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Tax Alert: Possibility of claiming Foreign Tax Credit on the income pertaining to section 10A / section 10AA eligible units (i.e. SEZ / EOU etc.)

11 November 2019

Background

A resident tax payer is eligible to claim Foreign Tax Credit (‘FTC’) if any tax has been paid by him in a country or specified territory outside India. As per the FTC Rules notified by the Central Board of Direct Taxes (CBDT), proportionate tax credit method is to be followed for claiming relief of foreign taxes paid. In other words, credit for foreign taxes cannot exceed the tax liability on such income in India.

A question generally arises as to whether the foreign tax credit is available in respect of income which has suffered tax in overseas jurisdiction but is not taxable in India. Recently, Mumbai Bench of Income-tax Appellate Tribunal (Mumbai Tribunal)[1], along with other grounds of appeal, had an occasion to delve on this aspect. We, at BDO in India, have summarized the ruling of the Mumbai Tribunal in so far as it relates to FTC and provided our comments on the impact of this decision.

Facts of the case

Taxpayer, IT and ITeS Company, is a Company resident in India. The Company earns income which is entitle for exemption under section 10A / 10AA of the IT Act. The tax officer, after examining Company’s claim and verifying the details, denied relief for FTC in respect of income subjected to tax abroad but exempt from tax in India. The taxpayer contested the tax officer’s action before the appellate authority [i.e. Commissioner of Income-tax (Appeals) (‘CIT(A)’)]. Relying on the decision of Karnataka High court in case of Wipro Ltd.[2], the CIT(A) allowed taxpayer’s claim in respect of income earned from USA. However, in respect of income earned from other DTAA countries and non-DTAA countries, CIT(A) rejected taxpayer’s claim. Hence, the taxpayer filed second appeal before the Mumbai Tribunal. Similarly, the tax department filed appeal before the tribunal against the CIT(A)’s order in respect of relief granted to the tax payer.

The taxpayer contended that section 90 of the IT Act empowers the Central Government to enter into Double Taxation Avoidance Agreement (‘DTAA’) with the Government of any other country for granting relief in respect of cases where the income tax is chargeable. The taxpayer further contended that the income covered by section 10A/10AA of the IT Act is chargeable to tax in India as per section 4 and 5 of the IT Act. Furthermore, the exemption is for a specified period and after expiry of that period such income would otherwise be chargeable to tax. It was further contended that Article 25 of India-USA DTAA mandates that if any income derived and tax paid in USA on such income then tax relief / credit shall be granted in India of such tax paid in USA. Thus, the Article does not say anything about income tax being paid by the resident taxpayer under the IT Act as a condition precedent for claiming the benefit of tax credit under the DTAA. It was contended that a similar clause is there in the DTAAs entered by India (i.e. Denmark, Finland, Hungary, Norway, Oman, South Africa, Saudi Arabia and Taiwan).

The Revenue Authorities contended that since entire income of section 10A / 10AA eligible units are exempt and not subjected to tax in India, the taxpayer would not get tax credit for taxes paid on such income in overseas countries, except USA.

Tribunal ruling

The Mumbai Tribunal made following key notings of Wipro’s decision:

  • The provision of section 90(1)(a)(ii) of the IT Act applies to a case where the income of the taxpayer is eligible to tax under the IT Act as well as in the corresponding law in force in the other country
  • Though income tax is chargeable under the IT Act, it is open to the Parliament to grant exemption under the IT Act from payment of tax for any specified period, normally, to incentivize the taxpayer to carry on manufacturing activities or providing services
  • It is not the requirement of law that the taxpayer before he claims credit under the Indo-US convention or under the provision of IT Act must pay tax in India on such income.
  • As per the embargo placed in the DTAA, the taxpayer is entitled to such tax credit only in respect of that income which is taxed in USA

Relying on Wipro’s decision, Mumbai Tribunal held that where the respective tax treaty 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. As India’s treaties with other countries such as Denmark, Hungary, Norway, Oman, Saudi Arabia and Taiwan have similar provision providing for benefit of foreign tax credit even in respect of income not subjected to tax in India, the foreign tax credit would be available to the taxpayer in respect of foreign taxes paid in such countries.

BDO Comments

With Foreign Tax Credit Rules in place, the credit for foreign taxes is allowed on proportionate basis. This Ruling will provide certainty to the tax payers on their claim for FTC in respect of foreign taxes paid on income of their SEZ units during the tax holiday period. Furthermore, it will help tax payers in their pending litigations on FTC pertaining to income of their SEZ units during the tax holiday period. Needless to mention that the taxpayer should analyse the relevant Article of the DTAA to support its claim for FTC basis this ruling. Commercially speaking, by claiming credit of foreign taxes in respect of exempt income the resident tax payer will get the refund of taxes paid in overseas jurisdiction.


 

[1] Tata Consultancy Service Ltd. Vs ACIT (ITA No. 5713/Mum/2016)

[2] Wipro Ltd vs DCIT (2015) 62 taxmann.com 26 (Kar.)