When multi-enterprise companies are set up across different companies, there is always the concern regarding double taxation of their incomes. Simply put, double taxation occurs when the same income is taxed across different jurisdictions. Countries often enter into double taxation avoidance agreements (DTAAs) in order to provide relief in one or more tax jurisdictions in cases where the income can be taxed in multiple locations.
Cases of double taxation are always complex, and pose a problem for companies as in general tax officers in India may tax the incomes which are meant to be exempted under the DTAAs. Furthermore, another complex problem that international companies may face is the issue of receiving foreign tax credits under the DTAAs in India, for taxes they may have paid abroad. Corporate structure are generally decided based on the tax exemptions and incentives companies may be receiving in different jurisdictions hence such decisions can have a drastic effect on the culture of investment in India. The Income Tax Appellate Tribunal, Bangalore (ITAT) recently clarified certain rules regarding the receipt of foreign tax credits in case before them in March 2021.
What are DTAAs and Foreign Tax Credits?
In order to prevent issues of double taxation of income, governments enter into DTAAs to grant relief to tax payers for incomes on which they may tax in one or more countries. They might also provide further incentives to promote trade and foreign investment between countries under the DTAAs.
DTAAs are permitted under Section 90 of the Income Tax Act, 1961 (‘ITA’), and India has entered into DTAAs with most major tax jurisdictions. DTAAs help provide tax certainty to taxpayers, especially multi-national enterprises which also encourages greater foreign investment into India.
Under DTAAs, depending on the specific clauses usually taxpayers will be allowed a credit in India against the taxes they may have paid in the other jurisdiction. These credits are known as ‘foreign tax credits’ or FTCs. Under Section 91 of the ITA, a credit or deduction may also be provided for taxes paid by taxpayers in countries that do not have DTAAs with India.
There are two main ways that the foreign tax credits can be availed:
- Exemption Method: Under this method, when a resident of one country derives income that is also taxable in another jurisdiction, under the provisions of the appropriate tax treaty, the residential country will have to exempt the income that is taxed in the foreign country. The exemption allowable will be determined as per the treaty rules or according to the proportionate method as compared to the applicable rate in the residential country.
- Credit Method: Under this method, if any taxes are paid in the foreign jurisdiction that amount will be an allowable expenditure from the taxable income in the country that the taxpayer is a resident. Hence, they will receive a “tax credit” for the taxes paid abroad.
ITAT Ruling: Bank of India v. ACIT
The taxpayer is a public sector undertaking in India, that has branches in several countries beyond India. It earns incomes and pays taxes in several of these jurisdictions including United Kingdom, France, Belgium, Kenya, United States of America, etc. India has DTAAs with some of these countries and under such agreements, the taxpayer in India could claim relief against any taxes paid on incomes taxable both in India and abroad.
Generally, Article 24 of a DTAA covers the treatment of foreign tax credits in India. However, the particulars of the treatment will vary depending on the DTAA. Amongst the relevant treaties, this treatment varied from receiving ‘ordinary’ tax credits to ‘full’ tax credits in India. The taxpayer claimed foreign tax credits against all the jurisdictions, although they had overall lost money and were not paying any tax in India. Both the assessing officers and the adjudicating authority rejected this approach, and hence the appeal before the Bangalore ITAT was filed.
The tribunal addressed the following issues:
- Whether foreign tax credits for taxes paid abroad can be availed in India, when such income is not taxed in India?
- What is ‘subject to tax’ versus ‘liable to tax’?
- What is the difference in application between the full credit method and the ordinary credit method?
On analyzing the contentions by the parties, the ITAT reached the following conclusions:
- The tribunal rejected the taxpayer’s contention that the foreign tax credits could be availed in India for most of the jurisdictions. However, they did allow that some of the taxes paid in other jurisdictions could be deducted as business expenditure in India. If the income is not being taxed in India, it could be allowed as a deduction rather than being provided credits for the tax paid.
- The tribunal compared the terms ‘subject to tax’ and ‘liable to tax’. They held that to avail foreign tax credits in India, the income must taxable in both the jurisdictions. Liable to tax would only impart benefits of the treaty, but subject to tax would provide access to the specific reliefs under the DTAA.
- The tribunal held that full tax credit method meant that the taxpayer would receive the credit for the foreign taxes paid, however not beyond the extent of the income that would be taxed in India. There will generally not be a situation when a taxpayer will be able to claim excess foreign tax credit (i.e. greater than what he would be taxed in the FTC receiving country). There will not be any situation where the taxpayer could claim greater tax credits in one country after paying lesser in another country.
Important Highlights:
- The taxpayer had placed reliance on the Karnataka High Court judgement of Wipro Ltd. v DCIT, wherein the High Court had allowed the entity to claim foreign tax credits for the taxes paid abroad although the income was not taxable in India. The tribunal disagreed with the application of the Wipro case for the case in hand, and held that since it was not a jurisdictional high court, it was not a binding precedent.
- In the holding regarding the difference between ‘liable to tax’ and ‘subject to tax’ the Tribunal reasoned that when a treaty states a party is liable to tax that means the party is falling within the ambit of the treaty. However, to be able to claim specific reliefs under the DTAA the party must also be ‘subject to tax’ under that provision in that jurisdiction. In this case, since the taxpayer was in a loss, his income was not subject to tax in India and hence he could not claim any foreign tax credit for the same.
- The tribunal did allow that the taxpayer could claim the foreign taxes paid as business expenditure deduction in India, as long as the credits were not claimed for the same.
Conclusion:
ITAT Rulings in 2020 had majorly focused on providing clarity to rules surrounding the receipt of foreign tax credits in India. To read more, visit our article covering these rulings
here. For a long time, companies were facing confusion due to the ambiguous rules surrounding whether the credits could be received by companies in all cases. This ruling clarifies how foreign tax credits can be granted only as a relief from Indian taxes and not as a refund. Indian residents also cannot expect foreign tax credits beyond the extent of the income that is also taxable in India.
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