How to Claim Tax Credit on Foreign Income of a Resident?

An income of a resident Indian or an NRI classified as non-resident income can be taxed in two different countries, due to an assessee being resident in one country and the oncome arising in another. This is called double taxation, and many countries have signed DTAA agreement to eliminate double taxation of income. In India, double taxation relief can be claimed using tax exemption and tax credit method. 

What is a Foreign Tax Credit?

Tax is charged by countries based on two rules:

1. Source Rule: Income is taxed in the country where it is earned, regardless of who earns it.
2. Residence Rule: The right to tax is vested in the country in which the assessee is a resident.

So, there may be situations where one country charges tax on an income based on source rule, whereas another country charges tax based on residence rule. This results in the same income being taxed twice, popularly called as double taxation. However, if you have paid taxes in a country, you can claim a credit for the tax paid in your home country. This concept is called foreign tax credit. 

Section 90 is intended to deal with situations of double taxation in which India has signed a DTAA with a foreign country. Section 91 deals with situations in which there is no such agreement.

Rule 128 of Income Tax Rules 1962

Adopting Rule 128 and Form 67 eliminated most of the ambiguity surrounding obtaining tax credits. Foreign Tax Credit (FTC) in India is governed by Rule 128 of the Income Tax Rules, which became effective on April 1, 2017. Following are the rules for claiming foreign tax credit on foreign income tax.

• Only a resident taxpayer is eligible to claim FTC if he paid tax or had tax deducted in a foreign country on foreign income.
• FTC shall be granted only in the year in which the foreign income has been taxed in India. 
• No FTC will be allowed for any sum payable as interest or penalty.
• Where a DTAA has been signed between India and a foreign country, the eligible FTC is restricted up to the amount as determined by the DTAA.
• Foreign tax credit is available on the income tax on foreign income of resident Indians under section 115JB (minimum alternate tax).
• No credit shall be allowed with respect to any amount of foreign tax or portion thereof that the assessee disputes in any way.

Provided, that the credit for such disputed tax shall be allowed in the year in which such income is offered to tax in India if the taxpayer furnishes evidence of settlement of dispute and evidence to the effect that he has discharged the liability for payment of such foreign tax within six months from the end of the month in which the dispute is finally settled.

• The credit for the foreign tax shall be the sum of the credit amounts estimated separately for each source of income emanating from a particular nation. i.e., calculation of FTC to be made source of income wise.
• The credit admissible is the lesser of: 
  • the tax payable on such income under the Indian tax laws; and 
  • the tax paid on such income in a foreign jurisdiction.

Documents Required to Claim Foreign Tax Credit

To claim FTC, the taxpayer must furnish the following documents.

1. Certificate/statement describing the nature of foreign income and the amount of tax deducted or paid by the assessee:
   1. from a foreign country's tax authority; or
   2. from the person deducting such tax; or
   3. signed by the assessee.
2. However, the statement provided by the taxpayer above is considered valid only if it accompanies proof of online / challan for payment of tax or proof of deduction of tax.
3. Form 67: Form 67 must be filed using the Income Tax Portal before filing the return of income to claim the FTC.

How to Claim Tax Credit on Foreign Income?

If you are a resident, income earned anywhere in the world must be included in your total income.

1. Convert the foreign income into INR as per the reference rates
2. Now, include this income under the respective income head; for example, include salary income under the head ‘salaries’.
3. You can take credit for such taxes if TDS has been deducted from your income. While taking TDS credit, ensure the correct DTAA is applied to take credit for the deducted foreign tax.
4. The taxpayer should obtain Tax Residency Certificate (TRC). It clarifies your tax residency status to ensure the application of the correct DTAA.
5. The taxpayer should add details of foreign income, i.e., income earned outside India, to Schedule FSI of the ITR.
6. Once the taxpayer adds details of Foreign Income in Schedule FSI, the particulars in Schedule TR (Tax Relief) get populated.