New Foreign Tax Credit Rules – certain grey areas

Recently, the Central Board of Direct Tax (‘CBDT’) has issued a notification [see end note 1] notifying Rules [see end note 2] for granting of Foreign Tax Credit (‘FTC’) to resident taxpayers on income earned in foreign jurisdiction (hereinafter referred as ‘foreign income’). Before, notifying these Rules, a letter was issued by CBDT seeking public comments on the draft FTC rules, however, without much modification, the draft rules were brought into effect as final in the notification.

Before proceedings ahead, let’s have a glance at the Rules as notified by the CBDT:

• The FTC shall be granted only when the taxpayer has paid the foreign tax on the income taxable in India.
• The FTC shall be granted in the year in which such income is offered to tax / assessed to tax in India.
• If such income is offered to tax / assessed to tax in India in more than one year, then the FTC shall be granted in proportionate to the income in which it is offered to tax / assessed to tax.
• FTC is available only in respect of tax, surcharge and cess payable on such income but not against interest or penalty.
• If the foreign tax or part thereof is a subject matter of dispute in foreign country, then FTC shall not be granted, unless such dispute attains finality and evidences to such extent should be furnished within six months from the end of the month in which dispute attains finality.
• FTC shall be the lower of the tax payable under the Act on such income and the foreign tax paid on such income, computed separately for each source of income arising from a particular country or specified territory. Any foreign tax paid in excess of domestic tax shall be ignored.
• FTC shall be determined by conversion of the currency of payment of foreign tax at the telegraphic transfer buying rate on the last day of the month immediately preceding the month in which such tax has been paid or deducted.
• FTC is available even in the case of tax payable under MAT scenario.

The new rules do not take into account certain critical issues.

Differences in taxable year

For better understanding the issue, let’s begin with an example. Take a foreign jurisdiction which adopts Calendar Year (‘CY’) as a taxable year and collects taxes in December by way of self-assessment tax on income earned in that CY, in contrast, India follows April to March (i.e., Financial Year (‘FY’)) as taxable year and collects taxes by way of TDS and / or advance tax.

An issue may arise with regard to timing difference in adoption of different taxable year by different jurisdictions. Income earned for the period January 2017 to March 2017 would be taxed in India in the FY 2016-17, whereas in such foreign jurisdiction, the income is taxed in CY 2017 and the tax on such income is collected /paid in December 2017 in such foreign jurisdiction.

Rule 128(1) states that FTC is available only when foreign tax is paid. In the above situation, foreign tax is paid in FY 2017-18, whereas income is offered to tax in India in FY 2016-17. Now a question arise regarding the year in which FTC will be granted. Whether FTC will be granted in FY 2016-17, i.e., the year in which income is offered to tax even though no foreign tax is paid in the said FY; or, FTC will be granted in the FY 2017-18, i.e., the year in which foreign tax have actually been paid.

The new Rules do not provide any guidance on dealing with this difference in timing. As the Rules are silent, one may argue that the FTC will not be granted in FY 2016-17. The tax payer, after taxes making payment of foreign taxes has to file a revised return [see end note 3] or rectification petition [see end note 4] to claim such FTC in FY 2016-17. However, these correction mechanisms have their own limitations.

Alternatively, one may argue that the objective of Sections 90(1), 90A and 91(1) is to give relief from taxation in India to the extent taxes have been paid abroad and these relief provisions do not specify any condition that the payment of taxes should also be made in the same previous year. A useful reference can be made to the judgment of Bombay High Court in the case of Petroleum India International [see end note 5], wherein the High Court upheld the ruling of the Tribunal that if taxpayer had paid taxes in Kuwait in respect of the same income in subsequent year, relief under section 91(1) cannot be denied.

Where tax liability is enhanced by the tax officer whether FTC should also be increased?

Another issue for consideration is in cases where tax officer increases the income of the taxpayer by way of making additions to the taxable income declared by the taxpayer, such increase would result in enhanced tax liability. A question arises as to whether FTC claimed by the taxpayer in his return of income has to be enhanced by tax officer in light of the additions made by him.

Rule 128 is silent on this aspect. As rules are silent one may make a useful reference to the decision of Delhi Tribunal in the case of Birla Soft India Ltd [see end note 6], wherein the Delhi Tribunal has held in favour of the tax payer that tax officer is bound to enhance the FTC to the extent the additions made by the tax officer, if there remains any unclaimed FTC by the tax payer.

Allowability of FTC in loss making scenarios

Let’s begin again with an example, A Ltd, an Indian company, in respect of its Japan business was assessed as loss in India, whereas in Japan, the same was assessed at a positive figure and taxed in Japan. Whether the FTC for taxes paid in Japan is allowable even though it is assessed as loss in India?
Rule 128 is silent even in dealing with this type of scenario. The Calcutta High Court in the case of Jeewanlal Ltd [ see end note 7], in a similar factual backdrop has held that as no income has been assessed to tax in India, no double taxation arises and hence, the taxpayer would not be entitled to any FTC.

Treatment of Partnership firms

Partnerships in India are opaque entities (i.e., India levies tax in the hands of partnership), whereas there are few foreign jurisdictions wherein partnership are treated as transparent entities (i.e., levy of tax is in the hands of partners).

Let’s consider an example, XYZ, an Indian partnership has a branch in a foreign jurisdiction where tax is levied in the hands of Partners on the income earned in such jurisdiction. In FY 2016-17, the income earned in such foreign jurisdiction is taxed in the hands of partners, whereas under the Indian tax laws, such foreign income is taxable in the hands of partnership.

Now a question arises, whether taxes paid by the partners in the foreign jurisdiction is available as FTC in the hands of Indian partnership. As stated above, Rule 128(1) specifically uses the phrase that foreign taxes have to be ‘paid by him’ (i.e., taxpayer). Applying this Rule, tax authorities will always contend that foreign taxes have to be paid by the partnership in order to claim the FTC in India by the partnership.

Joint filing of tax return - whether splitting of taxes is permissible?

In countries like, UK, USA, there is an option of joint filing of tax return by the married couple. The taxes in those case will be borne by the married couple. However, India does not follow joint filing of tax return. The married couple have to separately file their return of income in respect of foreign income in India, unless clubbing provisions apply. An issue may arise that in order to comply with the tax laws of India, whether the married couple has to split their income and taxes and arrive at the tax liability under the Indian tax law.

Rule 128 does not provide any guidance on handling this situation. In fact the Rule 128(1) enhances the complication by using the phrase foreign taxes have to be ‘paid by him’ (i.e., taxpayer). This leads to a scenario where there is no judicial precedent on this subject. Hence, CBDT has to provide a specific set of guidelines dealing with similar issues.

Conclusion

The above are few issues which require the guidance from CBDT. Since appropriate guidelines have not be provided, tax payers may face difficulty in availing credit of taxes to which they are entitled.

[The author is a Principal Associate, Direct Tax Practice, Lakshmikumaran & Sridharan, Bangalore]