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Direct Tax Alert - Tax Tribunal denying FTC credit where taxpayer has net loss

23 March 2021

Background

Section 90 of the Income-tax Act, 1961 (IT Act) empowers the Government of India to enter into an agreement (DTAA) with other country, inter-alia, to grant relief in respect of income which is taxed in both countries and tax has been deducted in foreign country - by allowing credit of taxes paid in foreign country against the Indian tax liability. Where India has not entered into any DTAA, section 91 of the IT Act permits deduction of tax paid overseas from Indian tax liability. The DTAA may contain either exemption method or credit method to grant relief of foreign tax paid in a foreign country. However, India has prescribed Foreign Tax Credit Rules1 which provides for credit method. A question may arise as to whether the Foreign Tax Credit (FTC) can be claimed in cases where the Indian taxpayer has incurred losses in India, or the income is exempt in India. Alternatively, where FTC is not allowed, whether tax paid in a foreign country is a deductible expense under section 37 of the IT Act.

Recently, the Mumbai Tax Tribunal2 (Tax Tribunal) had an occasion to examine whether the credit of taxes paid in foreign countries can be claimed in a case where the taxpayer has incurred losses. The Tax Tribunal also delved upon whether the tax paid in foreign country whose credit is not allowed in India can be claimed as deduction under section 37 of the IT Act.

We, at BDO in India, have summarised the ruling of Tax Tribunal and provided our comments on the impact of this decision hereunder:

Facts of the case

The taxpayer, an Indian public sector Bank, has several branches located abroad. While DTAAs exist in respect of these foreign locations, there are few countries with which DTAAs are not there. Apart from having Branch Offices, the taxpayer has made investment in two foreign banks. During the relevant Fiscal Year (FY), the taxpayer earned profits from its foreign branches – UK, USA, France, Belgium, Kenya, Japan, Singapore, China, Hong Kong, Cambodia and Jersey. With respect to investment into two foreign banks, it earned dividend income. On these incomes, it paid taxes in the foreign countries and claimed credit of the said taxes while filing tax returns in India. However, since the taxpayer has globally suffered a loss, it claimed refund of tax paid in foreign countries in the tax return filed in India. The Tax Officer denied the taxpayer’s claim and made the following observation:

As per section 90 of the Income-tax Act, 1961, relief of taxes paid in foreign countries is given against the income tax chargeable under Income-tax Act, 1961 and hence it does not say that the tax paid in foreign countries would be refunded in the cases where income tax chargeable under Income-tax Act, 1961, is NIL.

Further, the Tax Officer abstained from granting deduction of taxes paid in foreign country towards computing business income or loss for the FY. The aggrieved taxpayer preferred an appeal before the First Appellate Authority which affirmed the Tax Officer’s action. Hence, the taxpayer filed an appeal before the Tax Tribunal.

Tax Tribunal’s observations

While the Tax Tribunal denied the taxpayer’s claim for refund of taxes paid in foreign countries, it allowed the taxpayer’s contention to claim such taxes paid as business deduction. While coming to this conclusion, the Tax Tribunal made the following observations:

  • ‘Liable to tax’ and ‘Subject to tax’:
    • The term 'liable to tax', as appearing in the definition of ’Resident’ as per DTAA, refers to a locality related attachment leading to residence type taxation, and not the taxation per se.
    • The entitlement of tax credits uses the expression of the related income having been ‘subjected to tax’ in both the tax jurisdictions, and that is the pre-condition for being granted FTC.
    • 'Liable to tax' is one thing, and 'subjected to tax' is another. When we are to compare DTAA with, say, a building or a residential unit, if 'liable to tax' is the key to open the main door, i.e., entitle someone to the tax treaty entitlement in general, 'subjected to tax in both India and United Kingdom' is a key to open doors of one of the rooms inside, i.e., one of the specific benefits of the treaty entitlement. The former is a condition precedent to be covered by the scope of the tax treaty, and the latter is a condition precedent for being eligible for getting the FTC under Article 24(2).
    • After referring to several rulings3, the Tax Tribunal stated that the income earned by the taxpayer in the UK cannot be said to have been ‘subjected to tax in India. The Tax Tribunal observed that while the income suffered taxation in UK, as the taxpayer did not have taxable income in India and this income was offset against the losses incurred by the taxpayer outside of UK, the income so earned in UK was never subjected to tax in India’. This observation was held valid for all other countries involved in the case.
  • Extent of FTC available to taxpayer:
    • The Tax Tribunal after referring to the works Prof Klaus Vogel4, Prof Michael Lang5 and Peter Harris and David Oliver6, opined that, in principle, there cannot be any occasion of refund of taxes paid in the source jurisdiction by the residence jurisdiction.
    • The scheme of tax credits, as evident from the international tax literature and model convention commentaries, do not envisage any situation in which the excess FTC can result in a situation in which a taxpayer can get refunds, from the exchequer of residence jurisdictions, in respect of taxes paid to the exchequers of the source jurisdictions. If the taxes paid in the source jurisdictions could be refunded in the residence jurisdictions, it would have been perhaps possible to be fiscally domiciled in a no tax or low tax treaty partner jurisdiction and take refund of all the taxes paid in all the treaty partner tax jurisdictions. Wherever tax credits exceed the tax liability, at best, a carry forward or back of excess tax credit can be given when permitted by the domestic law of residence country, or at best when not restricted by the domestic law of residence country.
  • Double jeopardy:
    • With respect to the taxpayer’s contention that it will be subjected to double jeopardy – i.e. while it won’t be granted credit for taxes paid overseas, the foreign sourced income will reduce its losses to be carried forward, on this aspect the Tax Tribunal observed that the double jeopardy will arise in the year in which the losses incurred in India in FY under consideration will be eligible for set-off against the eligible profits of subsequent year. In case the taxpayer does not make any profits during the period eligible for set off, there cannot be any double jeopardy.
    • While the Tax Tribunal rejected the taxpayer’s contention on double jeopardy, it left the issue unresolved i.e., whether in the absence of any specific legal bar or enabling provisions on carrying forwards of FTC, can the taxpayer, on the grounds of equity and double disadvantage, claim those unutilised tax credits in the subsequent years in which the taxpayer is actually subjected to a higher tax burden.
  • Karnataka High Court’s decision in case of Wipro Ltd.7 on which taxpayer placed heavy reliance:
    • The Tax Tribunal distinguished Karnataka High Court’s decision in case of Wipro Ltd. It observed that the issue before the Hon’ble Karnataka High Court was whether credit for foreign taxes paid in relation to an income eligible for deduction under section 10A of the IT Act would be available under section 90 of the IT Act. However, in the instant matter, the refund of foreign taxes is claimed in light of losses incurred by the taxpayer.
    • The Tax Tribunal followed decision of co-ordinate bench ruling in the case of Digital Equipment India Pvt. Ltd.8 wherein it was held that it is not the tax payment abroad which is the material figure for the purpose of computing Indian income tax liability, but it is the admissible FTC in respect of the same which affects such an Indian income tax liability. Thus, refund of FTC is restricted to the extent of Indian tax liability.
  • Countries with which India do not have DTAA

The Tax Tribunal denied the contention of the taxpayer by relying on two rulings9 wherein it was held that the relief under section 91 of the IT Act is available only in respect of such income which is doubly taxed and this is done by allowing deduction of tax on that income at the Indian rate unless rate of tax in the foreign country is less in which case at the rate applicable in that foreign country.

  • Alternate plea to claim business deduction of such taxes paid:

The Tax Tribunal notes that the said issue in squarely covered in favour of the taxpayer by Jurisdictional High Court’s decision in the case of Reliance Infrastructure Ltd10 and thereby permitted the deduction of tax paid in foreign countries in the computing business income for the FY.

BDO comments

The claim for FTC has always been under the lens of Tax Authorities. This Ruling will gain significance as it covers all aspects relating to FTC and has also referred to various commentaries and the suggestions provided by the Institute of Chartered Accountants of India in its Study Material for International Tax Practice. Apart from the DTAA, the taxpayer should also take cognisance of Rule 128 in of the Income-tax Rules, 1962 which grants credit of foreign taxes on proportionate basis.

Recently, the Bangalore Tax Tribunal11 has granted full exemption of FTC in respect of taxes withheld in US, Germany, Japan and Korea by relying on the decision of Wipro. Also, Mumbai Tribunal in case of Tata Consultancy Service Ltd. Vs ACIT (ITA No. 5713/Mum/2016) has held that where the respective DTAA provides for benefit for foreign tax paid even in respect of income on which the taxpayer has not paid tax in India, still, it would be eligible for tax credit under section 90 of the IT Act. Whereas in the present ruling, the Tax Tribunal is of the view that the taxpayer ought to satisfy the test of ‘subject to tax’ and if the foreign income is not subject to tax in India (on account of eligible losses from other sources), taxes paid in foreign countries would not be eligible for tax credit in India.

In relation to deduction of FTC against the computation of business income, it is imperative to note that the Bombay High Court in the case of Reliance Infrastructure Ltd has held that since ‘tax’ includes tax payable under the provisions of the IT Act, foreign tax does not fall under the provisions of the IT Act. Thus, disabling provision pertaining to of section 40(a)(ii)12 of the IT Act would not apply. Accordingly, the Hon’ble Bombay High Court held it is an allowable business expense. On the contrary, the Ahmedabad Tax Tribunal in the case of Elitecore Technologies Pvt. Ltd.13 has denied the claim by observing that the words “any rate or tax” as referred in section 40(a)(ii) of the IT Act would have to be assigned the meaning any kind of tax levied or leviable on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains. It is pertinent to note that the Ahmedabad Tax Tribunal did not follow Reliance Infrastructure Ltd’s ruling since it was not rendered by jurisdictional High Court. With the Tax Tribunal following jurisdictional High Court’s decision and the Ahmedabad Tax Tribunal declining to follow the said decision and there being interpretational difference, the issue pertaining to deduction of FTC against the computation of business income continues to be open for litigation.


1Rule 128 of Income-tax Rules, 1962

2Bank of India vs. ACIT, ITA No. 869/Mum/2018- Mumbai Tribunal

3General Electric Pension Trust [2006] 280 ITR 425 (AAR)

Paul Wiser vs. The Commissioners [2012] UK FTT 501 (TC)

Durametallic India Ltd vs. ACIT [2003] 85 ITD 442 (Chennai Tax Tribunal)

4Klaus Vogel on Double Taxation Conventions, second Indian reprint- page 1227

5Introduction to the Law of Double Taxation Conventions, 2nd edition- page 140

6International Commercial Tax, 2010 edition

7Wipro Ltd. v. DCIT [2015] 62 taxmann.com 26 (Kar. HC)

8JCIT v. Digital Equipment India Pvt. Ltd. [2004] 94 ITD 340 (Mum.)

9CIT v. M.A. Morris [1994] 210 ITR 284 (Andhra Pradesh High Court) andCIT v. Dr. R N Jhanji [1990] 185 ITR 586 (Rajasthan High Court)

10Reliance Infrastructure Limited vs. CIT [2016] 390 ITR 271 (Bombay High Court)

11ITTIAM Systems Pvt. Ltd (ITA No.2464 & 2465/Bang/2017)

12Section 40(a)(ii)- Any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains shall not be deducted in computing the income chargeable under the head profits and gains of business or profession.

13DCIT v. Elitecore Technologies Pvt. Ltd. [2017] 80 taxmann.com 6, Ahmedabad Tribunal