A tax credit can be termed as a deduction of taxes already paid to the government treasury from taxes payable by a taxpayer. Such tax credits may be claimed under the Indian Income-tax Act. An individual may claim credit for taxes in the form of foreign tax credits (FTC) for taxes paid in a foreign country.
Globalisation of business operations and liberalisation of exchange control regulations have led to increased movement of personnel and capital across borders. India has gradually established itself as a global hub of talent and a major source of skilled human resources. In view of this, foreign tax credits have assumed great significance when determining the overall taxability of an individual earning income from abroad.
Generally, double tax relief is provided in the article on Elimination of Double Taxation incorporated in Article 23 of most tax treaties. The said article provides the mechanics of claiming the relief. Since a resident is generally taxed on his worldwide income, it is the country of residence that typically provides relief from double taxation.
Accordingly, the primary objective of the treaty is to eliminate double taxation in the country of residence. In cases where India does not have a treaty with the foreign country in question, credit may be claimed under the relevant section of the Indian Income-tax Act.
Practically, when applying the principles laid down for claiming FTCs, a host of issues surface, necessitating greater clarity in the intention and implementation of Article 23. One of the key issues regarding availability of FTCs is in cases where different countries follow different tax years.
For example, the US follows the calendar year (i.e. year ended December 31) as the tax year, whereas in India, the tax year runs from April 1 to March 31. In such cases, a tax resident of India may face difficulty in claiming FTC for taxes paid in the US, as he may not be able to provide appropriate evidence of taxes paid.
Issues also arise in situations where excess taxes are deducted in the foreign country, resulting in a refund on the foreign tax return; or in the reverse case, where additional taxes are required to be paid in the foreign country on assessment. Further, there is lack of clarity regarding the exchange rate to be applied in computing the foreign taxes for which a credit is to be claimed.
Indian employers are increasingly deploying their employees for varied assignments around the world. Under a typical structure of these global assignments, an Indian employee in an Indian company is deputed to a foreign country, say the US. The Indian company is the primary employer and continues to pay salary to its deputed employee.
In addition, the employee is paid an overseas allowance during his deputation. The income earned by the employee is subject to withholding tax in the US. The Indian company, being an employer of the deputed employee, would be required to withhold taxes on the salary income of the employee.
One of the key issues faced by employers is whether FTC should be considered when computing the taxes to be withheld. Although an amendment has been made to the Indian Income-tax Act, clarifying that FTC should be considered when computing self assessment tax, no such amendment has been made to the relevant section of the Act dealing with tax withholding on salary.
An issue also arises in a case where the foreign country and the country of residence characterise the same income differently, resulting in the same income being taxed differently in the two countries.
For example, a difficulty may arise in claiming credit for taxes paid in a foreign country on profits from sale of shares, which are treated as capital gains in one country and business income in the other.
In addition to the above issues, an individual may also face certain compliance issues such as obtaining tax residency certificate, providing evidence of taxes paid in the foreign country, etc.
Aashish Kasad & Poonam Mehta Ghelani Ernst & Young