Merely because exemption has been granted under the Indian Income Tax Act, foreign tax credit cannot be denied
The Karnataka High Court, in the case of Wipro Ltd, apart from other substantial questions on law, has held that tax credit for the income tax paid in a foreign jurisdiction shall be available under Section 90(1)(a), even if the income is not taxable in India by way of a specific exemption under Section 10A of the Indian Income Tax Act. The specific provisions in the Double Taxation Avoidance Agreement (DTAA) shall apply for granting relief, irrespective of the provisions of Income Tax Act.
Section 10A appears under Chapter III which refers to incomes that do not form part of the total income. However, sub section(1) states that “a deduction of such profits and gains as are derived by an undertaking from the export … shall be allowed from the total income.”
Section 4 specifies the chargeability of income tax on total income and Section 5 provides for the inclusion of all incomes under the scope of total income.
The foreign tax credit is being claimed under the provisions of Section 90 (1)(a) if:
* Income on which income tax has been paid under the Indian Income Tax Act and income tax in the other country or specified territory; (or)
* Income tax chargeable under the Indian Income Tax Act and the corresponding law in force in the other country or specified territory, to promote mutual economic relations, trade and investment.
It is clear that the relief is granted for the income tax paid in the foreign country, if the same is “subjected to tax” or “chargeable to tax”.
Foreign tax credit shall be available under either of the situations, in the instant case:
* If the income is subjected to tax in both the countries, then it is ordinary tax credit;
* If the income is subjected to tax in foreign country but is exempted by way of a specific enactment for a specified period of time, it shall be construed as “chargeable to Indian Income Tax” and but for the exemption, the taxes were to be paid.
If the income is subjected to tax, both in India and the foreign country, the foreign income taxes paid attributable to such income is allowed as tax credit in India. This falls under Section 90(1)(a)(i).
Section 90(1)(a)(ii) is in respect of granting of relief in respect of income tax chargeable under the Act and under the corresponding law in force in that country to promote mutual economic relations, trade and investment. Income derived by an undertaking falling under Section 10A is chargeable to tax in view of Section 4 of the Act. If we refer to Section 10A, it was available for a consecutive period of 10 years only and thereafter incomes earned in that undertaking shall be subjected to tax.
Once the assessee is made to pay tax on such exempted income in the other contracting state, Section 90(1)(a)(ii) enables him to claim credit of the tax paid in the contracting country. Though this provision 90(1)(a)(ii) is effective from April 1, 2004, it is clarificatory in nature. As per Section 90(2) of the Act, the assessee-company was always entitled to the said benefit as the provisions of the agreement was more beneficial than the statutory provisions.
Section 4 and Section 5 expressly state “subject to the provisions of this Act”. This clearly means that these sections are subject to the provisions of Section 90 for grant of relief in respect of income tax paid or payable in the foreign country, for avoidance of double taxation of income.
Circular No 333 dated April 2, 1982, states that where a DTAA is provided for a particular mode of computation of income, the same should be followed, irrespective of the provisions in the Income Tax Act.
Article 25, Clause 2(a) of the India-US DTAA simply mentions that the income derived and subjected to tax in the US shall be allowed as deduction in India from the tax on the income of that resident, whether directly or by deduction. The above provision does not impose a condition that the income tax shall be paid for claiming foreign tax credit. Therefore, this provision is in conformity with Section 90(1)(a)(ii) of the Act, i.e. the income tax chargeable under the Act and in the corresponding law in force in the US. The assessee is entitled to tax credit on such income, which is taxed (local as well as federal taxes) in the US. It was held that the foreign taxes paid shall be adjusted in two assessment years, as taxes paid in the US fall in one calendar year itself.
Insofar as the India-Canada treaty is concerned, Article 23 restricts the entitlement of foreign tax credit. It states that 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. Therefore, if the assessee is exempted from payment of tax in India, then tax credit is not available for taxes paid in Canada. This falls under the situation enumerated under Section 90(a)(i). If there is any residuary profits subjected to tax in India for Section 10A unit, then such taxes payable in India can be adjusted for taxes paid in Canada.
This judgment explains that merely because exemption has been granted under the Indian Income Tax Act, foreign tax credit cannot be denied. The specific provisions in the DTAA shall prevail over the domestic law. The provisions of the Act shall be subject to the terms of the double taxation treaty. The high court relied upon the Supreme Court’s verdict in the Azadi Bachao Andolan case on applying the provisions of DTAA.
The author is executive partner, Lakshmikumaran & Sridharan