Background

The rapid infusion of digitisation into the business has made world one global market. In today’ era, the business transactions extend beyond national boundaries and the businesses are tailored to meet the needs of consumers over wider geographic areas. Tax treaties play a crucial role in these times to ensure that the taxes on income are distributed between the sovereigns while minimising double taxation in the hands of person earning the income. 

The tax treaties provide that wherever the source country exercises a right to tax the income of the resident of another country, the latter country should provide a credit of tax paid in the source country while exercising its sovereign right to tax its resident.  For example, an Indian resident receives certain fees in lieu of providing technical services from Japan which is subject to tax in Japan. In such a case, the Indian resident shall be allowed a credit of tax paid in Japan against the income tax liability in India. In this regard, appropriate provisions have been provided not only in the tax treaties but also in the Income-tax Act, 1961 (‘IT Act’).

Provisions pertaining to avoidance of double taxation and foreign tax credit in the IT Act

Section 90(1) of the IT Act, inter alia, empowers the Central Government to enter into a Double Taxation Avoidance Agreement (‘DTAA’) with other countries for avoidance of double taxation and for granting relief in respect of income on which tax has been paid or income tax is chargeable both in India and the foreign country

Further, Section 295(2)(ha) of the IT Act empowers the Central Board of Direct taxes (‘CBDT’) to make rules and prescribe the procedure for granting of relief or deduction under Section 90 for income-tax paid in any foreign country against the income-tax payable in India. Accordingly, vide Notification No. 54/2016 dated 27 June 2016, CBDT notified Rule 128 in the Income tax Rules, 1962 (‘IT Rules’) on Foreign Tax Credit (‘FTC’).

Rule 128 of the IT Rules, inter alia, provides that FTC shall be lower of the tax payable on a foreign income in India and in the foreign country.

Further, there are specific provisions relating to FTC in the DTAAs entered by India with various countries and as per Section 90 of the IT Act, the DTAA will override the provision(s) of the IT Act in case they are more beneficial to the assessee[1].

Provisions relating to relief from double taxation in various DTAAs

On a plain reading, the Article relating to India’s obligation to provide credit of taxes seems to be worded on similar lines in most treaties entered by it. However, on a closer look, one may observe some changes in the language. As illustration, the extracts of article relating to FTC in India-USA and India-UK are reproduced as under:

• India-USA DTAA [Article 25(2)(a)]:

‘Where a resident of India derives income which, in accordance with the provisions of this Convention, may be taxed in the United States, 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 United States, whether directly or by deduction. Such deduction shall not, however, exceed that part of the income-tax (as computed before the deduction is given) which is attributable to the income which may be taxed in the United States.’

• India-UK DTAA [Article 24(2)]:

‘2. Subject to the provisions of the law of India regarding the allowance as a credit against Indian tax of tax paid in a territory outside India (which shall not affect the general principle hereof), the amount of the United Kingdom tax paid, under the laws of the United Kingdom and in accordance with the provisions of this Convention, whether directly or by deduction, by a resident of India, in respect of income from sources within the United Kingdom which has been subjected to tax both in India and the United Kingdom shall be allowed as a credit against the Indian tax payable in respect of such income but in an amount not exceeding that proportion of Indian tax which such income bears to the entire income chargeable to Indian tax.’

Juxtaposing the aforesaid Articles reveals that India-UK tax treaty explicitly states that the FTC to be allowed in India will be equivalent to a portion of the total income tax liability in India in the same ratio which the income generated in UK is to the total income of such assessee. Meaning thereby, that the FTC in India shall be restricted to the extent of the Indian tax liability on the income received from UK which is similar to that of Rule 128 of the IT Rules.  However, the India-USA DTAA simply states that the claim of FTC in India will not exceed that income tax which is attributable to the income which is generated and taxed in USA. Thus, unlike India-UK tax treaty, India-USA tax treaty does not make a specific reference to Indian income-tax while providing for restriction on the quantum of credit.

Now, due to the difference in the language of the abovementioned Articles of the DTAA, the taxpayers have contended that where the Article relating to foreign tax credit is worded like that in India-USA tax treaty, the quantum of credit allowed in India should not be restricted to income-tax payable in India but restricted to income-tax paid in USA. The judicial forums have rendered divergent views on this issue. Various judgements in this regard have been discussed below.

Entire tax paid in the foreign country will be allowed as FTC

In the case of Wipro Ltd.[2], the Karnataka High Court discussed the issue of availability of FTC for an income which is eligible for exemption under section 10A of the IT Act. The Hon’ble High Court held that the income derived by an Indian resident, which is taxable in USA (directly or by deductions), would get FTC in India for the entire amount of income tax paid in USA. The Court held that the India-USA DTAA does not make the payment of income tax in India as a condition precedent to claim FTC and that the only embargo prescribed under the IT Act is that the FTC will be available to an assessee only in respect of that income, which is taxed in USA. The reading of the Hon’ble High Court had the effect of allowing FTC even in a case where the income of the Indian resident is not taxable in India and only taxable in USA.

While interpreting the India-Canada DTAA (similar to the India-UK DTAA as reproduced above), the court differentiated it from the India-USA DTAA and observed that if the income tax paid in India is less than the income tax paid in Canada, then the assessee would be entitled to relief only to the extent of tax paid in India and not to the extent of tax paid in Canada.

Further, the India-Japan DTAA (similar to the India-USA DTAA) was analysed in a recent judgement of Canon India Private Limited[3], wherein, the Income Tax Appellate Tribunal (‘ITAT’) Delhi relied upon Wipro (supra) and gave a similar decision.

In Ittiam Systems Private Limited[4], ITAT Bangalore has held that the DTAAs of India with USA, Germany and Japan have similar double taxation avoidance Articles. Accordingly, relying on Wipro (supra) the ITAT held that the assessee is eligible for FTC in India on full amount of taxes paid in USA, Japan and Germany. However, while interpreting the India-Korea DTAA (similar to the India-UK DTAA as reproduced above), the ITAT held that FTC is limited to taxes paid in Korea or India, whichever is less.

Further relying on the judgement of Wipro (supra), similar view has been taken while analysing India – USA DTAA by ITAT Delhi in HCL Comnet Systems and Services Ltd.[5] and by ITAT Mumbai in Tata Consultancy Services Ltd.[6].

FTC allowed to the extent of tax payable on the foreign income in India

In the case of Digital Equipments India Ltd.[7], the Assessing Officer did not allow the credit on account of taxes paid on income generated in USA. The Hon’ble ITAT Mumbai analysed the India-USA DTAA and held that the India-USA DTAA in the last sentence of Article 25(2)(a) states unambiguously and beyond any controversy that the deduction on account of income tax paid in USA, from income tax payable in India, cannot exceed Indian income tax liability in respect of such an income. The ITAT further held that the India-USA DTAA, and other DTAAs as well, does stipulate that the FTC cannot exceed the income tax leviable in respect of that income in the country of which the assessee is resident.

Similarly, while considering the India-Singapore DTAA (which is similarly phrased as that of India-Japan DTAA with respect to the Article on FTC) ITAT Ahmedabad in the case of Elitecore Technologies (P.) Ltd.[8] has held that FTC shall be available to the extent of income tax payable in India on such foreign income.

Conclusion

The intent behind formulating the article on FTC in the DTAA can be understood by referring to Paragraph 14 on Article 23 of the UN Model Commentary 2021, wherein it states that ‘the credit for tax imposed by the other State is limited to the tax attributable to items of income which the other State is entitled to tax under the provisions of the treaty.’

Further, OECD Model Commentary 2017, while discussing Article 23B (which is identical to Article 25 of India-USA DTAA) states in paragraph 57 that the state of residence (in our case India) will allow deduction of FTC against its own tax, but such deduction will be restricted to the appropriate proportion of its own tax. The commentary further states that the deduction which India has to allow is restricted to that part of the Indian income tax which is appropriate to the income derived from the other foreign state (in our case USA). Accordingly, as per OECD commentary, the FTC allowed in India is intended to be restricted to tax payable in India.

However, it should be noted that Supreme Court in the case of P.V.A.L. Kulandagan Chettiar[9] and High Court of Madhya Pradesh in the case of Turquoise Investment & Finance Ltd.[10] have held that the commentaries on the articles of the model convention will not have any applicability when the terms of the DTAAs have provided for the manner in which tax is to be levied on the assessee. Therefore, the OECD commentaries are not binding on Indian Courts.

Further, Revenue’s appeal against the ruling of High Court of Karnataka in Wipro (Supra) has been granted a Special Leave for Appeal[11], leaving the decision of the High Court to be adjudicated upon by the Supreme Court. Accordingly, it would be interesting to see as to how the Apex Court interprets India-USA DTAA especially in the light of newly introduced Rule 128 of the IT Rules. In the meanwhile, the taxpayers claiming the entire amount of foreign taxes paid as a credit are likely to face resistance from the income-tax department in India which may seek to restrict credit to limits provided in Rule 128 of the IT Rules.

[Both the authors are Associates in Direct Tax Team, Lakshmikumaran and Sridharan Attorneys, New Delhi]

1. [1] SC in Azadi Bachao Andolan: [2002] 125 Taxman 826 (SC)[18 November 2002]
2. [2] Wipro Ltd. v. DCIT: [2016] 382 ITR 179 (Kar)
3. [3] Canon India Private Limited v. ACIT [ITA No. 468/DEL/2021]
4. [4] Ittiam Systems Private Limited v. ITO [2021] 86 ITR(T) 611 (Bangalore - Trib.)
5. [5] DCIT v. HCL Comnet Systems and Services Ltd. [ITA No. 5555 / DEL / 2014]
6. [6] Tata Consultancy Services Ltd. v. ACIT [ITA No. 1650/Mum.
7. [7] JCIT v. Digital Equipments India Ltd. [2005] 94 ITD 340 (MUM.)
8. [8] Elitecore Technologies (P.) Ltd. v. DCIT, Ahmedabad [2017] 184 TTJ 166 (Ahmedabad - Trib.)
9. [9] CIT vs. P.V.A.L. Kulandagan Chettiar [(2004) 137 taxman 460(SC)]
10. [10] DCIT vs. Turquoise Investment & Finance Ltd. [(2006) 154 taxman 80 (MP)]
11. [11] Special Leave to Appeal (C) CC No(s).  15932/2016 / Diary No. 25267/2016