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All About Foreign Tax Credit

Foreign Tax Credit

Background-:

1. Karnataka High Court has vide its order dated 25 March 2015 has pronounced a significant ruling on the issue of claiming foreign tax credit.

2. The assessee has paid tax in USA by way of source rule on an income which is exempt u/s 10A in India.

3. After referring to the Judgment of the Madras High Court in the case of CIT –vs- K.S.Vaidyanathan (1985) 153 ITR 11(FB) under the Wealth Tax Act, ITAT held credit for income tax paid in other country in relation to income under Section 10-A will not be available under Section 90(1)(a).

4. Supreme Court, in the case of CIT vs. Vegetable Products Ltd., 88 ITR 192, has held that, in a scenario, where there is no judgement of jurisdictional high court and there are differing opinions on a vexed issue, the view favourable to the assessee should be adopted.

5. Karnataka High Court has held that, the said foreign tax credit is available even when such income is not chargeable to tax in India.

6. Thus at least for assessees other than under the jurisdiction of Madras High Court, it is a relief.

7. During the course of judgement, the High court has also held that,

  • a foreign tax credit can be claimed in respect of tax on income levied by states u/s 91.
  • though sec 10A uses the word “deduction”, it is an exemption section.

A few things before we discuss the issue

8. The judgement runs into 199 pages. It contains many substantial question of laws admitted through various appeals and cross objections. The judgement relating to issue of foreign tax credit ends at page 92.

9. Though not required, ideally, the reader should keep the copy of the judgement ready while reading this article.

10. With each of the heading, I have put the page numbers of the judgement for ready reference. It will help the audience to choose what to read. Following is the relevant index of the judgement.

ParticularsPage numbers
 fromTo
   
List of various appeals decided vide this judgement0115
Facts of the case and happenings in brief till the point case reached HC1632
Arguments of the assessee3336
Arguments of the revenue3738
   
Judgement of the Court3992
   
History of section 90 and law relating to DTAA3951
Analysis of section 905256
Analysis of section 10A5769
Analysis of judgement of Wallace Flour Mills Contracting State Ltd., Vs. Collector of Central Excise, Bombay Division III, and in the case of Kasinka Trading and Another Vs. Union of India and another,7073
Analysis of Indo-USA Agreement7376
Analysis of Indo-Canada Agreement7780
Analysis when there is no agreement8083
Amendment in section 90 – prospective / re-trospective8486
Whether not claimed in return will nullify the claim8692

Facts of the case and happenings in brief till the point case reached HC

11. The assessee is engaged in rendering information technology services.

12. It pertains to assessment years 2001-02, 2002-03, 2003-04 and 2004-05.

13. The assessee being a domestic company, its world-wide income was chargeable to tax in India. The assessee paid taxes in USA, UK, JAPAN, GERMANY and Canada on the same income.

14. It was either on account of the assessee falling in permanent establishment rule or emanating from rules framed under source based taxation, typically the expenditure being treated as fees from technical services.

15. The assessee was enjoying deduction / exemption u/s 10A.

16. The assessee claimed the credit of foreign taxes paid as pre-paid credit i.e. exactly like normal TDS, advance tax, self assessment tax etc.

17. During AY 1990-91, the said argument of the assessee was accepted by Income Tax Department.

Arguments of the assessee

18. The assessee was of the opinion that, a foreign tax credit as available under article 25 read with section 90(1)(a)(ii) is available to assessee evenif it culminates into a refund.

19. The assessee is eligible for tax on income charged by states u/s 91.

20. The amendments made by the Finance Act, 2003 are clarificatory in nature.

21. It took residual / technical arguments that mere not claiming it in original return will not and can not invalidate the claim.

Arguments of the revenue

22. Double Tax Avoidance Agreement, as the name suggests is there to avoid double tax. The Department was of the view that, since no tax is paid on that income in India, question of elimination of double taxation does not arise.

23. It compared the anology with section 14A i.e. dis-allowance of expenses for exempt income.

24. It took residual / technical arguments that these are these areguments were not taken before lower court and thus now these can not be taken.

History of section 90 and law relating to DTAA

25. The HC has reproduced the text of the FA, 2003, notes to clauses and memorandum to bill. It also drew attention to circular No.333 dated April 2, 1982.

26. FA, 2003 substantially amended section 90 making the purpose of DTAA more explicit and vocal.

27. The HC also discussed the decision of SC in Azadi Bachao Andolan and its observation in this regard.

Analysis of section 90

28. The philosophy of giving tax credit can be given in 3 manners

29. Firstly, 90 (1)(b) exemption mode i.e. only one country will tax a particular income.

30. Secondly, 90 (1)(a)(i) is giving credit for taxes paid in other country

31. Thirdly, and the case on hand i.e. 90 (1)(a)(ii) whereby the INCOME is chargeable to tax under both the countries, and one of the countries has given exemption from payment of taxes for a specified period.

32. In this case, only one of the Countries gives the exemption from payment of tax.

Analysis of section 10A

33. The HC has considered the section 10A along with section 4, 5, definition of total income u/s 2(45). It has gone into the history of making of the exemption chapter III.

34. It has also considered chapter VI-A

35. It has concurred with the decision of co-ordinate bench in the case of CIT v yokogawa India Ltd. (2012) 341 ITR 385 (Karn.)

36. It has held that, despite the section 10A using the word “deduction”, it is an exemption section.

Analysis of judgement of Wallace Flour Mills Contracting State Ltd., Vs. Collector of Central Excise, Bombay Division III, and in the case of Kasinka Trading and Another Vs. Union of India and another

37. One may wonder what are these cases about.

38. These cases are under indirect tax laws i.e. under customs Act and under Excise Act.

39. One is aware of the fact that, excise duty is a charge on manufacture but the collection of the duty is postponed to the point where the goods are removed from factory. Thus these two phases are different and can not be read interchangeably.

40. The HC has relied upon it to put forth the point that, the two phases i.e. bringing some income under the charge of tax and quantification of the charge thereof are different and can not be read interchangeably.

41. It means that, section 4, 5 and 9 very well levies a charge on income from export of software by STP units.

42. Another section i.e. 10A eliminates a tax on only this portion of income.

43. This can not be interpreted that the charge u/s 4,5 and 9 fails.

44. This is a very important argument because 90(1)(a)(ii) talks only about income for which a charge u/s 4, 5 and 9 is sufficient.

Analysis of Indo-USA Agreement

45. The article 25 clause 2(a) reads as follows. Para-phrased by me

“2.(a) Where a resident of India derives income which, in accordance with the provisions of this Convention, may be taxed in the United States, India shall allow as a deduction from the tax on the income of that resident an amount equal to the income-tax paid in the United States, whether directly or by deduction.

Such deduction shall not, however, exceed that part of the income-tax (as computed before the deduction is given) which is attributable to the income which may be taxed in the United States.”

46. Thus first sentence reads about the charge which has nexus to income and second sentence has nexus to quantification of the tax credit. In first sentence, there is no requirement that, the said income shoud actually suffer tax in both the countries.

47. It is in conformity with section 90(1)(a)(ii).

48. It is in a context that compares when we compare the language in Canada treaty where such specific requirement is there.

Analysis of Indo-Canada Agreement

49. Refer article 23 clause (a). Para-phrased by me

“(a) The amount of Canadian tax paid, under the laws of Canada and in accordance with the provisions of the Agreement, whether directly or by deduction, by a resident of India, in respect of income from sources within Canada which has been subjected to tax both in India and Canada shall be allowed as a credit against the Indian Tax payable in respect of such income but in an amount not exceeding that proportion of Indian Tax, which such income bears to the entire income chargeable to Indian tax.”

50. A reading of the aforesaid provision makes it clear that the benefit of Article 23 would be available to an assessee in India only in respect of the income from sources within Canada, which has been subjected to tax both in India and Canada, which forms part of the total income of the assessee and has suffered tax in India under the Income tax Act and has suffered tax in Canada also i.e., assessee has paid tax both in India as well as in Canada on the same income.

Analysis when there is no agreement

51. In this case, I would like to re-produce the para 66 which is very important. Also read the last line as underlined by me. Para phrased by me.

66. The said provision provides for deduction of the tax paid in any country from the Indian Income tax payable by him of a sum calculated on such doubly taxed income even though there is no agreement under Section 90 for the relief or avoidance of double taxation. Explanation (iv) defines the expression income tax in relation to any country includes any excess profit tax or business profits tax charged on the profits by the Government of any part of that country or a local authority in that country.

Therefore the intention of the Parliament is very clear. The Income Tax in relation to any Country includes Income Tax paid in any part of the country or a local authority. It applies to cases where in a Federal structure a citizen is made to pay Federal Income tax and also the State Income Tax.

The Income tax in relation to any country includes income tax paid not only to the Federal Government of that Country, but also any income tax charged by any part of that country meaning a State or a local authority, and the assessee would be entitled to the relief of double taxation benefit with respect to the latter payment also.

Therefore, even in the absence of an agreement under Section 90 of the Act, by virtue of the statutory provision, the benefit conferred under Section 91 of the Act is extended to the income tax paid in foreign jurisdictions. India has entered into agreement with the Federal Country and not with any State within that country.

In order to extend the benefit of this, relief or avoidance of double taxation, aforesaid explanation explicitly makes it clear that income tax in relation to any country includes the income tax paid to the Government of any part of that country or a local authority in that country.

Therefore, even though, India has not entered into any agreement with the State of a Country and if the assessee has paid income tax to that State, the income tax paid in relation to that State is also eligible for being given credit to the assessee in India.

Therefore, the argument that in the absence of an agreement between India and the State, the benefit of Section 90 is not available to the assessee is ex-facie illegal and requires to be set aside.

Amendment in section 90 – prospective / retrospective

52. It is clarificatory in nature.

Whether not claimed in return will nullify the claim

53. The answer is no.

Foreign Tax Credit

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