Navigating Foreign Salary Taxation: ITAT Grants Relief for Mistaken ITR Disclosures but Draws the Line on Foreign Tax Credits
Delhi Tribunal Affirms Treaty Supremacy Under Section 90 to Exclude Overseas Earned Income Wrongly Reported in Indian Tax Returns
Crucial Tax Catch: Why Foreign Tax Credit Under Rule 128 Cannot Be Claimed When Foreign Income Enjoys Complete Exemption from Indian Tax Liability
By Legal Editor
New Delhi: July 29, 2026:
Cross-border employment and global mobility frequently present complex tax compliance challenges for Indian resident taxpayers. A landmark ruling by the Delhi bench of the Income Tax Appellate Tribunal (ITAT) has brought critical clarity to the taxation of foreign salary, rectificatory remedies under Indian tax law, and the strict statutory limitations governing Foreign Tax Credits (FTC).
The case involved an Indian resident taxpayer who earned a salary of ₹14.16 lakh while physically working in Australia during the relevant financial year corresponding to Assessment Year (AY) 2020-21. Taxes amounting to ₹3.40 lakh were deducted at source in Australia. However, while filing the Indian Income Tax Return (ITR), the taxpayer inadvertently included this foreign salary as taxable income in India. Upon realizing the error, the taxpayer-initiated rectification proceedings under Section 154 of the Income-tax Act, 1961, seeking to exclude the Australian salary from total taxable income and simultaneously filed Form 67 to claim FTC for the taxes paid in Australia.
The Centralised Processing Centre (CPC) in Bengaluru rejected the rectification application. On appeal, the Delhi ITAT delivered a nuanced verdict: it granted substantive relief by ordering the exclusion of the Australian salary from Indian taxable income under the Double Taxation Avoidance Agreement (DTAA) but squarely denied the taxpayer’s claim for Foreign Tax Credit. This decision encapsulates the delicate balance between statutory income scope, treaty relief, procedural rectification, and FTC eligibility.
2. The Scope of Total Income vs. Treaty Benefits: Section 5 vs. Section 90(2)
To appreciate the tribunal's reasoning, one must examine the fundamental interplay between domestic tax provisions and international tax treaties. Under Section 5(1) of the Income-tax Act, 1961, an individual who qualifies as a "Resident and Ordinarily Resident" (ROR) in India is subject to tax on worldwide income, regardless of where that income accrues or is received.
However, Section 90(2) of the Act introduces an essential statutory safeguard. It provides that where the Central Government of India has entered into a Double Taxation Avoidance Agreement (DTAA) with the government of any country outside India, the provisions of the Income-tax Act shall apply to the taxpayer only to the extent they are more beneficial. Consequently, if a DTAA allocates exclusive taxing rights to the source nation or exempts a specific income stream from Indian taxation, the taxpayer is legally entitled to override the worldwide taxation principle embedded in Section 5.
3. Deconstructing Article 15 of the India-Australia DTAA: The Source Rule
The substantive relief granted by the Delhi ITAT rested on Article 15 of the India-Australia DTAA, which governs "Dependent Personal Services" (income from employment). Under Article 15(1):
Salaries, wages, and other similar remuneration derived by a resident of a Contracting State in respect of employment are taxable only in that State, unless the employment is exercised in the other Contracting State.
If the employment is exercised in the other Contracting State, such remuneration as is derived from that exercise may be taxed in that other State.
Under international tax law principles, employment is "exercised" in the geographical location where the employee is physically present while performing the duties. In this case, because the taxpayer rendered services physically within Australia, Australia acquired the primary taxing rights over the salary earned for those services.
Because Article 15 allocates the taxing power over employment physically performed in Australia to Australia, the salary income derived from services rendered in Australia is exempt from tax in India under the treaty provisions. Applying Section 90(2), the ITAT ruled that since treaty exemption is more beneficial than Section 5 global taxation, the Australian salary could not be taxed in India and had to be excluded from the taxpayer's total Indian income.
4. Correcting Inadvertent Reporting Errors: Section 154 vs. Section 139(5)
A crucial aspect of the ruling addresses how reporting errors can be rectified. Typically, a taxpayer who discovers an error or omission in an ITR must file a revised return under Section 139(5) within the prescribed statutory timeframe. However, when the deadline for filing a revised return has lapsed, taxpayers frequently resort to Section 154, which permits the tax authority to rectify any "mistake apparent from the record".
The revenue authority initially argued that mistakenly declaring foreign income in an ITR is a substantive legal issue that cannot be resolved via a summary rectification order under Section 154. However, appellate courts and tribunals, including the Delhi ITAT in this matter, have repeatedly held that taxing non-taxable income merely because the taxpayer mistakenly included it violates the fundamental constitutional principle enshrined in Article 265 of the Constitution of India—which dictates that no tax shall be levied or collected except by authority of law.
When the underlying documents (such as overseas tax receipts, passport entry/exit stamps, and employment contracts) unequivocally demonstrate that employment was exercised abroad, taxing such income constitutes a demonstrable mistake apparent from the record. The ITAT therefore held that the Assessing Officer was legally obligated under Section 154 to rectify the assessment and exclude the exempt foreign salary.
5. Foreign Tax Credit Architecture: Rule 128 and the "Zero Tax Liability" Catch
While the taxpayer succeeded in excluding the foreign salary from Indian tax liability, the ITAT firmly rejected the concurrent claim for a Foreign Tax Credit (FTC) of ₹3.40 lakh. To understand why, one must examine Rule 128 of the Income-tax Rules, 1962, which provides the administrative and legal framework for claiming FTC under Section 90 or Section 91.
Key Provisions of Rule 128:
Rule 128(1) - The Corresponding Income Requirement: FTC is allowed to a resident taxpayer for any foreign tax paid outside India "in the year in which the income corresponding to such tax has been offered to tax or assessed to tax in India".
Rule 128(3) - The Cap on Tax Credit: FTC is available only against the amount of Indian tax, surcharge, and cess payable on such foreign income.
Rule 128(4) & Computation Rules: Under Rule 128(1)(i) proviso, the credit shall be the lower of the tax payable under the Indian Income-tax Act on such foreign income and the foreign tax paid.
The Legal Paradox of Exemption vs. Credit:
International tax treaties eliminate double taxation using two primary methods:
The Exemption Method: The home country (India) excludes the foreign income from its tax base altogether.
The Tax Credit Method: The home country taxes the global income but allows a credit for foreign taxes paid, capped at the Indian tax attributable to that foreign income.
When the ITAT ruled that the Australian salary was exempt from Indian taxation under Article 15 of the DTAA, the Indian tax liability on that specific foreign income dropped to zero. Because the Indian tax payable on that salary was zero, applying the credit mechanism under Rule 128 produced a maximum permissible foreign tax credit of zero.
A taxpayer cannot simultaneously enjoy the Exemption Method (paying zero Indian tax on foreign income) and the Credit Method (claiming a cash refund or offset of foreign taxes paid against Indian tax due on other, unrelated Indian income). Foreign tax credit is strictly an offset against Indian tax liability arising from that specific foreign income—it is not a refundable tax credit. Consequently, denying the ₹3.40 lakh FTC claim was legally precise and fully aligned with Rule 128.
6. Procedural Rules: Form 67 and CBDT Notification No. 100/2022
Under Rule 128(8) and Rule 128(9), a taxpayer claiming FTC must submit a mandatory statement of foreign income and tax paid in Form 67 electronically before filing the ITR. Historically, failing to upload Form 67 on or before the due date specified under Section 139(1) led to routine disallowance of FTC by the CPC.
Recognizing genuine hardship, the Central Board of Direct Taxes (CBDT) issued Notification No. 100/2022, amending Rule 128(9) with effect from April 1, 2022. Under the relaxed rule, Form 67 can now be filed on or before the end of the relevant Assessment Year, provided the return for that year is filed within the time specified under Section 139(1) or Section 139(4). Furthermore, judicial consensus across various ITAT benches has held that filing Form 67 is a directory procedural requirement rather than a mandatory condition precedent, meaning delayed filing of Form 67 should not result in permanent loss of substantive FTC where tax was genuinely paid abroad.
However, in this specific Delhi ITAT case, the delay in filing Form 67 was secondary. The primary hurdle that doomed the FTC claim was the substantive legal bar under Rule 128(1): zero Indian tax liability on exempt income equals zero allowed credit.
7. Strategic Lessons for Cross-Border Taxpayers
This ITAT decision offers critical practical guidance for taxpayers earning overseas income:
Analyze Taxability Before Reporting: Taxpayers must determine whether foreign income is exempt under a DTAA before filing their ITR. If income is exempt under Article 15, it should be disclosed properly in Schedule FSI/EI (Exempt Income) as non-taxable under treaty provisions.
Do Not Mix Exemption and FTC Claims: Claiming FTC under Schedule TR (Tax Relief) while simultaneously treating the underlying foreign income as non-taxable in India is legally untenable.
Maintain Precise Documentation: Taxpayers must retain proof of overseas employment, physical stay duration, foreign tax withholding certificates, and passport stamps to support claims under Section 154 or appellate proceedings.
Detailed FAQ Index & Knowledge Base
Searchable Index
Section A: DTAA & Income Taxability Questions
Section B: Foreign Tax Credit (FTC) & Rule 128 Questions
Section C: Rectification, Form 67 & Procedural Compliance Questions
Section A: DTAA & Income Taxability Questions
Q1: If I am a resident in India, is my foreign salary automatically taxable in India?
Answer: Not automatically. While Section 5(1) of the Income-tax Act, 1961 taxes global income for Indian residents, Section 90(2) allows taxpayers to claim benefits under an applicable Double Taxation Avoidance Agreement (DTAA) if the DTAA provisions are more beneficial. If the DTAA allocates exclusive taxing rights over the salary to the foreign country where employment was exercised, the salary is exempt from tax in India.
Q2: How does Article 15 of standard DTAAs determine foreign salary taxation?
Answer: Article 15 (Dependent Personal Services) follows the physical location rule. Salary is taxable in the country where the employment is physically exercised. If an Indian resident works physically in Australia, Article 15 of the India-Australia DTAA gives Australia the taxing right over that salary.
Q3: What happens if I mistakenly report exempt foreign salary as taxable income in my Indian ITR?
Answer: You can seek rectification under Section 154 of the Income-tax Act or file an appeal before appellate authorities (such as the CIT(A) or ITAT). Under Article 265 of the Constitution, the government cannot collect tax on non-taxable income merely due to a taxpayer's inadvertent disclosure error.
Section B: Foreign Tax Credit (FTC) & Rule 128 Questions
Q4: What is Foreign Tax Credit (FTC) under Indian tax law?
Answer: Foreign Tax Credit is a mechanism governed by Rule 128 of the Income-tax Rules, 1962. It allows resident taxpayers to set off taxes paid in a foreign country against the Indian income tax payable on that same foreign income, preventing double taxation.
Q5: Why did the ITAT deny Foreign Tax Credit when the foreign salary was declared exempt?
Answer: Under Rule 128(1) and Rule 128(3), FTC is only allowable against Indian tax payable on the corresponding foreign income offered to tax in India. When foreign income is held to be exempt from Indian tax under a DTAA, the Indian tax liability on that income becomes zero. Since no Indian tax is payable on that income, no foreign tax credit can be granted.
Q6: Can foreign tax paid abroad be refunded by the Indian Income Tax Department?
Answer: No. Foreign Tax Credit in India is non-refundable. It can only reduce your Indian tax liability on that foreign income down to zero, but it cannot create a net refund of tax paid to a foreign government.
Section C: Rectification, Form 67 & Procedural Compliance Questions
Q7: What is Form 67 and when must it be submitted?
Answer: Form 67 is a mandatory electronic statement required under Rule 128(8) to claim Foreign Tax Credit. It provides details of foreign income earned and foreign tax paid/deducted. Following CBDT Notification No. 100/2022, Form 67 can be filed on or before the end of the relevant Assessment Year.
Q8: Can the Centralised Processing Centre (CPC) reject Section 154 rectification for foreign income errors?
Answer: Yes, CPC often automatedly rejects complex rectification claims involving foreign income. However, taxpayers have the legal right to challenge such rejections by appealing to the Commissioner of Income Tax (Appeals) and subsequently the ITAT, where substantive relief can be granted based on treaty provisions.