A ‘Resident’ is further categorised into Not Ordinarily Resident (NOR) or Ordinarily Resident (OR) depending on his/her physical presence in India during the previous financial years. Such residential status is required to be determined for each financial year to ascertain the scope of taxable income. For example, an OR is liable to pay tax on his/her global income. However, NOR is not required to pay tax in India on the global income, subject to certain conditions. Once an individual qualifies as ‘OR’ in India, his/her global income becomes taxable in India, irrespective of whether such income is earned/received in India or outside India.
The issue arises when an income is earned in one country (source country) and the person earning such income qualifies to be a Resident of another country and is taxable on global income in the country of residence. For example, an individual (who qualified as NOR in previous years) qualifying as an OR of India for first time as per conditions laid down in Section 6 of the Act earns rental income from a house property in France. As per French tax laws, France, being the source country, may tax the rental income in France. On the other hand, as per the provisions of the Indian Income Tax Act, such rental income is also taxable in India by virtue of the residential status of the individual which triggers the taxability of global income. This is commonly known as double taxation of income.
To mitigate the burden of double taxation, Section 90 of the Act empowers the Indian government to enter into bilateral agreements with other countries. These agreements are known as Double Taxation Avoidance Agreements (DTAAs). The DTAA contains an ‘Article’ on the elimination of double taxation by virtue of which taxes paid in the source country of income can be claimed as a deduction from taxes payable in India on doubly taxed income. This is commonly referred to as Foreign Tax Credit (FTC). Further, where there is no agreement between India and the other country, Section 91 of the Act provides relief from double taxation by allowing the benefit of FTC for a ‘Resident’ of India.
An individual taxpayer can avail the benefit of FTC on doubly taxed income at the time of filing his/her income tax return (ITR) in India by reporting requisite details in Schedule FSI (i.e. foreign sourced income) of the ITR form. Such claim of FTC may get picked up for scrutiny in select cases wherein taxpayers are required to submit proof of foreign-sourced doubly taxed income and taxes paid on such income outside India. For instance, claiming of substantial FTC in ITR can lead to ITR getting picked up for scrutiny.
To reduce litigation and provide the income-tax authorities with necessary documents to verify the claim of FTC, the Central Board of Direct Taxes (CBDT) introduced Rule 128 through Income-tax (Eighteenth Amendment) Rules, 2016 which came into effect from April 1, 2017. Rule 128 prescribes the method of determining the FTC and mandated filing of Form 67 by the taxpayers before the due date of filing their original ITR in India (i.e., July 31 for salaried individuals and others whose accounts are not required to be audited). Form 67 is required to be accompanied by prescribed proof of taxes paid outside India on doubly taxed income. The proof may include documents such as tax payment counterfoil, salary certificate or payslips showing tax deduction outside India. Since different countries follow different tax years, many taxpayers were not able to gather necessary information and pay taxes outside India by July 31. Hence, practically, the taxpayers used to file a revised ITR in India to claim correct FTC once the overseas tax return and tax payment proof were available. However, with the introduction of Rule 128 which requires the filing of Form 67 on or before the due date of filing original ITR (normally July 31), FTC benefit claimed in revised ITR from FY 2017-18 onwards has been largely rejected by the Central Processing Centre (CPC) of income-tax authorities at the time of processing the revised ITR and thus, raising a tax demand for taxpayers. This rejection has been further upheld by local jurisdictional officers stating that conditions of Rule 128 are not satisfied when Form 67 is filed after the prescribed date of July 31. Income tax authorities have often adjusted the refund claimed by taxpayers in their ITR of subsequent financial years with the outstanding tax demand triggered due to denial of FTC even if the taxpayer has disagreed with the demand on the income tax portal and re-submitted the proof for claim of FTC.
Due to the increasing cases of litigation on FTC denial by CPC and local jurisdictional officers, CBDT through its notification dated August 18, 2022 amended Rule 128 to allow filing of Form 67 even after the due date of July 31 provided Form 67 is filed on or before due date of filing belated ITR under Section 139(4) (normally December 31) of the Act and updated ITR under Section 139(8A) of the Act. However, there is still no clarity for FTC claimed in a revised ITR under Section 139(5) of the Act and the same is still prone to litigation from the income tax authorities.
All these persisting issues have created a lot of hassle for the taxpayers in terms of long-drawn litigation and blockage of their funds for which they have to resort to filing an appeal before higher level of income tax authorities for a resolution. Many such appeals are still pending to be concluded from the last 2-3 years without any definitive timeline given by the income tax authorities. Through the upcoming interim budget, the taxpayers are hoping that such anomalies related to the claim of FTC benefit are addressed by the government. Some relief measures could include:
- Fast track the conclusion of appeal cases that are long pending to be settled by setting up additional technical unit and allowing virtual hearings with the taxpayers for faster communication.
- Provide clarity on whether FTC benefit can be claimed in revised ITR filed under Section 139(5) of the Act.
- Before making adjustment of refund against demand of subsequent years, give proper opportunity (including virtual hearing) to the taxpayer where requested.
- Responses submitted by taxpayers be reviewed by tax officers having sufficient knowledge of DTAA in double taxation and relief domain.
- With the increasing mobility of employees across the countries resulting in double taxation, the government may consider introducing a provision in Indian tax laws that allows DTAA benefits to be considered by the employers at the withholding stage (i.e., at the time of deducting TDS)
The above measures, if introduced, will help to reduce the administrative challenges for both the taxpayers and income tax authorities by reducing the cases of litigation as it will streamline the compliance with provisions of law and will help to unblock the resources that are currently allocated to resolve these anomalies.
(The article is written by Shalini Jain, Tax Partner, People Advisory Services, EY India.)