[Opinion] Foreign Tax Credit: How it’s Treated as Assessee’s Income

Authored by Nitin Baijal – Director | Deloitte India, Sahil Bhasin – Manager & Kajal Gupta – Deputy Manager | Deloitte Haskins and Sells LLP

Finance Minister Nirmala Sitharaman is all set to present Union Budget 2023 on 1 February, 2023. The Finance Ministry has been in pre-Budget consultations with various ministries and departments, and as this may be the last full Budget before General Elections kick off in 2024, taxpayers have lot of expectations on additional tax benefits and lower tax rates.

However, like the previous Budget, we may expect the Government to be more focused on rationalisation of existing provisions. One issue which may need the attention of the Government is on taxability of income that has been subjected to tax in a foreign country.

As per income tax provisions, gross income is subject to taxation and exclusion is available only for certain expenditures/allowances specifically called out under the Act. Further, various judicial precedents have laid out the fundamental principle under taxation laws – that income spent after it has been earned, is not allowed to be excluded from the gross income since it is merely application of income. However, when any income is diverted before reaching the assessee, due to contractual obligations, the said income may be treated as diversion of income. But, as opposed to application of Income, only that income which has been diverted, can be excluded from the gross income and is not taxable.

In the past, certain taxpayers incorrectly offered only the net amount received in their hands, to tax, and did not consider the taxes deducted at source (‘TDS’) as their income. Further, they also claimed credit of the TDS against tax payable on the said net income, which led to a leak in tax revenue. In other words, taxpayers were paying tax on the net income as opposed to the gross income and at the same time claiming credit of taxes separately as well. This led to a double whammy of sorts for the Revenue. In an ideal scenario, gross income needs to be offered to tax and credit of tax deducted at source be claimed.

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To protect the interest of the Revenue and to consider TDS as income received, the government introduced section 198 under the Income Tax Act, 1961 (‘The Act’). The provisions clarified that any TDS under the Act was deemed to be income received. This section was added so that people may not interpret the law incorrectly. Hence, the intention of this section was to ensure, that the portion of the income (TDS) which was not received by the taxpayer in hand but deposited with the government, is not treated as diversion of income.

Accordingly, the taxes which have been deducted in India from the gross income was now to be deemed as income received by the individual.

However, Section 198 did not mention anything about taxes deducted in overseas countries on the income which was taxable in India as well. Hence, the computation of income earned outside India may still be done incorrectly by some taxpayers, i.e., if taxes have been withheld outside India, then only the corresponding net income is offered to tax in India. In the absence of an explicit provision in this regard, a taxpayer may inadvertently include the net income (i.e., the amount so remitted to India after withholding of taxes) instead of his gross total income which is not a correct position as per law.

Hence, the government may insert a further clarificatory amendment to Section 198 to remove any ambiguity that may exist regarding taxability of gross income earned outside India.

Consider an example: Suppose an assignee has earned income from other sources in India of INR 60,000/-, out of which taxes of INR 6000/- have been deducted at source in India. Further, the assignee has earned income of INR 50,000/- from foreign sources, on which the foreign government has already deducted taxes of INR 5000/- at source. In the above scenario, taxable income should be as follows:

Income taxable under the head Other Sources:

Income from India Source                                      INR 60,000
Income from foreign Source                                  INR 50,000
Total Income                                                               INR 1,10,000

Taxpayer can claim credit of tax deducted at source of INR 6,000/- and can claim INR 5,000/- (Foreign tax credit calculation as per section 90/91) as foreign tax credit in his return of income.

With the upcoming Budget round the corner, we will soon know whether this ambiguity on the existing provisions for the common man is removed and clarifications issued to avoid litigation on this front.

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