13.1 Indian residents earning income abroad on which tax is paid in a foreign country, are eligible for credit for such foreign tax paid. While the DTA and Income-tax Act permit Foreign Tax credit (FTC), there were no rules / procedures. Only basic principles were laid down by the Courts. This resulted in assessees being denied credit in many cases.
The Government came out with rules on FTC vide Notification dated 27.6.2016. These are effective from A.Y. 2017-18. Some of the rules have been incorporated in the ITA by this Finance Bill.
The key provisions of FTC specified in the notification and finance bill are discussed below.
13.2 FTC will be available on that income which is doubly taxed – in India and the foreign country. It is restricted to the Indian tax or the foreign tax whichever is lower. Thus if foreign tax is more than the Indian tax, the excess will not be available.
If the foreign income to be taxed in India is spread over more than one year, FTC will be allowed proportionately over that many years. It will be available against each source of income separately. See Example 1 below.
An Indian resident earns income in UK which is taxed as under:
In India the income is taxable @ 30% irrespective of the source. How much credit will be available? The FTC in India will be as under:
Less: FTC for UK tax
On interest 200 (restricted to actual UK tax)
On Business 300 (restricted to Indian tax)
Net payable in India 100
Excess tax in UK on Business income, cannot be set off against tax on interest in India.
FTC will be available against income-tax, surcharge and cess. It is however not available against interest, fee or penalty. This is a good clarification.
13.3 The FTC will be available in the year in which the foreign income is submitted to tax in India. It will be proportionate to the amount which is taxable in India.
In the US, calendar year is followed for taxation. In India, the tax year is 1st April to 31st March. An Indian resident has earned US income for 2016. In India, the US income for 9 months (1st April to 31st December 2016) and 3 months (1st January to 31st March 2017) has to be submitted to tax.
In what manner will the FTC be available in India?
Tax paid for 2016 in US will be considered proportionately for 9 months. Similarly, tax paid for 3 months of 2017 will be considered proportionately.
However the tax return in India has to be filed by 31st July / 30th September. How does one get credit for US taxes? The final tax for 2017 will be known somewhere by March /April 2018.
In such cases, the tax return in India will have to be filed based on the basis of tax paid in US till the time of filing the Indian tax return. When the final tax amounts are known by March 2018, the return in India will have to be revised. Additional tax will have to be paid or a refund will have to be claimed.
FTC rules provide for some situations where foreign tax amount is not finalised. However it does not take care of all such situations.
13.4 If tax amount is disputed abroad or a refund of tax is claimed, credit will not be available for that amount. In the year in which the dispute is finally settled, credit will be available.
In such situations, the dispute will normally be settled after a few years. The final FTC will be available for the year in which the income has been offered for tax.
Thus in the example in para 13.3, if the resident disputes some tax in the US for 2016 and that dispute is settled and tax is paid in 2020, the FTC will be available in 2020 for the final tax paid – but for the year 2016-17.
13.5 The tax payer is required to submit the following documents:
i) Form No.67 with details of foreign income and tax paid.
ii) Further, Certificate or statement specifying the nature of income and the amount of tax deducted therefrom or paid by the assessee is also required from any of the following:
(a) from the tax authority of the country or specified territory outside India; or
(b) from the person responsible for deduction of such tax; or
(c) by the assessee:
The statement by the assessee should be accompanied by –
(A) an acknowledgment of online payment or bank counter foil or challan for payment of tax where the payment has been made by the assessee;
(B) proof of deduction where the tax has been deducted.
The above documents should be furnished by the due date of filing the tax return.
13.6 The rules clarify that FTC will be available against Minimum Tax payable by companies or other persons. (See paras 21 and 22 for more details about MAT). If there is FTC against MAT, the credit for MAT in subsequent years is reduced. This is a simple computation. However the language in the rules is complicated (Rule 128(7)). Hence we have explained the same with an illustration.
An Indian company has a taxable income of Rs. 100. Book profit as per MAT provisions amounts to Rs. 190. The amount of tax paid in foreign countries is Rs. 32.
In what manner will FTC be available against tax payable in India?
Rate of tax
Normal provisions (1)
As per MAT (2)
Tax to be paid
(Higher of 1 or 2)
Normal MAT credit for subsequent years - - - - - - - - - -
- - -
- - - - - - - -
Tax to be paid
MAT to be carried forward to subsequent years
Thus to the extent MAT is actually paid less, no credit for the excess MAT will be available.
13.7 In some countries, the losses can be carried backwards. For example, in year 1, an Indian company has earned income in Australia. Tax has been paid – say 1,000. This has been set off against tax in India.
13.7.1 In year 4, there is a loss in Australia. In India, such a loss can be carried forward and set off against future income. However let us assume that in Australia, the loss can be carried backward. Thus the loss of year 4, can be set off against income of year 1. Tax will be refunded – say 250. Net tax paid in Australia for year 1 will be 750. Whereas in India, credit for 1,000 would have been claimed. Thus in India, it results in excess credit to the extent of 250 for year 1.
13.7.2 The rules provide that in such cases, Form 67 should provide such details. However in which year should the Indian company pay this additional tax, has not been specified. Will the tax have to be paid in year 1 or year 4? Logically it should be year 1. It will however mean that an old return will have to be revised. Further interest on the same will have to be paid. This will become unfair as the Indian company has not enjoyed the excess credit of 250. It was paid to Australian Government. Now it will be paid to Indian Government. Practically it may be provided that the tax in such cases should be paid in the year in which the refund is received by the Indian company from the foreign Government.
14.1 Indirect transfer provisions were introduced in 2012 to overcome the SC decision in the case of Vodafone. Briefly, Hutchison Hong Kong sold shares of a Cayman island company to Vodafone Netherlands. Through this transaction, Hutchison sold the Indian mobile telecom business “indirectly” and avoided income-tax on the ground that the transaction is for a foreign company’s share outside India and between non-residents. Hence India does not have jurisdiction to tax. The tax department raised a demand of US$ 2 billion. The Supreme Court ruled in favour of Vodafone. Kindly see our detailed note available at the following link:
14.2 The amendments in the law to overcome the Vodafone decision provided that if the foreign entity derives substantial value from India, then the share or interest in the foreign entity will be considered to be “in India”. Thus if Indian assets are sold indirectly through foreign entities, the gain will be taxable in India. The amendments however had some unintended consequences / concerns. For example: “How should substantial value be determined?” “How much is substantial value?” “Will even small shareholders be taxed if they sell shares on stock exchange abroad?” “Will dividend declared by the foreign company to foreign shareholders also be taxed?”.
Some of these were resolved in 2015 and 2016 by further amendments in the law and issue of rules. Substantial value has been explained to mean that if the foreign company derives its value from assets in India exceeding Rs. 10 cr. and forms 50% or more of the total value of its global assets, substantial value will be considered as in India. Similarly shareholders holding less than 5% interest in the foreign company and who do not have management rights, will be exempt from Indirect transfer provisions.
14.3 In 2015, CBDT issued a circular (No. 4 dated 26.3.2015) stating that indirect transfer provisions are deeming provisions. They have to be interpreted strictly. The provisions apply to transfer (sale). These do not apply to dividends. Thus if foreign company declares dividend to foreign shareholders, the same will not be taxable in India.
14.4 One of the issues is – if there is a multi-level structure through which shares in an Indian company are held, will it give rise to multiple taxation? For example, Foreign company 1 (FCO1) holds shares in FCO2; FCO2 holds shares in FCO3; and FCO3 holds shares in Indian company. If FCO1 sells shares in FCO2, it will be taxed in India. When FCO2 sells shares in FCO3, again it will be taxed.
14.4.1 Various representations were made. CBDT issued a circular (No. 41 of 2016) essentially stating the law. In vertical structures, there will be multiple taxation.
14.4.2 Again the investors represented. The Finance Bill now provides that in case of FIIs which are registered as category 1 or category 2 with SEBI, investors in those FIIs will not be taxed when they sell their investment in the FII. Thus in case of FIIs, there will be one tax when the FII sells the shares. There will be no further tax when the investor sells the shares/units in the FII. In any case, FIIs largely earn Capital gain on sale of listed shares. Long Term gain on such shares is exempt. It led to a situation where the primary gain is exempt in the hands of FII, but sale of units of the FII by the investor of the FII is taxable. This situation has now been resolved.
14.4.3 However in case of other foreign investors – e.g. Venture Capital funds, Private Equity investors, etc. multiple tax remains. All investors in the structure where ultimately the value is substantially from India, remain taxable.
14.5 The amendment is proposed from 1st April 2012 (when indirect tax provisions were enacted). However the indirect tax provisions have been made applicable from 1.4.1961. Hence the exemption to investors in FIIs also will be applicable from 1.4.1961.
14.6 This has been our suggestion even before. We re-emphasise, that multiple level structures will not be useful. On the contrary they may cause harm. It is better to hold investments directly than through intermediate structures.
15.1 Foreign investors can normally remit profits out of India when the Indian company declares dividend. There is an additional tax on dividend. The dividend is not deductible as expenditure. Thus there is double tax – on profits of the Indian company, and again on dividend.
One of ways in which a foreign investor can remit profits out of India without tax or lower tax is to charge expenses to its Indian subsidiary. The expense in the Indian subsidiary reduces the profits. The corresponding income may be taxed in India or may not be taxed – depending on the kind of expenses. However there is only one tax.
15.2 One of the expenses which the foreign investor charges to the Indian company is interest. This is done by providing a loan by the foreign investor to the Indian subsidiary - apart from equity capital. (FEMA has its own restrictions on foreign loans. However that is a different subject. Under FEMA, it is possible for a foreign shareholder to provide loan to an Indian subsidiary.)
Higher the debt, more is the interest which can be claimed. High debt means less equity (thin equity). This is known as “Thin capitalisation”. Hence under Thin Capitalisation rules, usually there is a limit on debt-equity ratio. If the loan is in excess of permitted debt-equity ratio, then the interest corresponding to excess loan is considered as dividend for income-tax purpose and taxed accordingly. Thus the benefit of debt is not available.
15.3 The finance bill provides a limit on the interest which can be allowed under ITA. Instead of providing a limit on debt-equity ratio, it has provided a limit on interest expenditure which can be claimed as a deduction. This is in BEPS action reports (No. 4) which G20 and OECD have agreed. The details are discussed below.
15.4 The amount of interest paid on loan borrowed from a non-resident Associated Enterprise (related party) is restricted to 30% of the Earnings before Interest, Tax, Depreciation and Amortisation or the actual amount of interest paid to the Associated Enterprise, whichever is lower. (Amortisation is spreading of expenses over more than one years). Popularly such earnings are known as “EBITDA”. This restriction also applies to a Permanent Establishment of a non-resident in India which pays interest to the Head Office or a group company.
There is no specific limit on interest paid to independent third parties except as mentioned in para 15.5 below.
15.5 Avoidance of Anti-Avoidance Provision:
15.5.1 S.94B is an Anti-Avoidance Provision. It restricts allowability of interest paid/ payable to a NR associated enterprise (AE).
To avoid such a restriction, parties can arrange the loan differently. The loan may be given to the Indian assessee based on or relying on:
(i) a guarantee given by the NR; or
(ii) funds provided by the AE to the lender.
Hence S.94B provides that even in such cases – where interest is not paid to NR AE, it will still be disallowed.
This is Anti-Anti-Anti Avoidance provision.
15.5.2 If say, the foreign parent company provides a guarantee to the foreign bank which lends funds to the Indian subsidiary, such a transaction will also be considered to a transaction with related party. Restriction on deduction of interest will apply.
Similarly if the foreign company keeps a deposit with a foreign bank which then provides the loan, similar restriction is there.
This restriction on allowability of interest expenditure is applicable only when all the following circumstances are applicable:
(i) Interest is payable by an Indian company; or by a permanent establishment of a foreign company. (Non-Corporate assessees should not bother.)
(ii) Interest payable is in excess of Rupees One Crore (presumably for the assessment year).
(iii) Interest is payable to a Non-Resident.
(iv) Interest is claimed as deductible expenditure against Indian income taxable under the head “Profits from Business or Profession”.
(v) If Indian assessee is a banking or Insurance company, S.94B won’t apply to it.
This is a protection from difficulties to small assessees. This provision is to prevent erosion of India’s tax base. If there is no “Base Erosion”; this restriction need not be applied.
15.5.3 A healthy approach may be observed:
Normally, for allowing tax relief, there are several conditions. Under the new provisions; restrictions, will be applied only if several conditions will be fulfilled. Further, the expenditure disallowed in one year is allowed to be carried forward.
The restriction applies to all kinds of financial arrangements – loans, financial leases, financial derivatives, etc. – which give rise to interest, discount or financial charges.
15.6 In case - interest in excess of 30% of EBITDA is disallowed, the excess can be carried forward to subsequent years and be set off against profits of those years. The total deduction (for past years’ interest and current year’s interest) in any case will not exceed the limit of 30%.
The excess interest can be carried forward for a maximum of 8 Assessment Years.
15.7 A concern is raised that many times a parent
company provides a guarantee only to enable the
subsidiary to avail of the loan. The parent company
provides a guarantee to all group companies. Other
than this facility, the subsidiary has to borrow at
competitive rates. Interest expenditure is paid to a
foreign bank which is a 3rd party. There
is no inter- company transfer of income. The parent
abroad does not derive any benefit/ income which
gets deducted as expenditure in India. There is no
base erosion due to Transfer Pricing. Even though
this may be the case, all such arrangements are
covered for the purpose of restriction.
(see para 15.10)
15.8 What should be considered for EBITDA? Does it refer to earnings as per accounting standards or earnings as per ITA? The law does not provide for the same. The BEPS reports state that EBITDA can be as per tax law or accounting standards as the country may provide. Further it also states that incomes which are exempt from tax (like dividend) should not be considered to compute EBITDA. This is logical. If the income is exempt, the expenses pertaining to such income also cannot be allowed. By not considering such incomes for EBITDA, automatically the interest to be allowed is restricted.
No such provision is made in the Finance Bill proposal. It will be better to have clarity in the Indian rules on EBITDA.
15.9 Does it mean that restricting the deduction of interest is the only adjustment for excess interest? Consider the following:
i) The MNC holding company provides that the rate of interest will be 20% instead of the market rate of 5%. Even after charging 20% interest, the total interest is within 30% of EBITDA. Will the excess interest due to extra 15% rate of interest be disallowed? Prima facie under the Transfer Pricing rules, the excess interest can be disallowed.
ii) If the MNC holding company provides funds in the ratio of low equity and high debt, can any adjustment be made? While Transfer Pricing rules do not provide a specific adjustment, the GAAR rules provide that high debt-equity ratio can be considered to determine whether GAAR rules should apply. (The difference between Transfer Pricing rules and GAAR is that in case of Transfer Pricing rules, the tax payer is required to suo-moto adjust the income to reflect the market price. Whereas GAAR needs to be invoked by the tax department if it considers that the arrangement is to avoid income-tax.)
iii) The DTAs provide that if interest paid is in excess of that which is normally payable between unrelated parties, then the lower rate of tax will not apply. Can this rule continue to apply? Legally, yes.
15.10 Disallowance of interest above 30% is a “Specific Anti-Avoidance Rule(SAAR)”. Having applied the specific rule, can other avoidance rules also apply? The circular by tax department (No. 7 dated 27.1.2017) states that GAAR can apply even if there is a specific anti-avoidance rule. By this logic, other rules can also apply.
15.11 The BEPS report discusses several ways (or combination of ways) in which excess interest can be disallowed. More countries are adopting a fixed ratio rule as adopted by India in this Finance Bill. BEPS has recommended that countries may fix a ratio between 10 and 30% above which the interest will be disallowed. India has adopted a ratio of 30% - perhaps considering the higher interest rates in India compared to developed countries where the rates are much lower. The thought behind applying a fixed ratio is that it is objective and simple. It avoids other difficulties of finding the market rate of interest, debt-equity ratio etc.
15.12 Wherever S.94B applies, Income-tax assessment proceedings can be lengthy and time consuming. It will be better for the assessee to collect all necessary evidence & information at the time of filing of the return – and in any case, even before the AO serves a scrutiny assessment notice.
16.1 Transfer Pricing rules provide that in case an Indian company earns less income from dealing with a related party abroad, than it would have earned from dealing with a third party, then the income can be “adjusted”, i.e., the income will be increased. This is known as “primary adjustment”.
It may be noted that Transfer pricing rules do not require the accounts and finances to be adjusted. These may remain as they are. However for tax purposes, the taxable income will be increased. This additional income due to primary adjustment does not have to be remitted to India. The accounts do not have to be re-written.
16.2 To make further adjustment on account of funds not coming into India, the finance bill has made amendments. It provides that if the additional income is not received by the Indian entity within a reasonable time (to be specified later), then it will be considered that the Indian entity has given a loan to the foreign related party. Interest on the same can be considered for tax purposes.
This adjustment is known as “Secondary adjustment”.
If the additional income due to primary adjustment is brought into India, no further “secondary adjustment” will be made.
This is also a fall out of BEPS Action reports on Transfer Pricing. Some countries consider such income outside India as dividend paid by the Indian entity to the foreign entity. Tax on dividend is levied. India has considered interest on loan as the secondary adjustment.
16.3 This secondary adjustment was considered by the department in the case of Vodafone-II case where Vodafone invested in the equity capital of its 100% Indian subsidiary. Vodafone invested at a particular price. The officer held that the market value of Indian company’s share was higher. Hence more funds should have been invested in India. He considered the difference in the market value of shares and the amount invested as income. This was primary adjustment. Further, as the funds were not brought into India, the officer considered the funds which were not brought into India, as loan given by the Indian company to Vodafone. On this, interest was also assumed. This was secondary adjustment.
The High Court struck down both adjustments. The first adjustment of increase in the amount due to higher premium was struck down as share investment was a capital receipt.
The secondary adjustment of interest was also struck down as the law did not provide for secondary adjustment.
Now with the amendment in law, secondary adjustment will be possible. However, as per the wording of the provision, this will be possible only in cases where primary adjustment impacts the taxable income. Primary adjustment in case of capital receipts cannot be made as they do not impact taxable income. Therefore, a view can be taken that secondary adjustment is not applicable in cases where primary adjustment is not possible.
16.4 The secondary adjustment has to be made from FY 2016-17.
If the secondary adjustment is less than Rs. 1 cr., then no secondary adjustment will be made.
16.5 Can further adjustment (tertiary adjustment and so on) be made if the deemed interest is not brought into India? That does not seem to be the case.
The reason is that “primary adjustment” and “secondary adjustment” have been specifically defined. “Primary adjustment” means the first adjustment made in case of actual transaction as per Transfer Pricing rules which leads to an increase in total income or reduction in loss, as the case may be. “Secondary adjustment” is dependent on “Primary adjustment”. If there is a primary adjustment, there can be secondary adjustment. Secondary adjustment has not been deemed to become primary adjustment.
Therefore there is no requirement of any further adjustments if interest is not remitted into India.
16.6 It may be noted that as in case of primary adjustment, the country where the related party is situated, may not allow the deduction of expense towards secondary adjustment too. (See para 16.7 below). This can lead to double taxation for the group as a whole. Any adjustment in the other country will require a Mutual Agreement Procedure. This is a time consuming and expensive process.
16.7 Compensatory Adjustment:
(i) In India & (ii) Abroad.
This is explained with an illustration.
Consider that I Co is an Indian Company. F Co is a Foreign Company & Associated to I Co.
I Co pays Rs. 100 to F Co as interest expenditure. Under S. 94B it is determined that allowable expense is only Rs. 50. Hence I Co will get a deduction of only Rs. 50.
However, F Co’s income will be Rs. 100. So I Co is expected to deduct Indian Income-tax at source on Rs. 100.
If I Co’s deduction is restricted to Rs. 50, will F Co’s income be reduced Rs.50; and hence TDS to be reduced appropriately?
Such an adjustment is called Compensatory Adjustment within India.
If F Co’s own income-tax department in the foreign country also considers the income to be reduced to Rs. 50; then that would be Compensatory Adjustment abroad.
CBDT has declared under second proviso to S. 92(C)(4) that no Compensatory Adjustment will be made within India. As far as foreign adjustment is concerned, it has to be decided by the Government of the foreign country. Indian law and DTA don’t provide any procedure to facilitate Compensatory Adjustment Abroad.
17.1 Capital Gain earned by an NR on sale of shares are taxed slightly differently compared to Indian residents.
17.2 Finance Act 2012 provided that when an NR sells an unlisted security, it would be taxable at a concessional rate of 10%. The benefit of foreign exchange fluctuation and indexation would not be available. The definition of security will be as per Securities Contracts (Regulation) Act.
17.3 In the case of Dahiben Umedbhai Shah (57 CompCas 700) the H’ble Bombay High Court opined that definition of securities under SCRA refers to shares which can be sold in the market. In that sense, shares of a private company are not “marketable securities”. Therefore, it was held that shares of private companies are not securities as defined in Securities Contracts (Regulation) Act. As this was not the Government’s intention, an amendment was brought in vide Finance Act 2016 clarifying the position that the concessional rate was available for the shares of privately held companies also.
17.4 The amendment of Finance Act 2016 was applicable only from FY 2016-17 onwards. However, the rate of 10% on sale of private company’s shares was applicable from FY 2012-13 onwards. This would mean that the rate would not apply for the FYs 2012-13 to 2015-16. Therefore, Finance Bill 2017 now provides that the 10% rate of tax will be available from FY 2012-13 onwards.
17.5 Thus sale of shares of private companies will be taxable @ 10% without considering inflation adjustment or foreign exchange fluctuation adjustment from FY 2012-13 onwards.
17.6 If tax at higher rate has been paid, and there is a possibility of revising the returns, then the returns should be revised. Alternatively, if the matter is open in assessments or appeals, it can be taken up there.