DCIT vs. Tata Sons (ITAT Mumbai)

Foreign income-taxes not eligible for deduction u/s 37(1). Despite bar in DTAA, credit for State taxes to be given u/s 91 in addition to Federal taxes

In respect of AY 2000-01, the assessee earned profits on export of software which was eligible for deduction u/s 80HHE. The assessee paid foreign income-taxes of Rs. 60 crores on the said profits in respect of which the assessee claimed tax credit u/ss 90 & 91. The assessee also claimed that it was eligible for a deduction u/s 37(1) in respect of the said foreign income-taxes. While the AO allowed tax credit, he denied deduction u/s 37(1) on the ground that the said payment of foreign taxes was an “application of income” and that it was hit by s. 40(a)(ii). On appeal, the CIT (A) upheld the claim of the assessee by following the orders of the Tribunal in the assessee’s own case & where a department’s reference u/s 256(2) had been rejected the Bombay High Court. In appeal before the Tribunal the department argued that the earlier decisions of the Tribunal should not be followed as they were against the basic scheme of the Act and also that they were no longer good law in view of Explanation 1 to s. 40(a)(ii) inserted by FA 2006 w.e.f. 1.4.2006. HELD upholding the plea of the department:

(i) While there are four basic methods in which relief in the home jurisdiction can be given for taxes paid in a foreign jurisdiction, ss. 90& 91 adopt the system of granting credit for the foreign taxes against the Indian taxes payable in respect of the income (Tax Law Design and Drafting referred);

(ii) The argument that the bar of deduction in s. 40(a)(ii) is not applicable to foreign taxes is no longer acceptable in view of Lubrizol vs CIT 187 ITR 25 (Bom) (being rendered after the lead order of the Tribunal) where it was held that foreign tax payments is an “appropriation of income” and that the words “any tax” in s. 40(a)(ii) covered foreign taxes. Further, this position is clarified by Explanation 1 to s. 40(a)(i) inserted by FA 2006. Accordingly, the earlier judgements of the Tribunal cannot be followed despite the fact that the department’s reference u/s 256(2) was rejected by the High Court;

(iii) The claim of the assessee that it is entitled to tax credit u/ss 90 & 91 in respect of the foreign taxes as well as a deduction u/s 37(1) is not justified and results in a double unintended benefit. On facts, while the assessee paid US Federal Income-tax @ 35% of Rs 35 crores and claimed deduction u/s 37(1) which resulted in tax advantage of Rs 13 crores being 38.5% of this amount, it also claimed tax credit of Rs 35 crores against its Indian income-tax liability despite the fact that the profits were not taxed in India owing to deduction u/s 80HHE. The result is that for a payment of US taxes of Rs 35.01 crores, the assessee claimed tax relief of Rs 48.49 crores in India. Even if tax credit was denied in cases where s. 80HHE was eligible (as done by the CIT (A)), the assessee would still get an effective advantage of 38.5% if it was granted a deduction u/s 37(1). This results in incongruity;

(iv) The argument that if deduction u/s 37(1) is not granted, credit for foreign taxes should be granted u/s 90 even in respect of income eligible for deduction u/s 80HHE is not acceptable because this would be contrary to the language of the DTAA and result in an assessee getting refund of US taxes if he had no tax liability in India. (Green Emirate Shipping 100 ITD 203 distinguished & Digital Equipments 94 ITD 340 followed);

(v) The argument that ss. 90 & 91 are confined to USA Federal taxes and not to USA State taxes and that therefore the bar in s. 40(a)(ii) does not apply to USA State taxes is not acceptable because any payment of income-tax is an application of income as held in Inder Singh Gill 47 ITR 284. Further, the scheme of ss. 90 & 91 does not discriminate between Federal taxes and State taxes and though the India-USA DTAA confines the credit only to Federal taxes, the assessee will be entitled to relief u/s 91 in respect of both taxes as that will be more beneficial to the assessee vis-à-vis tax credit under DTAA. Consequently, the bar against deduction in s. 40(a)(ii) will apply to USA State taxes as well though the assessee will be entitled to credit in respect of USA State taxes.