8 March 2021

EY Tax Alert

Mumbai Tribunal denies refund of foreign taxes but allows business expense deduction in absence of Indian tax liability on foreign incomes

Tax Alerts cover significant Executive summary tax news, developments and This Tax Alert summarizes a ruling of the Mumbai Income Tax Appellate Tribunal changes in legislation that (Tribunal), dated 4 March 2021, in the case of Bank of India1 (Taxpayer), wherein the affect Indian businesses. They Tribunal denied refund of foreign taxes but allowed it as business expense deduction in the absence of Indian tax liability on foreign incomes. act as technical summaries to keep you on top of the latest tax The Taxpayer, an Indian public sector bank, earned business income from foreign branches and dividends from foreign companies in tax year 2011-12 from various issues. For more information, countries with which India either had or did not have a Double Taxation Avoidance please contact your EY advisor. Agreement (DTAA). It paid taxes in those countries as per domestic tax laws of the respective countries, read with the DTAA wherever applicable. However, on an overall basis, it incurred loss in India even after setting off the foreign incomes and, hence, it did not have any Indian tax liability on such foreign incomes. Nevertheless, the Taxpayer claimed credit (and, consequently, refund) of foreign taxes as a primary claim and, alternatively, as business expense deduction.

1 [TS-118-ITAT-2021(Mum)]

► Article 24 (elimination of double taxation) of After an extensive review of several Indian and the DTAA usually provides the mechanism to foreign court rulings, commentaries on model grant FTC. However, the language of Article conventions and views of Indian and foreign 24 can vary between different DTAAS. The international tax experts, the Tribunal denied the three variants (amongst others) considered refund claim by holding that, in the absence of by the Tribunal in the present case are the Indian tax liability on such foreign incomes, the DTAAs with Namibia, UK and US. The Taxpayer is not entitled to foreign tax credit (FTC) relevant portions of the Articles in these in India, either as per the DTAA or domestic tax DTAAs, with reference to FTC available to rules. The Tribunal held that that the foreign Indian residents, are reproduced below: incomes should be “subject to tax” or “doubly taxed” in both jurisdictions to avail FTC, which is Article 24(2) of the India-UK DTAA states available only to the extent of Indian tax liability. that, “Subject to the provisions of the law of However, the Tribunal allowed the secondary claim India regarding the allowance as a credit of the Taxpayer and held that the taxes paid in against Indian tax of tax paid in a territory foreign jurisdictions can be claimed as business outside India (which shall not affect the expense deduction in the computation of business general principle hereof), the amount of the profits since no credit of such foreign taxes was United Kingdom tax paid, under the laws of allowable against Indian tax liability. the United Kingdom and in accordance with the provisions of this Convention, whether directly or by deduction, by a resident of Background and facts India, in respect of income from sources ► The Taxpayer, a public sector banking within the United Kingdom which has been company in India, has several branches in subjected to tax both in India and the United foreign jurisdictions. During tax year 2011- Kingdom shall be allowed as a credit against 12, the Taxpayer earned business profits the Indian tax payable in respect of such from its branches outside India viz., in UK, income but in an amount not exceeding that US, France, Belgium, Kenya, Japan, proportion of Indian tax which such income Singapore, China, Hong Kong, Cambodia and bears to the entire income chargeable to Jersey. It also earned dividend income from Indian tax.” investment in foreign banks. Article 25(2) of the India-US DTAA states ► Section (S.) 90 of the Income Tax Laws (ITL)2 that, “Where a resident of India derives provides that the Government of India (GOI) income which, in accordance with the may enter into an agreement (DTAA) with provisions of this Convention, may be taxed any other country, inter alia, to grant relief in the United States, India shall allow as a in respect of: 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 • Income on which income tax is by deduction. Such deduction shall not, paid in both the countries. however, exceed that part of the income-tax (as computed before the deduction is given) • Income tax chargeable under the which is attributable to the income which ITL and under the foreign tax may be taxed in the United States.” laws. Article 23(2) of the India-Namibia DTAA states that, “In India, double taxation shall be eliminated as follows : Where a resident of India derives income or capital gains from Namibia, which, in accordance with the provisions of this Convention may be taxed in Namibia, then India shall allow as a deduction from the tax on the income of that resident an amount equal to the tax on income or capital gains paid in Namibia, whether directly or by deduction.” 2Income Tax Act, 1961 read with Income Tax Rules, 1962

jurisdiction of the Bombay HC and, hence, the Wipro ruling was a non-jurisdictional HC As can be seen from the above, FTC under ruling for it. As an alternative claim, the the India-Namibia DTAA is available under Taxpayer put forth the contention that if FTC the “full credit” method i.e., full deduction is is not allowed in respect of such foreign available to the extent of taxes paid in taxes, then they should be allowed as Namibia in accordance with the DTAA. On business expense deduction in line with the the other hand, FTC under the India-UK Reliance Infrastructure ruling (supra) which DTAA is available under the “ordinary credit” was a jurisdictional HC ruling for the method i.e., FTC is available against Indian Taxpayer. tax payable in an amount not exceeding the proportion of Indian tax which such income ► The Taxpayer’s claims were rejected by the bears to the entire income chargeable to tax authority and the first appellate Indian tax. The India-US DTAA represents a authority. Hence, the Taxpayer filed further variant of ordinary credit where deduction is appeal before the Tribunal. available from Indian tax to the extent of Indian tax payable on the income which may be taxed in US. Tribunal’s ruling

► In respect of countries with which India does ► The Tribunal rejected the Taxpayer’s claim not have a DTAA, like Jersey in the present for refund of foreign taxes but allowed claim case, S. 91 of the ITL provides for FTC by the for business expense deduction for reasons “ordinary credit” method. The FTC under this that are briefly discussed in the following method is available on “doubly-taxed paragraphs. income” (i.e., income which is taxed both in India and the foreign country) to the extent ► Distinction between “liable to tax” and of the lower of Indian tax rate or foreign tax “subject to tax” rate on such income. However, no FTC is available on foreign incomes which are • The Taxpayer’s contention was deemed to accrue or arise in India. that the foreign incomes were “liable to tax” in India. The mere ► In the case of Wipro Ltd.3, the Karnataka fact that there was no final Indian High Court (HC) was concerned with the tax liability due to overall losses, DTAAs with Canada and US. FTC under the is not relevant. The foreign India-Canada DTAA is on the lines of the incomes had the effect of India-UK DTAA (ordinary credit method). The reducing the losses incurred in taxpayer earned business income from India. Hence, it is entitled to FTC Canada and US on which it paid taxes in on foreign incomes. those countries. But, in India, such income was entitled to profit-linked deduction. Yet, • But the Tribunal held that what is the Karnataka HC granted FTC on the relevant for FTC, as per Article interpretation of the Canada and US DTAAs, 24, is that the Taxpayer should be which reduced the Indian tax liability of the “subject to tax” on such incomes taxpayer on other incomes. both in India and the tax treaty country. The terms “liable to tax” ► In the case of Reliance Infrastructure v CIT4, and “subject to tax” have different the taxpayer paid taxes in Saudi Arabia on meanings and connotations. income which was deemed to accrue or arise in India and was also entitled to profit-linked • The term “liable to tax” is relevant deduction in India for tax year 1982-83 when for gaining access to tax treaty India did not have a DTAA with Saudi Arabia. benefits. It means comprehensive The Bombay HC held that since the taxpayer liability to tax based on connect is not entitled to claim FTC on such income factors like residence, domicile, under S. 91 of the ITL, it is entitled to claim place of effective management business expense deduction for such etc. As per judicial precedents in expense. India, the test is satisfied even if there is no income tax in the tax ► The Taxpayer, in the present case, relied treaty country (like the Middle upon Wipro’s case (supra) to claim FTC for East countries). But the taxpayer taxes paid in foreign countries, even though is within the scope of jurisdiction it had incurred loss on an overall basis. This of such countries in the event that had the effect of the Taxpayer claiming such country exercises its refund of such foreign taxes from the Indian sovereign right to tax5. tax authority. The Taxpayer fell within the

3 Wipro Ltd v. DCIT [(2015) 62 taxmann.com 26 (Kar)] 5 This is now subject to amendment proposed by Finance 4 [TS-676-HC-2016 (Bom)] Bill, 2021 with effect from tax year 2020-21 to define “liable to tax” to mean, in relation to a person, that there

• On the other hand, the term against future incomes. But, no “subject to tax” has a narrower credit is granted for foreign taxes meaning and means actual liability paid on such incomes. to tax. The Tribunal took support from various Indian6 and foreign7 • The Tribunal rejected this rulings for this proposition. contention on two grounds: (a.) Such difficulty does not arise in • In the present case, the Taxpayer the current year but in future did not satisfy the test of “subject years in which the taxpayer is to tax” since the foreign incomes unable to set off the loss which it, were not subjected to tax in India otherwise, could have done. (b.) in view of the overall loss incurred Carry forward of unutilized FTC is by the Taxpayer. subject to domestic tax rules. The Indian domestic tax rules do not ► Distinction between “full credit” and currently permit such carry “ordinary credit” forward. However, the Tribunal clarified that while the Taxpayer’s • In the present case, the foreign claim is premature for the current incomes were earned by the year, it is leaving the issue open Taxpayer from countries which for adjudication in future years. either had a DTAA based on the “ordinary credit” method (or ► Wipro ruling is distinguishable and not variant thereof like the US) or binding, being non-jurisdictional HC ruling from countries with which India had no DTAA (and, hence, • The Karnataka HC ruling in governed by the ”ordinary credit” Wipro’s case (supra) is applicable method as per S. 91 of the ITL). only in a situation where the foreign source income is eligible • The Tribunal discussed exposition for profit-linked deduction, but the of the FTC under different taxpayer has sufficient taxable methods by referring to views of income against which it can claim international tax experts, the FTC of foreign taxes paid on such OECD8 and the United Nations income. It is not an authority for model convention commentaries granting refund of foreign taxes and Indian literature to conclude by the Indian exchequer. that FTC does not envisage any situation in which excess FTC can • The Karnataka HC interpreted the result in a scenario where the Canada and US DTAAs as granting taxpayer can claim refund from full credit like the India-Namibia the exchequer of the resident DTAA, which the Tribunal found jurisdiction. difficult to accept having regard to peculiarities of interpretation of • At best, subject to domestic tax DTAAs as per principles laid down rules, excess FTC can be in several Supreme Court (SC) permitted to be carried forward or rulings. Unlike statutory backward. But the Tribunal provisions, the DTAAs are to be clarified that it was not required interpreted in good faith, in to adjudicate upon this issue in accordance with the ordinary the present case. meaning to be given to the terms of the DTAA in their context, ► No double jeopardy due to denial of having regard to their object and credit/refund purpose rather than a purely literal or legalistic interpretation9. • The Taxpayer contended that if credit/refund is not allowed for • In any case, it being a non- foreign taxes, it will face double jurisdictional HC ruling, it may jeopardy since the foreign only have a persuasive effect, incomes reduce the Indian losses unlike the binding effect of a which, otherwise, could have been jurisdictional HC ruling. Amongst carried forward and set off others, the Tribunal relied on the is a liability of tax on such person under any law for the 7 Paul Wiser v. The Commissioners [(2012) UK FTT 501 time being in force in any country and shall include a case (TC)] where subsequent to imposition of tax liability, an 8 Organisation for Economic Co-operation and exemption has been provided. Development 6 General Electric Pension Trust In Re [(2006) 280 ITR 9 Reliance placed on UOI v. Azadi Bachao Andolan [(2004) 425 (AAR), CIT v. Petroleum India International [(2013) 263 ITR 702(SC)] and UOI v. Ram Jethmalani [(2011) 12 29 taxmann.com 250 (Bom HC)] taxmann.com 27 (SC)]

Bombay HC ruling in the case of jurisdictional Bombay HC ruling in CIT v. Thana Electricity Co. Ltd.10 Reliance Infrastructure (supra). for this proposition. • The Tribunal did take note of the • It is also not possible to give the Ahmedabad Tribunal ruling in the benefit of doubt in interpretation case of DCIT v. Elitecore to the Taxpayer since it is well- Technologies Pvt. Ltd.14 where settled that such principle is not the Ahmedabad Tribunal did not applicable in the context of follow the Reliance Infrastructure deduction, exemptions and ruling (supra). But it held that the exceptions, which can be granted Ahmedabad Tribunal, in that case, only if clearly authorized by the had made it clear that it was not law11. following the Reliance Infrastructure ruling because it • The Tribunal preferred to follow was not a binding jurisdictional HC its own coordinate bench ruling in ruling. However, in the present the case of JCIT v. Digital case, the Reliance Infrastructure Equipment India Pvt. Ltd.12 in ruling was a binding jurisdictional which it had ruled that the India- HC ruling. US DTAA merely grants FTC to the extent of Indian tax liability on the income taxed in US and does not permit grant of refund of US taxes from the Indian exchequer. Comments The present Tribunal ruling represents a thorough ► The Tribunal applied similar conclusion to FTC claimed in respect of taxes paid in UK, exposition of law on the principles of interpretation of Singapore, US, Belgium, Japan, Kenya, FTC provisions under the DTAA and domestic laws. It reaffirms the conventional understanding that an China and France. Indian resident cannot expect refund of foreign taxes from the Indian exchequer. FTC under the DTAA or ► Refund of taxes not possible even under domestic tax rules can merely relieve Indian tax liability unilateral FTC for non-treaty countries and cannot result in refund of Indian taxes. The Tribunal has also reiterated its reservations on the • The Tribunal also applied similar correctness of the Wipro ruling (supra) to the extent reasoning to deny refund in that it has granted FTC despite foreign income being respect of FTC claimed in respect eligible for profit-linked incentive deduction. of non-DTAA countries like Jersey. S. 91 of the ITL grants This Tribunal ruling also highlights the difficulties of FTC in respect of “doubly-taxed Indian taxpayers in the absence of express provisions income”. If there is no tax liability for carry forward/ backward of unutilized FTC and in India due to loss at an overall makes out a good case for the GOI to consider such a level, the condition is not measure from a tax policy perspective. satisfied. While the Tribunal has granted business expense • The Tribunal placed reliance on deduction for foreign taxes which were not eligible for two HC rulings13 which denied FTC FTC, either under the DTAA or domestic tax rules, by under S. 91 to the extent the following the binding jurisdictional HC ruling in the foreign incomes were allowed as Reliance Infrastructure case (supra), the issue remains deduction from the Indian income highly debatable. under the profit-linked incentive provision. ► ► Expense deduction allowable in view of jurisdictional HC ruling

• While the Tribunal denied the Taxpayer’s primary claim of refund of foreign taxes, it allowed

secondary claim of business expense deduction. For this conclusion, it followed the

10 [(1994) 206 ITR 727 (Bom)] 13 CIT v. M. A. Morris [(1994) 210 ITR 284 (AP)] and CIT v. 11 Reliance placed on several SC rulings for this Dr R N Jhanji [(1990) 185 ITR 586 (Raj)] proposition 14 [(2017) 80 taxmann.com 6 (Ahd)] 12 [(2004) 94 ITD 340 (Mum)]

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