Tax Alert | Delivering Clarity 24 February 2021

Taxpayers eligible to claim foreign tax credit per tax treaty, domestic tax law The Bangalore Bench of the Income-tax Appellate Tribunal gave its decision that taxpayers are eligible to claim foreign tax credit as per the terms of relevant tax treaty and in terms of the Income-tax Act, 1961, in absence of a tax treaty.

Background: • The taxpayer1 specialises in signal processing application, media processing and communication. • During audit proceedings for the Financial Years (FY) 2012-13 and 2013-14, corresponding to Assessment Years (AY) 2013-14 and 2014-15, the Assessing Officer (AO) observed that taxes had been withheld on the taxpayer’s income in Japan, Korea, Germany, Taiwan and USA. The taxpayer in this regard submitted that: ─ It had claimed relief under section 90 of the Income-tax Act, 1961 (ITA) for Foreign Tax Credit (FTC) in respect of revenue which was subjected to tax outside India. ─ Its entire revenue was offered to tax in India. The FTC claim worked out to effective tax rate of 14.32% in respect of income-tax outside India and the effective tax rate in India worked out to be 32.45%. Hence, as 14.32% was less than 32.45%, the entire amount of taxes paid outside India was eligible for FTC as per section 90 of the ITA. • The AO held that: ─ The taxpayer had wrongly compared the rate of tax outside India (calculated on receipts) with the rate of tax in India (calculated on income), thereby resulting in a mismatch. ─ As per the tax treaties, relief was to be calculated based on deduction from tax on income of the resident and not the receipts. • During appeal proceedings, the matter reached the Bangalore Bench of the Income-tax Appellate Tribunal (ITAT).

Certain relevant provisions: Article 25(2a) of India-US Tax Treaty: 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

1 M/s ITTIAM Systems Pvt. Ltd. V. ITO ITA No.2464 & 2465/Bang/2017

the income-tax (as computed before the deduction is given) which is attributable to the income which may be taxed in the United States. Article 23(2)(a) of India-Japan Tax Treaty: Where a resident of India derives income which, in accordance with the provisions of this Convention, may be taxed in Japan, India shall allow as a deduction from the tax on the income of that resident an amount equal to the Japanese tax paid in Japan, whether directly or by deduction. Such deduction in either case shall not, however, exceed that part of the income-tax (as computed before the deduction is given) which is attributable, as the case may be, to the income which may be taxed in Japan. Article 23(2) of India-Germany Tax Treaty: Where a resident of the Republic of India derives income or owns capital which, in accordance with the provisions of this Agreement, may be taxed in the Federal Republic of Germany, the Republic of India shall allow as a deduction from the tax on such income of that resident an amount equal to the income-tax paid in the Federal Republic of Germany, whether directly or by deduction, and as a deduction from the tax on such capital of that resident an amount equal to the capital tax paid in the Federal Republic of Germany. Such deduction in either case shall not, however, exceed that part of the income-tax or capital tax (as computed before the deduction is given) which is attributable, as the case may be, to the income or the capital which may be taxed in the Federal Republic of Germany. Article 23 of India-Korea Tax Treaty: Where a resident of India derives income which, in accordance with the provisions of this Agreement, may be taxed in Korea, India shall allow as a deduction from the tax on the income of that resident, an amount equal to the tax paid in Korea. Such deduction shall not, however, exceed that portion of the tax as computed before the deduction is given, which is attributable, as the case may be, to the income which may be taxed in India. Section 91(1) of the ITA: If any person who is resident in India in any previous year proves that, in respect of his income which accrued or arose during that previous year outside India (and which is not deemed to accrue or arise in India), he has paid in any country with which there is no agreement under section 90 for the relief or avoidance of double taxation, income-tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal. Explanation (iv) to section 91 of the ITA: the expression "income-tax" in relation to any country includes 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.

Decision of the ITAT: The ITAT noted the following:

India-US, India-Japan and India-Germany tax treaties

• The conditions mandated in Article 25(2)(a) India-US tax treaty for claiming FTC are that if any “income derived” and “tax paid in the United States of America on such income”, then tax relief / credit shall be granted in India on tax paid in the United States of America. The relevant Articles under the India-Japan and India-Germany tax treaties were identically worded as Article 25(2)(a) of India-US tax treaty. • Relevant clauses for the elimination of double taxation in the aforesaid treaties state that, FTC shall not exceed part of the income tax as computed before the deduction is given, “which is attributable as the case may be, to the income which may be taxed in the other state”. These clauses used the expression “income”, which essentially meant income embedded in the gross receipt and not the gross receipt itself. • As per these clauses, for eliminating double taxation in the hands of a taxpayer, it was necessary to establish that taxes were paid by the taxpayer in USA / Japan / Germany, as the case may be. The condition stipulated was very clear that FTC was available on taxes paid in these countries.

India-Korea tax treaty • As per Article 23 of the India-Korea tax treaty, FTC was available in India in respect of taxes paid in Korea and such credit should not exceed taxes payable in India on doubly taxed income. Thus, there was a difference in FTC available to the taxpayer on taxes paid in USA, Japan and Germany vis-à-vis Korea.

Taiwan • India has not entered into a tax treaty with Taiwan. Therefore, FTC available to the taxpayer against taxes paid in Taiwan were to be computed as per the provision of section 91 of the ITA. • Section 91 of the ITA lays down certain conditions for relief, contemplated to be given to the taxpayer. These conditions are as under: ─ The taxpayer should be a resident in India as per section 6 of the ITA; ─ The income which has accrued or arisen outside India, to such resident in India, shall not be deemed to accrue or arise to him in India; and ─ Such resident taxpayer should have paid income-tax on such income under the law in force in that country. Once the aforesaid three conditions as outlined under section 91 of the ITA were fulfilled, such taxpayer was entitled to deduction from Indian income-tax, of a sum calculated on the doubly taxed income at the Indian rate of tax or tax rate of the other country concerned, whichever is lower. In view of the above, the ITAT held that:

India-US, India-Japan and India-Germany tax treaties

• Article 25 of the India-US tax treaty, Article 23(2) of the India-Japan tax treaty and the India- Germany tax treaty allowed FTC in India to the extent of tax paid in these countries. Thus on perusal of treaty provisions and as per the decision of the Karnataka High Court in an earlier case2, the taxpayer was eligible for FTC in full, amounting to taxes paid in USA, Japan and Germany.

India-Korea tax treaty • As per Article 23 of the India-Korea tax treaty, FTC was limited to taxes payable on doubly taxed income in India, before any deduction (i.e. FTC was limited to or taxes paid in Korea or India, whichever was less).

Taiwan • FTC is to be computed based on rate of tax applicable in India or Taiwan, whichever is less, on such doubly taxed income.

Accordingly, the ITAT directed the AO on the following: • USA, Japan and Germany: To grant FTC in full, amounting to taxes paid in such countries. • Korea: To grant FTC limited to taxes paid in Korea or India, whichever was less. • Taiwan: To grant FTC as computed based on rate of tax applicable in India or Taiwan, whichever was less, on such doubly taxed income.

Comment: This ruling reiterates the principle that respective tax treaty provisions are relevant for claiming tax credit by a taxpayer. In the absence of a tax treaty with the relevant country, the provisions of section 91 of the ITA would be relevant. Taxpayers may want to evaluate the impact of this ruling to the facts of their specific cases.

2 Wipro Limited 382 ITR 179 (Karnataka)

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