Tax Insights
from India Tax & Regulatory Services
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Tribunal holds that for computing foreign tax credit, net foreign
income taxable in India should be considered
March 23, 2020
In brief
Recently1, the Ahmedabad bench of the Income-tax Appellate Tribunal (Tribunal) held that for the purpose of computing foreign tax credit (FTC) under section 91 of the Income-tax Act, 1961 (the Act), the rate of tax in the foreign country is to be determined by considering net receipts (after deducting eligible expenses) and not gross receipts. It also held that where the taxpayer had not furnished details of expenses incurred to earn such income from outside India, the net receipts embedded in such income should be determined on a proportionate basis.
In detail
Facts
• The taxpayer is a public limited company in India and is engaged in the business of customised software development and maintenance. During the year under consideration, the taxpayer had earned certain income from foreign parties based in
Afghanistan, from which taxes were withheld at 7%.
The applicable rate of tax in India on such income was 30.90%.
• The taxpayer claimed relief under section 91 of the Act for the entire amount of taxes paid in the foreign country, being taxes based on the lower of the two tax rates - rate of tax in India or rate of tax in a foreign
1
ITA No. 1135/ AHD/ 2017 dated 6 March 2020
country, applicable on such income.
• On the other hand, the Tax Officer (TO) held that to determine the rate of tax in the foreign country, the amount of income that is getting taxed twice should be computed. Accordingly, the expenses incurred by the taxpayer against the gross income from foreign countries need to be adjusted to determine doubly taxed income and the rate of tax in the foreign country.
• Since the taxpayer did not submit any details of expenses incurred in earning the aforesaid income from outside India, the TO computed the approximate net receipts from outside India on a
proportionate basis, i.e. by applying the overall profit percentage on which taxes were paid in India to the gross receipts from outside India.
• Accordingly, the TO disallowed the excess tax credit claimed by the taxpayer. This was further upheld by the
Commissioner of Income- tax (Appeals).
Issues before the Tribunal
• Whether rate of tax in foreign country needs to be determined after
considering the gross receipts or the net receipts/
profit embedded in such gross receipts?
• If not, whether tax paid in a foreign country which is not eligible for benefit under
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section 91 of the Act, is expenditure eligible for deduction under section 37(1) of the Act?
Taxpayer’s contentions
• For the purpose of computing the tax credit, “income” is relevant and not overseas net profit, net income or
proportionate income.
Therefore, for determining the
“rate of tax in the foreign country”, the “gross receipts”
should be considered.
• Relief for the entire amount of taxes paid outside India should be given since rate of tax in the foreign country @ 7% is less than the rate of tax of 30.90% in India. In support of its contention, the taxpayer relied on the decision in the case of Hindustan
Construction Co. Limited.2
• Alternatively, if the tax credit is not allowed, then the same should be allowed as an expense under section 37(1) of the Act. In support of its contention, the taxpayer relied on the judgment in the case of Reliance Infrastructure Limited3.
Tribunal’s ruling
• The Tribunal observed that as
2 Hindustan Construction Co. Limited v.
DCIT [2006] 25 SOT 359 (Mumbai)
per Explanation (iii) to section 91 of the Act, the amount of tax/ super tax needs to be divided by the whole amount of income to work out the rate of tax in foreign company. The term “whole amount of income” denotes the income that remains after deducting expenses. The term “gross receipts” has not been used therein. Even under the normal parlance, the income denotes only the net profit, i.e.
gross receipts minus the expenses.
• It is only the profit that should be considered while
determining the rate of tax in the foreign country, but the same needs to be compared with the tax rate in India.
• The Tribunal also observed that since the taxpayer had not furnished the details of
expenses incurred in relation to the gross receipts from outside India in the given case, the TO had no alternative except to work out the proportionate amount of income eligible for relief under section 91 of the Act.
• In respect of the alternate argument of the taxpayer, the Tribunal, placing reliance on
3 Reliance Infrastructure Limited v. CIT [2017] 390 ITR 271 (Bombay)
the judgment in the case of Reliance Infrastructure Limited3, observed that the tax paid in a foreign country that is not eligible for benefit under section 91 of the Act is
expenditure eligible for deduction under section 37(1) of the Act as such tax was paid in the normal course of business and the corresponding business receipts were made to tax in India.
The takeaways
The ruling provides clarity on the methodology to be used in computing FTC in a non-tax treaty situation. Also, the eligibility to claim the balance taxes paid as a deduction under section 37 of the Act would allow taxpayers to recoup all taxes paid in an overseas jurisdiction.
Let’s talk
For a deeper discussion of how this issue might affect your business, please contact your local PwC advisor
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