NRI Tax Planning - Foreign Tax Credit

Income is said to be earned by a person in the country (source country):

Where he either renders his services or
Where he receives any income arising from an asset that is located in that country.

But his base of operations might be elsewhere (his nation of residency). It’s possible that you earn money from multiple nations. Due to the domestic laws of both countries, even though you only reside in one of them for tax purposes, such incomes can be taxable in both. Double taxation avoidance agreements (“DTAA”), also referred to as tax treaties, are thus entered into between multiple nations in order to avoid paying such double taxes on the same income in both the country of origin and the country of residency.

For instance, tax on income earned in Singapore is due for the Indian business ABC Limited, which operates there, as well as tax on income gained domestically in India. As a result, it will also need to pay down its tax obligation on income received in Singapore. Nonetheless, tax relief may be requested in accordance with section 90 if the India-Singapore treaty is in effect. If not, section 91 may be used to request relief.

In general, taxes paid in the source country are deducted from the overall tax burden under the tax legislation of the several resident countries.

A Foreign Tax Credit is a method of deducting or crediting taxes paid in the country of residence against taxes owed in the country of origin.

Types of Relief

Tax relief can be provided in two ways:

a. Bilateral Relief: When two countries agree to offer relief from double taxation, then such relief shall be calculated in accordance with the mutual agreement between two such countries. Either of the following methods may grant bilateral relief:

Exemption Method: Income is taxed in only one country and exempted from tax in the other country. Two countries enter into an agreement that the income which is otherwise taxable in both countries shall be taxed in one of the countries or that each of the two countries shall tax a specific portion of the income to avoid any double taxation.

Tax Credit Method: Under this method, income is taxed in both countries, and the foreign tax credit shall be granted to the taxpayer in his country of residence.

b. Unilateral Relief: Section 91 of the Income Tax Act 1961 provides for Unilateral Relief which states that when there is no DTAA between two countries, the relief shall be provided by the country of residence.

Relief under Section 90 and 90A

Only Indian residents who have engaged in a DTAA with the other nation or designated association from whom they have received money are eligible to claim relief under this clause. Tax relief may be claimed under Section 90 if there is a DTAA with that nation; if the DTAA is with the designated associations, tax relief may be claimed under Section 90A.

The Indian government and the foreign governments may agree to any or all of the following conditions under such DTAAs:

For providing relief regarding the income on which tax is paid under the Income Tax Act and tax law prevalent in such other countries.
For avoiding double taxation of income under the tax laws of both the countries
For exchange of information and data:
a. to prevent tax evasion or avoidance under the tax laws of either of the countries or
b. for investigation of such tax evasion or avoidance or
For recovery of income tax under the tax laws of both the countries

Suppose a bilateral agreement has been entered into with a foreign country. The taxpayer has an option to either be taxed as per the agreement (DTAA) or as per the normal provisions of the Income Tax Act, whichever is more beneficial to such taxpayer.

Relief under Section 91

Relief under this section may be claimed by an Indian resident only if there is no DTAA with the other country from where you have earned income. Such relief is given voluntarily by India in case of unilateral agreements.

Manner of computation

The foreign tax credit shall be computed separately for each source of income. It shall be computed as lower of:

Tax payable on such income under the Income Tax Act and
Foreign tax paid;

The foreign tax credit shall be determined by conversion of the foreign currency at the Telegraphic Transfer Buying Rate (TTBR) on the last day of the month immediately preceding the month in which the foreign tax has been paid or deducted.

Note that the foreign tax credit shall be the total of credit computed separately for each source of income arising from a particular country.

Computing double taxation relief under section 90:

Step 1: Compute Global Income, i.e., the aggregate of Indian income and Foreign income;
Step 2: Compute tax on such global income under Income tax;
Step 3: Compute average rate of tax (amount of tax divided by global income);
Step 4: Compute an amount by multiplying such average rate of tax with foreign income;
Step 5: Compute tax paid in a foreign country

The amount of relief shall be lower of step 4 and step 5

Computing relief under section 91:

Step 1: Calculate the tax payable in India
Step 2: Compare the Indian tax rate and foreign tax rate
Step 3: Multiply the lower tax rate with the doubly taxed income. This will be the amount of relief under section 91.

Rules for claiming the foreign tax credit

Rules for claiming the foreign tax credit are notified under Rule 128 of Income Tax Rules. Certain significant rules are enumerated below

1. An Indian resident may only claim the overseas tax credit if he has paid any taxes in a foreign nation or on a designated area outside of India. This credit may be used in the year that the income responsible for the tax was assessed or made available for taxation in India. The foreign tax credit can be claimed over the course of those years in proportion to the income offered/assessed to tax in India, albeit, if such income is offered/assessed to tax over the course of more than one year;

2. The foreign tax credit cannot be used to offset interest, penalties, or fees; it can only be applied to the tax (including tax paid in accordance with MAT/AMT), surcharge, and cess that are due under Indian tax legislation;

3. On the foreign tax that the taxpayer contests, the foreign tax credit will not be accessible. Only once the disagreement is resolved will such a tax credit be granted, if the taxpayer submits the following within six months of the end of the month in which the dispute was finally resolved:

Evidence for the settlement of dispute
Evidence for payment of the disputed tax
A declaration that no refund of such amount is claimed or will be claimed whether directly or indirectly

4. Documents required to be provided for claiming the foreign tax credit: For claiming the foreign tax credit, the taxpayer shall be required to provide the following documents:

Statement in Form No. 67
Certificate or statement indicating the nature of income and the amount of tax deducted or paid by the taxpayer
- From the tax authority of foreign nation; or
- From the person who is responsible for deduction of such tax; or
- A statement signed by the taxpayer accompanied by the following documents:
  - Where tax has been paid: an acknowledgment or challan for online payment or bank counterfoil
  - Where the tax has been deducted: proof of deduction

Such documents shall be furnished on or before the due date of filing an income tax return as per section 139(1) of the Income Tax Act.

Penalties for tax evasion or avoidance

A) Default in making payment of tax

The tax authorities shall determine the penalty amount leviable. However, such a penalty amount will not exceed the amount of tax payable.

B) Under-reporting of income

The penalty shall be 50% of tax payable on under-reported income, i.e. income declared by the taxpayer is less than the income determined by the tax authorities.

The penalty shall be increased to 200% of the tax payable if under-reporting is due to misreported income.

C) Failure to maintain relevant documents and books of accounts

The penalty leviable is Rs.25,000 generally.

However, if the taxpayer has entered into any international transaction, then the penalty will be 2% of the value of such international transactions or specified domestic transactions.

D) Penalty for fake documents such as counterfeit invoices

In case the income tax authorities find that the books of accounts provided by the taxpayer contain the following:

Forged or counterfeit documents such as a fake invoice or any fake documentary evidence
A sales invoice or purchase invoice without actual supply or receipt of goods or services.
A sales invoice or purchase invoice received from a person who does not exist
An omission of any entry that is significant for the computation of taxable income.

Regarding the above cases, the assessee might have to pay the penalty equivalent to the sum of such false or omitted entries.

E) Undisclosed income

a. In case of undisclosed income, a penalty @10% is payable.

b. Where search proceeding has been initiated on or after 1/7/2012 but before 15/12/2016:

If undisclosed income is admitted during search and the taxpayer pays the tax along with interest and files ITR, then a penalty @ 10% of such undisclosed income shall be levied.

If undisclosed income is not admitted during the search, but the same is furnished in the ITR filed after such search, then a penalty of 20% of such undisclosed income shall be levied. – In all other cases, a penalty shall be levied @ 60%

Read More: Income Tax Due Dates for November 2023

c. Where Search has been initiated on/ after 15/12/2016

If undisclosed income is admitted during search and the taxpayer pays the tax along with interest and files ITR, then a penalty @ 30% of such undisclosed income shall be levied.

In all other cases, a penalty shall be levied @ 60%

F) Penalty for not Filing Income Tax Return

In case the Income Tax Return is not furnished in full compliance with the relevant provisions of the Act, then the Assessing Officer can penalize the taxpayer with a penalty of INR 5,000.

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