Whether taxes paid outside India is deductible from business profits under section 37(1) or whether such deductions are disallowable under section 40(a)(ii).
Prepared by Ganesh R
As per Section 37(1) of the Income Tax Act, 1961. (“the act”) “Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.
As per Section 40(a)(ii) “Notwithstanding anything to the contrary in sections 30 to 38, the following amounts shall not be deducted in computing the income chargeable under the head “Profits and gains of business or profession”, in the case of any assesse –
any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains.
Explanation 1.—For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, any sum paid on account of any rate or tax levied includes and shall be deemed always to have included any sum eligible for relief of tax under section 90 or, as the case may be, deduction from the Indian income-tax payable under section 91.
Explanation 2.—For the removal of doubts, it is hereby declared that for the purposes of this sub-clause, any sum paid on account of any rate or tax levied includes any sum eligible for relief of tax under section 90A;
In the case of Smithkline & French India Ltd. (supra), that 40(a)(ii) of the present Act do not contain any words indicating that the profits and gains should be determined following the provisions of the IT Act. All it says is that it shall be any rate or tax levied on the profits and gains of business or profession”.
Accordingly, in the case of DCIT vs. Elitecore Technologies (P.) Ltd., it was held by the Ahmedabad Tribunal that if taxes, for which relief under section 90/ 91 was available, was covered by the Explanation 1 to section 40(a)(ii) of the Act, they were covered by the scope of section 40(a)(ii) of the Act also. Therefore, deduction under section 37(1) of the Act shall not be available for that portion of income tax paid abroad, for which relief is available under section 90/ 91 of the Act.
In the case of Elitecore Technologies (supra) wherein it was held that taxes on profits and gains paid outside India would be hit by rigours of section 40(a)(ii), even though benefit in respect of the same was not available under sections 90/ 91 of the Act;
Contradictorily
In the case of Reliance Infrastructure Limited v. CIT
It was noticed by the Mumbai tribunal that in the decision of S. Inder Singh Gill (supra) was rendered under the Indian Income-tax Act, 1922 and not under the Income-tax Act, 1961 (the Act).
Section 40(a)(ii) of the Act does not allow deduction on tax paid on profit and/or gain of business. The Indian Income-tax Act, 1922 Act also contains a similar provision in Section 10(4). However, the Indian Income Tax Act, 1922 contains no definition of “tax” as provided in Section 2(43) of the Act. Consequently, the tax paid on income/profits and gains of business/profession anywhere in the world would not be allowed as deduction for determining the profits/gains of the business under section 10(4) of the Indian Income-tax Act, 1922.
However, the ratio of the aforesaid decision in S. Inder Singh Gill (supra) cannot be applied to the present facts in view of the fact that the Act defines “tax” as income tax chargeable under the provisions of this Act. Thus, by definition, the tax which is payable under the Act alone on the profits and gains of business are not allowed to be deducted notwithstanding Sections 30 to 38 of the Act.
It also noted that the Explanation to Section 40(a)(ii) of the Act arose as the assessees were claiming foreign tax credit under sections 90 or 91 of the Act and also claim the benefit of tax paid abroad as expenditure on account of not being covered by Section 40(a)(ii) of the Act. This is evident from the Explanatory notes to the Finance Act, 2006 as recorded in Circular No. 14 of 2006 dated 28th December, 2006 issued by the CBDT.
In view of the above, Explanation inserted in 2006 to Section 40(a)(ii) of the Act, would require in the context thereof that the definition of the word “tax” under the Act to mean also the tax which is eligible to the benefit of Sections 90 and 91 of the Act. However, this departure from the meaning of the word “tax” as defined in the Act is only restricted to the above and gives no license to widen the meaning of the word “tax” as defined in the Act to include all taxes on income/profits paid abroad.
Therefore, on the Explanation being inserted in Section 40(a)(ii) of the Act, the tax paid in Saudi Arabia on income which has accrued and/or arisen in India is not eligible to tax credit under section 91 of the Act. Therefore, not hit by Section 40(a)(ii) of the Act. Section 91(1) of the Act, itself excludes tax credits for the income which is deemed to accrue or arise in India. Thus, the benefit of the Explanation would now be available and on application of real income theory, the quantum of tax paid in Saudi Arabia, attributable to income arising or accruing in India would be reduced under section 37(1) for the purposes of computing the income on which tax is payable in India.
Section 91 – Countries with which no agreement exists.
91(1) 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.
In the case of Bank of India vs. ACIT,
Mumbai ITAT states that the tax which has been paid abroad would not be covered with in the meaning of Section 40(a) (ii) of the Act in view of the definition of the word ‘tax’ in Section 2(43) of the Act.
To be covered by Section 40(a)(ii) of the Act, it has to be payable under the Act. It is conscious of the fact that Section 2 of the Act, while defining the various terms used in the Act, qualifies it by preceding the definition with the word “In this Act, unless the context otherwise requires” the meaning of the word ‘tax’ as found in Section 2(43) of the Act would apply wherever it occurs in the Act. It is not even urged by the Revenue that the context of Section 40(a)(ii) of the Act would require it to mean tax paid anywhere in the world and not only tax payable/paid under the Act.
ITAT questioned itself whether can it be open to us to hold that the meaning of expression ‘tax’ under section 40(a)(ii) will be restricted by the definition of tax under section 2(43), so far as the question of credit for taxes abroad is concerned, even though Hon’ble Supreme Court notes, in the case of Smithkline & French India Ltd. (supra), that s. 40(a)(ii) of the present Act do not contain any words indicating that the profits and gains spoken of by them should be determined in accordance with the provisions of the IT Act. All they say is that it must be a rate or tax levied on the profits and gains of business or profession”.
“It is not even urged by the Revenue that the context of Section 40(a)(ii) of the Act would require it to mean tax paid anywhere in the world and not only tax payable/paid under the Act”. The very thrust of stand of the revenue was that the connotations of expression ‘tax’ in section 40(a)(ii) must be taken in its contextual meaning which extends to any tax ascertainable regarding the profits of the assessee as evident from the wordings of section which refer to “any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise based on, any such profits or gains , and that its connotations cannot be treated as restricted to tax under the Income-tax Act. This argument, in the context of deduction in respect of tax outside Income-tax Act, 1961, has already met the approval of Hon’ble Supreme Court.
Therefore Mumbai ITAT held that taxes paid abroad will be allowed as a deduction in the computation of the business income of the assesse, by referring to the Judgment in Reliance Infrastructure (supra), wherein it was held that taxes have been paid by the assessee in the foreign jurisdiction to earn global income on which tax is payable in India, therefore, such foreign taxes paid shall be allowed as expenditure [not hit by section 40(a)(ii) of the Act], to the extent credit for the same is not granted to the assessee. The said judgment, being rendered by the jurisdictional Bombay High Court, was held to be binding.
The Tribunal did take note of the Ahmedabad Tribunal ruling in the case of DCIT v. Elitecore Technologies Pvt. Ltd. where the Ahmedabad Tribunal did not follow the Reliance Infrastructure ruling (supra). But it held that the Ahmedabad Tribunal, in that case, had made it clear that it was not following the Reliance Infrastructure ruling because it was not a binding jurisdictional HC ruling. However, in the present case, the Reliance Infrastructure ruling was a binding jurisdictional HC ruling.
In the case of Daimler, Relief under section 90 was available for the taxes paid in abroad, 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. Therefore, to play safe considering the explanations provided in section 40(a)(ii) of the act, deduction under section 37(1) of the Act shall not be available for that portion of income-tax paid abroad, for which Daimler is eligible for relief under section 90/ 91 of the Act.
CIRCULAR
FINANCE ACT, 2006
Finance Act, 2006 – Explanatory Notes on provisions relating to Direct Taxes
CIRCULAR NO. 14/2006, DATED 28-12-2006
- Deduction in the computation of income against taxes paid on income earned outside India not allowable
15.1 Under the existing provisions contained in sub-clause (ii) of clause (a) of section 40, any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits and gains (hereafter income-tax), is not allowed as deduction in the computation of income. Any such tax paid outside India is also not allowable as deduction in the computation of Income. However such tax paid outside India is eligible for credit against tax payable in India on the global income of the person in accordance with the provisions of section 90 or, as the case may be, section 91.
15.2 Doubts have been expressed whether Income-tax paid in a foreign country is eligible for deduction in the computation of profits and gains from business or profession. In this regard, the judicial opinion is divided with overwhelming number of decisions in favour of the Government. Nevertheless, some assessees continue to claim both i.e. income-tax paid in the foreign country, as deduction in the computation of profits and gains from business or profession and as credit against tax payable in India on their global income. This double benefit claimed by some taxpayers is against the legislative intent.
15.3 With a view to ending the judicial conflict, Explanation 1 has been inserted to sub-clause (ii) of clause (a) of section 40 of the Income-tax Act thereby clarifying that any sum paid outside India and eligible for relief of tax under section 90 or deduction from the income-tax payable under section 91 is not allowable, and is deemed to have never been allowable, as a deduction under section 40 of the Income-tax Act. The taxpayers, however, will continue to be eligible for tax credit in respect of income-tax paid in a foreign country in accordance with the provisions of section 90, or as the case may be, section 91.
15.4 This amendment is clarificatory in nature and is inserted in the Income-tax Act on 1-4-2006.
15.5 Another Explanation has been inserted in the aforementioned clause (ii) as Explanation 2 to provide that any sum paid outside India and eligible for relief of tax under newly inserted section 90A will not be allowed as a deduction in the computation of profits and gains of business or profession.
15.6 This amendment will take effect from 1-6-2006.
