India 15,000 5,000

(15,000-10,000)

Total tax cost 25,000 15,000

(in Rs.)

Credit Method – Ordinary credit method


• Under ordinary credit method,

• Total Foreign tax Credit available in country of residence is lower of the =

‒ Taxes paid on such income in the country of residence as per the domestic tax

laws; or

‒ Foreign taxes paid on such income

• In other words, the tax payer does not get refund of excess foreign taxes paid if the

foreign tax exceeds the home tax on the same income

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Credit Method – Ordinary credit method


Illustration

26

Particulars No tax

credit

Full tax credit Ordinary credit

method

Gross income doubly taxed 100,000 100,000 100,000

Less: cost attributable to such income 80,000 80,000 80,000

Profit from double taxed income 20,000 20,000 20,000

Other income 30,000 30,000 30,000

Net taxable income 50,000 50,000 50,000

Withholding Tax rate in country of source 10% 10% 10%

Taxes withheld on gross income 10,000 10,000 10,000

Tax rate in India 30% 30% 30%

Taxes to be paid in India 15,000 5,000

(15,000-10,000)

9,000

(15,000-6,000)

Total tax cost 25,000 15,000 19,000

(in Rs.)

Credit Method – Tax sparing method


• Concept of ‘tax sparing credit’ means that if income earned in Country of Source is

exempted under the domestic laws (say, section 10 of the Act), the actual tax payment

in Country of Source may be Nil and yet tax payer would get credit of an amount of tax

which would have been paid in Country of Source had there been no such exemption in

domestic tax laws

• Such method can arise only if there is a specific provision to this effect in the treaty

• Almost all tax treaties which India has signed contain tax sparing provisions. For e.g.

India Japan, India Canada, etc.

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Wordings example: India- Japan DTAA

Double taxation shall be avoided in the case of India as follows :

• Where a resident of India derives income which, in accordance with the provisions of this

Convention, may be taxed in Japan, India shall allow as a deduction from the tax on the

income of that resident an amount equal to the Japanese tax paid in Japan, whether directly

or by deduction. Such deduction in either case shall not, however, exceed that part of the

income-tax (as computed before the deduction is given) which is attributable, as the case

may be, to the income which may be taxed in Japan. Further, where such resident is a

company by which surtax is payable in India, the deduction in respect of income-tax paid in

Japan shall be allowed in the first instance from income-tax payable by the company in India

and as to the balance, if any, from surtax payable by it in India.

• Where a resident of India derives income which, in accordance with the provisions of this

Convention, shall be taxable only in Japan, India may include this income in the tax base but

shall allow as a deduction from the income-tax that part of the income-tax which is

attributable, as the case may be, to the income derived from Japan.

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Illustration

29

Particulars Canada India

Interest Income from Government of

India

200,000 200,000

Tax rate 40% 15% as per DTAA but

exempt under 10(15)(iv)

of the Act

Particulars No tax sparing

method

Tax sparing

method

Taxes payable in Canada 80,000 80,000

Less: Foreign Tax Credit (15%*200,000) - (30,000)

Canadian Tax Payable 80,000 50,000

(in Rs.)

Exemption method

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Exemption Method – Full exemption


• Under full exemption method

• Income taxed in the country of source is not included in taxable income of country of

residence

• India generally does not follow exemption method. Exception - India Brazil DTAA

wherein full exemption method is applied in respect of dividend income

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Wordings example: India- Brazil DTAA

• Subject to the provisions of paragraphs 3 and 4, where a resident of a Contracting State derives income which, in accordance with the provisions of this Convention may be taxed in the other Contracting State, the first-mentioned State shall allow as a deduction from the tax on the income of that resident an amount equal to the tax paid in that other State.

• Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given, which is attributable to the income which may taxed in that other State.

• For the deduction mentioned in paragraph 1, the tax paid in that other State shall always be deemed to have been paid at the rate of 25 per cent of the gross amount of interest referred to in paragraph 2 of Article 11 and of royalties referred to in paragraph 2(b) of Article 12, provided however, that the tax so deemed to have been paid shall not exceed the tax leviable on that income in the first-mentioned State.

• Where a company which is a resident of a Contracting State derives dividends which, in accordance with the provisions of paragraph 2 of Article 10 may be taxed in the other Contracting State, the first-mentioned State shall exempt such dividends from tax.

• Where a resident of India derives profits which, in accordance with the provisions of paragraph 5 of Article 10 may be taxed in Brazil, India shall exempt such profits from tax

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Illustration:

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Particulars Country of

Residence

Country

of

Source

Taxable income 700,000 400,000

Tax rate

If income upto

250,000

- 25%

If income is from

250,001 to

500,000

10% 25%

If income is from

500,001 to

1,000,000

20% 25%

If income is

above

1,000,001

30% 25%

Particulars Amount

Total income (including

foreign income)

1,100,000

Applicable tax rate 20%

Taxes payable in Country of

Residence (700,000*20%)

140,000

Taxes paid in Country of

Source (400,000*25%)

100,000

Total Taxes Paid 240,000

(in Rs.)

Exemption Method – Exemption with progression


• Under this method,

• Country of residence does not impose tax on such foreign income but includes such exempt

income for the purpose of computing the tax rate applicable on other income.

Illustration:

34

Particulars Country of

Residence

Country

of Source

Taxable income 700,000 400,000

Tax rate

If income upto

250,000

- 25%

If income is from

250,001 to

500,000

10% 25%

If income is from

500,001 to

1,000,000

20% 25%

If income is above

1,000,001

30% 25%

Particulars Amount

Total income (including

foreign income)

1,100,000

Applicable tax rate 30%

Taxes payable in Country of

Residence (700,000*30%)

210,000

Taxes paid in Country of

Source (300,000*25%)

75,000

Total Taxes Paid 285,000

(in Rs.)

Exemption Method – Issue


• Interest arising in a Contracting State and paid to a resident of the other Contracting

State may be taxed in that other State.

• However, such interest may also be taxed in the Contracting State in which it arises,

and according to the laws of that State, but if the beneficial owner of the interest is a

resident of the other Contracting State, the tax so charged shall not exceed :

‒ 10 per cent of the gross amount of the interest if such interest is paid on a loan

granted by a bank carrying on a bona fide banking business or by a similar

financial institution (including an insurance company) ;

‒ 15 per cent of the gross amount of the interest in all other cases.

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Will exemption method work for income streams like interest wherein the taxing rights are

with both the resident state and source state?

Recent Karnataka HC

judgement and draft

CBDT circular in claiming

foreign taxes credit (FTC)

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Recent Karnataka HC Judgement

• Can FTC be available for set off against income other than the double taxed income?

• There are 2 contrary views on the same -

‒ FTC would be available - Karnataka High Court in the case of Wipro Ltd. held that

as per India USA DTAA, an assessee whose income is taxed in USA but exempt in

India under section 10A is entitled to tax credit in India as the language of the India

USA DTAA does not require that the income should have been taxed in both the

countries

‒ However, with respect to India Canada DTAA the High Court held that in order to

claim credit, income must be taxed in both the Countries. High Court based the

difference in treatment on the method of computing credit. India Canada DTAA

requires credit to be computed on proportionate credit method unlike India USA

DTAA

‒ FTC would not be available - Mumbai Tribunal in the case of Digital Equipment

while analyzing the India USA DTAA held that the foreign tax credit cannot exceed

the income tax leviable in respect of that income in the country of which the

assessee is resident

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Recent CBDT draft circular on computation of FTC

• Credit shall be granted in the year in which income is offered to tax in India

• Foreign tax shall mean –

‒ In case where Tax Treaty exists – the tax covered under the said agreement

‒ In other cases –tax payable under law in force in the foreign country in the nature

of income-tax referred to in section 91 [i.e. any excess profits tax or business

profits tax charged on the profits by the Government of any part of that country or a

local authority in that country]

• Credit for foreign taxes shall be available against he amount of tax, surcharge and cess

payable under the Act but not in respect of any sum payable by way of interest, fee or

penalty

• No credit for foreign taxes shall be available in respect of any amount of foreign tax

which is disputed in any manner by the assessee

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Recent CBDT draft circular on computation of FTC

• Quantum of foreign tax credit would be computed as below:

‒ Amounts of credit shall be computed separately for each source of income arising in source

country

‒ Credit shall be lower of tax payable under the Act and the foreign tax paid on such income

‒ Exchange rate to be applied for conversion of such foreign taxes would be the TT Buying rate

on the date of payment/deduction of foreign taxes

• Documents to be furnished by the assessee for grant of FTC:

‒ Certificate from tax authority of the country of source specifying the nature of income and the

amount of tax deducted therefrom or paid by the assessee

‒ However, in a case where the foreign tax is deducted at source, the assessee may furnish tax

deduction certificate obtained from the payer of such income;

‒ Acknowledgement of online tax payment or bank counter foil or slip or challan for tax payment

where the payment of foreign tax has been made by the assessee; and

‒ Declaration that amount of foreign tax in respect of which credit is being claimed is not under

any dispute

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Is this a prospective Circular or will this apply to the pending appeals as well?

Case studies

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Case Study 1

• Mr. X an Indian ROR has a property in

Australia

• During FY 2015-16 he sold the property to a

Company in Australia for USD 10 million

• Out of the sale proceeds of USD 10 million

he made a charity contribution in Australia

for USD 3 million

• He has paid taxes in Australia for USD 7

million@ 45%

• Question:

‒ What is the amount on which Mr. X will

get a credit for taxes in India?

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India

Australia

Sale of

property for

USD 10 million

Case study 2• Income taxable in 3 countries –

‒ Japan – withholding tax

‒ USA – taxable in the hands of

branch, being resident in USA

‒ India – taxable in the hands of Indian

co., being resident in India global

income would be taxable in India

• Can FTC be available in India for taxes

paid by the US branch in Japan?

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India Co

US

Branch

India

Japan

Customer

Income received

from after

withholding in

Japan

Japan USA India

Income 100 200 500

Profit - 50 100

Tax rate 10% 30% 30%

Tax 10 15 30

Other questions for discussion

• Is FTC claimable on taxes including surcharge and cess?

• Losses in the foreign jurisdiction- Can that also be claimed in India for set-off under the

FTC article?

• What is the exchange rate used for the purpose of FTC credit to be considered?

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44

Questions

45

Thank You

Disclaimer

This material is prepared for the purpose of the Course conducted by the Institute of Chartered Accountants of India on 4 June 2016 for

the reference of its members. The information contained herein is meant for general purposes and is also not an exhaustive treatment of

such subject(s) and accordingly is not intended to constitute any kind of professional advice or services The information is not intended to

be relied upon as the sole basis for any decision which may affect you or your business. Before making any decision or taking any action

that might affect you or your business, you should consult a qualified professional adviser. By using any part of the information in this

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