Foreign Tax Credit (FTC): Importance, Concept and How to Claim FTC

by Neha Raheja

Partner, Direct Tax

In an increasingly globalized world, individuals and businesses engage in cross-border transactions, leading to tax obligations in multiple jurisdictions. India, like many other countries, has provisions to avoid double taxation on income earned abroad. One such provision is the Foreign Tax Credit (FTC) mechanism, which allows taxpayers to offset taxes paid in foreign jurisdictions against their Indian tax liability. The concept of FTC is a significant aspect of international taxation, particularly for individuals and businesses engaged in cross-border transactions. In India, the foreign tax credit mechanism allows taxpayers to claim a credit against their Indian tax liability for the taxes paid in a foreign country on the same income that is also subject to tax in India. The idea behind FTC is to prevent double taxation on the same income, ensuring that taxpayers are not taxed twice on the same earnings, once in the foreign country where the income is earned and again in India.

What is FTC:

FTC is a mechanism that prevents double taxation on the same income in both the taxpayer’s home country and the foreign country where the income was earned. In the Indian context, it allows taxpayers to claim a credit for taxes paid abroad against their Indian tax liability.

Suppose Mr. A is an Indian resident but earns interest income in the United States. The source state, i.e., the US, will withhold a percentage of the amount as tax. In addition, Mr. Ramana will also have to pay taxes on his U.S. income in India. This will result in double taxation on the same income. FTC is a facility that helps people like Mr. A avoid paying double tax on the same income.

Importance of Foreign Tax Credit in India:

Prevents Double Taxation:
One of the primary reasons for introducing the foreign tax credit mechanism in India is to prevent double taxation of the same income. Without FTC, taxpayers earning income abroad would be subject to tax in both the foreign country and in India, leading to double taxation and reducing the incentive for cross-border trade and investment.
Promotes International Trade and Investment:
By providing relief from double taxation, foreign tax credits encourage cross-border trade and investment by making it more attractive for Indian taxpayers to conduct business overseas. This promotes economic growth, fosters international business relationships, and enhances India’s position in the global economy.
Avoiding Tax Evasion and Tax Avoidance:
The availability of foreign tax credit in India helps combat tax evasion and tax avoidance practices by ensuring that taxpayers accurately report their foreign income and pay the appropriate taxes, thus contributing to the overall integrity of the tax system.
Encourages Compliance and Transparency:
Foreign tax credit requires taxpayers to maintain proper documentation and comply with relevant tax laws and regulations, promoting transparency and accountability in tax reporting and compliance.

The Concept of FTC in India:

As per the tax laws of India, sections 90 and 91 of the Income Tax Act, 1961, deal with the concept of FTC. Section 90 discusses claiming of FTC in a case where India has entered into a Double Taxation Avoidance Agreement (DTAA) with another country and such DTAA provides for claiming of such FTC, while Section 91 deals with claiming of FTC in scenarios where India has not entered into a DTAA with the country where the income arises for a taxpayer. Under these sections, if the taxpayer is a resident of India and has paid taxes outside India, he can claim a credit for such foreign taxes paid against his tax payable in India.

Rules for claiming FTC have been notified under Rule 128 w.e.f. 1.4.2017, which have helped clear out ambiguity around claiming of FTC, some of which have been briefly captured here under:

Only residents of India can claim FTC for taxes paid in foreign countries or specified territories.
FTC can only be claimed in the year when the foreign income is taxed in India.
FTC is limited to the proportion of income on which tax is paid or levied abroad.
FTC cannot be claimed on interest, fees, or penalties paid abroad.
If a Double Tax Avoidance Agreement (DTAA) exists between countries, only taxes covered by the agreement are eligible for FTC.
Disputed income amounts are not eligible for FTC unless resolved within six months with evidence of dispute settlement and no outstanding tax liabilities.
FTC is calculated separately for each source of income from each country.
The lower of the resident country’s tax payable and foreign tax paid is allowed as FTC.
FTC is available for income tax on foreign income under section 115JB (minimum alternate tax).
FTC amount is determined by converting the foreign tax payment currency at the telegraphic transfer buying rate on the last day of the preceding month.

Steps to Claim Foreign Tax Credit for Indian Residents with Foreign Income

Convert Foreign Income to INR:
Convert foreign income into Indian rupees using the Telegraphic Transfer Buying Rate (TTBR) on the last day of the preceding month.
Classify Income:
Classify foreign income into relevant categories such as salaries, interest, dividends, etc., and ensure it does not exceed the basic exemption limit of INR 2,50,000.
Claim TDS Credit: Refer to the DTAA with the source country and claim credit for any tax deducted at source (TDS) in the foreign country.
Obtain a TRC Certificate:
Obtain a TRC to establish tax residency status and ensure eligibility for DTAA benefits.
Fill Schedule FSI: Enter details of foreign income in Schedule FSI of the Income Tax Return (ITR), including country code, taxpayer identification number, income amount, tax paid in the source country, and tax payable in India.
File Form 67:
Before filing the ITR for the particular, Form 67 is also required to be filed, in which particulars of the FTC along with relevant proof of tax deduction are also required to be attached.
Calculate Tax Relief:
Calculate foreign tax relief as the lower of the tax paid in the foreign country or the tax payable in India, per applicable tax rates.
Provide DTAA details:
Specify the relevant article of the DTAA applicable to the foreign income.