In this article, we will understand what is Foreign Tax Credit (FTC), who can avail it and how can it be claimed?
Foreign Tax Credit is a credit availed on the taxes paid to a foreign government on the US return. The purpose of claiming FTC is to avoid double taxation. This credit can be availed by filling out Form 1116.
For e.g. A US expat earns interest income in India. He pays tax on this income to the Indian government. Being a US citizen, he will have to declare this interest income on his US tax return. But he can take a tax credit of the tax paid on this income in India on the US return.
Do all types of income qualify for Foreign Tax Credit?
All types of income do not qualify for foreign tax credit. As the name suggests, this credit can be availed only on the tax paid to a foreign government. The purpose of this form is to avoid double taxation. So, income that is not taxed in a foreign country will not qualify for FTC.
E.g. dividend income earned in India is not taxed in India and therefore, you cannot avail a credit for this income on your US tax return.
What are the sources of income on which FTC can be claimed?
For a US expat staying in India, generally, he can claim a FTC on the following sources of income:
- Salary income
- Income from business or profession
- Bank interest
- Capital gains (FTC on capital gains cannot be claimed in certain cases. Please check the necessary provisions or consult a tax professional for your specific case)
- Rental income
Generally, FTC cannot be claimed on the following sources of income:
- Dividend income earned in India since it is not taxed in India.
- Sale of house property where capital gains tax has not been paid in India due to reinvestment of capital gains.
The above examples have been given as a broad way to understand how FTC works.
