EY Tax Alert. Executive summary
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1 7 October 2015 EY Tax Alert Karnataka HC rules on availability of foreign tax credit relief where the income is exempt from Indian taxes under incomelinked incentive scheme Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert summarizes a recent ruling of the Karnataka High Court (HC) in the case of Wipro Ltd. [1] (Taxpayer), wherein the HC, amongst various other issues, ruled on the matters relating to the availability of foreign tax credit (FTC). The question before the HC was whether the tax paid in a foreign country in respect of income which is exempted under the income-linked incentive scheme (ILIS) of the Indian Tax Laws (ITL), is eligible for FTC in India. The HC analyzed the charging provisions, as well as the double tax relief (DTR) provision, of the ITL and ruled that the income which is exempt by virtue of the ILIS of the ITL, though exempt from Indian taxes, qualifies as income chargeable to tax. Accordingly, any foreign taxes paid in respect of such income shall be available for FTC, if allowed under the relevant double taxation avoidance agreement (DTAA). The HC evaluated the availability of FTC in respect of the DTAA with the US (US DTAA) and Canada (Canada DTAA). In terms of the US DTAA, it held that FTC is available in India for taxes paid in the US, even though no taxes are paid in India. With regard to the Canada DTAA, it held that the Taxpayer, being exempted from payment of tax in India, the benefits of FTC will not be available as there is no payment of tax in India. The HC also held that the State taxes paid in the foreign countries are to be allowed as FTC under the unilateral tax credit provision of the ITL [2]. [1] [TS-565-HC-2015(KAR)] [2] Section 91 of the Indian Income Tax Act.
2 Facts and background of the case The Taxpayer, an Indian company, is engaged in the business of export of computer software, including services for on-site development of software through its permanent establishments (PEs) in many foreign countries, including the US and Canada. During the tax years under consideration, the Taxpayer claimed 100% deduction of profits from its export business, as per the ILIS under the ITL. In certain instances, taxes were withheld on such export income in the foreign countries. The Taxpayer failed to claim the FTC paid on such export income for certain years under consideration while filing its return of income (ROI). Thus, during the assessment, a letter was filed by the Taxpayer before the Tax Authority requesting to allow the FTC. The DTR provision of the ITL provides that the Government of India (GoI) may enter into an agreement with any other country to grant relief in respect of: Income on which income taxes are paid in both the countries (first limb of the DTR provision), or Income tax chargeable under the ITL and the foreign country, as the case may be, to promote mutual economic relations, trade and investment (second limb of the DTR provision) [3] Furthermore, the ITL provides for the unilateral tax credit provision wherein the FTC is to be allowed for income tax paid in any country with which India has not entered into any DTAA. The FTC provisions of the US DTAA provide that, if an Indian resident derives income which is taxed in the US, India shall allow deduction of such taxes paid in the US. On the other hand, the FTC provisions of the Canada DTAA provide that the FTC would be available to a taxpayer in India only in respect of the doubly-taxed income from sources within Canada, and only to the extent of Indian tax which such income bears to the entire income chargeable to Indian tax. In the instant case, the Tax Authority rejected the claim of FTC on the following grounds: Claim was not made in the ROI filed by the Taxpayer and neither was it claimed through revision of the ROI. Since the Taxpayer s income from export business is exempt in India, there is no income chargeable to tax in India and, hence, double taxation relief under the provisions of the ITL is not available. The First Appellate Authority, relying on the earlier years rulings in the Taxpayer s own case, allowed the claim of FTC. On a second appeal, the Bangalore Income Tax Appellate Tribunal ruled that since the Taxpayer was claiming the exemption under the ILIS, no tax has actually been paid in India. Therefore, as per the DTR provision of the ITL, the Taxpayer was not eligible for FTC. However, the matter was restored to the First Appellate Authority to consider the availability of FTC under the respective DTAAs. Aggrieved, the Taxpayer preferred an appeal before the HC. [3] The second limb was inserted via Finance Act, 2003 w.e.f. 1 April Prior to insertion of the second limb, S.90(1) read as under: The Central Government may enter into an agreement with the Government of any country outside India, (a) for the granting of relief in respect of income on which have been paid both income-tax under this Act and income-tax in that country
3 Taxpayer s contentions on FTC entitlement The Taxpayer contended on eligibility to claim the FTC on the following premises: The export income, though claimed as exempt under the ILIS of the ITL, is otherwise chargeable to tax under the charging sections of the ITL. Such exemption, therefore, does not mean that the income is not chargeable to tax in India. FTC benefit should be available to the Taxpayer by virtue of the second limb of the DTR provision. The second limb of the DTR provision was introduced vide Finance Act, 2003 w.e.f. 1 April 2004 to grant relief in respect of income tax chargeable under the ITL and under the corresponding law in force in that country to promote mutual economic relations, trade and investment. The amendment was clarificatory in nature and, hence, should apply retrospectively. The unilateral tax credit provision of the ITL allows credit for income tax paid in any country. The term income tax in relation to any country includes excess or business profit taxes levied by the Government of any part of that country. Accordingly, FTC of State taxes paid in the US and Canada shall be allowed under a unilateral tax credit provision of the ITL. Furthermore, it was submitted that the Taxpayer cannot be denied the FTC credit on the ground that the same was not claimed in the ROI or by filing of revised return. Tax Authority s contentions The Tax Authority argued as below: Since the income of the Taxpayer is exempt under the ILIS of the ITL, the Taxpayer has effectively not paid any taxes in India and, hence, FTC should not be allowed. Benefit under the second limb of the DTR provision is not available to the Taxpayer as the same came into force from 1 April 2004 and is neither retrospective nor clarificatory in nature. HC s ruling On availability of FTC under the ITL Interpretation of the DTR provision of the ITL The first limb of the DTR provision applies to a case where the taxpayer has paid tax, both in India as well as in the foreign country. The second limb, on the other hand, applies to a case where the income of the taxpayer is chargeable under the ITL, as well as in the other country, irrespective of whether tax is actually paid in India on the same or not. Thus, payment of tax is not a sine qua non for granting the relief and the intent of the second limb is to thus promote mutual economic relations, trade and investment. It was by virtue of the policy of the GOI that such an amendment was brought in to the ITL. Income claimed as exemption under the ILIS qualifies as income chargeable to tax The ILIS, granting tax exemption, falls under Chapter III of the ITL, which deals with the incomes forming part of the total income on which no income tax is payable. These are incomes which are exempted from charge of income tax, but are included in the total income of the taxpayer and later exempted from such income on satisfaction of certain prescribed conditions. The act of Parliament to retain the aforementioned provision under Chapter III indicates that the intention of Parliament was to regard it as an exemption and not as a deduction. The very fact that the export income is exempted from payment of tax means, but for that exemption, such income is chargeable to tax in India. The said exemption granted under the statute has the effect of suspending the collection of income tax for a period of 10 years. This, by itself, does not make the said income not chargeable to income tax.
4 Basis the earlier ruling of the HC in the case of CIT v. Yokogawa India Ltd. [4], it may be held that the relief under the ILIS is in the nature of exemption, although the same is termed as deduction. Supreme Court (SC) rulings in the cases of Kasinka Trading [5] and Wallace Flour Mills Co. Ltd. [6], rendered in the context of custom duty and excise duty respectively, support that, merely because exemption has been granted in respect of the taxability of a particular source of income, it cannot be postulated that the taxpayer is not liable to tax. The SC ruling in the case of Azadi Bachao Andolan [7] supports that the income should be computed after giving effect to the beneficial DTAA provision as is applicable to the taxpayer. In the present case, the fact that export income was exempted from the total income computed under the provisions of the ITL did not debar them from forming part of the charging provisions of the ITL and that income and tax thereon was to be computed after considering the DTAA relief. The Taxpayer is, however, entitled to FTC only in respect of that income which is taxed in the US. The provision becomes necessary because the tax year [8 ] in India varies from the tax year in the US. Therefore, the income derived by an Indian resident, which falls within the total income of a particular tax year when it is taxed in the US, falls within two tax years in India. Therefore, while claiming FTC in India, the Taxpayer would be entitled to only the tax paid for that relevant tax year in the US i.e., the income attributable to that year in the US. On availability of FTC under the Canada DTAA The FTC Article of the Canada DTAA is in alignment with the first limb of the DTR provision of the ITL and, accordingly, if income tax paid in India is less than income tax paid in Canada, then the Taxpayer would be entitled to relief only to the extent of tax paid in India. On availability of FTC under the US DTAA The FTC Article under the US DTAA provides that, if an Indian resident derives income which is taxed in the US, India shall allow deduction of taxes paid in the US. The double tax relief provision under the US DTAA is in conformity with the second limb of the DTR provision of the ITL. In other words, where the Indian resident pays no tax on income derived in India, whereas the said income is taxed in the US, 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 US. Therefore, payment of tax in India is not a prerequisite for provisions of both the US DTAA and the second limb of the ITL. The Taxpayer, being exempted from payment of tax in India, the benefits of FTC will not be available under the Canada DTAA, as there is no payment of tax in India. In the given case, since the whole of exports profits are not exempted by virtue of formulae provided under the ILIS, the residuary surplus that has been subjected to tax would qualify for FTC. Proportionate credit of Canadian taxes paid in respect of residuary income subjected to tax in India shall, therefore, be available as FTC against the India tax liability on such income. [4] [(2012) 341 ITR 385 (Kar)] [5] [AIR 1995 SC 874] [6] [44 ELT 598] [7] [263 ITR 706 (SC)] [8] The tax year in India starts from 1st of April and closes on 31st of March of the succeeding year. Whereas, in the US, the 1st of January is the commencement of the tax year and it ends on 31st of December of the same year.
5 On whether the amendment including the second limb to the DTR provision is retrospective in nature The case under consideration is related to tax years prior to 1 April 2004, wherein the second limb of the DTR provision was not in force. The US DTAA was signed in December 1990, whereas the amended ITL provision came into force from 1 April Even prior to the insertion of the second limb, the FTC Article of the US DTAA was in force, which allowed the benefit of FTC, and the Taxpayer has been claiming the benefit of the US DTAA prior and post the amendment also. The second limb is in conformity with the benefit under the DTAA and, thus, the question as to whether the said amendment was retrospective or not was not answered. On availability of FTC for State taxes paid in the US and Canada Under the unilateral tax credit provisions of the ITL, the term income tax in relation to any country has been defined so as to include any excess profits 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. The term, hence, includes income tax paid not only to the Federal Government, but also any income tax charged by a State or a local authority. Direct Taxes (CBDT), which states that it is the duty of the Tax Authority to make available to the taxpayer any legitimate and legal tax relief to which the taxpayer is entitled but has omitted to claim for one reason or another. The Tax Authority is, thus, legally bound to take into consideration the said letter and decide whether the Taxpayer is entitled to such relief or not. The Tax Authority was not correct in rejecting the claim of FTC on the ground that the revised return claiming the same was not filed. Comments This HC ruling is a significant judgment on principles governing claim of FTC under the ITL, as well as under the DTAA. This ruling provides guidance as to how FTC can be claimed under the ITL and the DTAA in respect of income on which exemption has been claimed under the ILIS. The ruling also deals with the availability of relief in respect of State taxes paid in the foreign jurisdiction. The State taxes paid in foreign countries shall be eligible for FTC in India under the unilateral tax credit provisions of the ITL. Validity of FTC claim without filing revised return The omission to provide FTC details in the ROI is not an omission of income. This has been claimed by way of filing of a letter before completion of the assessment proceedings. Reference was made to Circular No. 14 of 1955 issued by the Central Board of
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