INCOME TAX APPELLATE TRIBUNAL, MUMBAI D BENCH, MUMBAI
Deputy Commissioner of Income Tax Vs. Tata Sons Limited
ITA No: 4776/Mum/04
Assessment year: 2000- 01
O R D E R
Per Pramod Kumar:
1. By way of this appeal, the appellant Assessing Officer has called into question correctness of Commissioner (Appeals)’s order dated 29th March 2004, in the matter of assessment under section 143(3) of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’). Grievance of the Assessing Officer is two fold– first, against CIT(A)’s restricting the dis allowances, under section 14 A, in respect of expenses incurred in earning dividend income, by restricting the interest dis allowance to Rs 30.35 crores, and deleting the administrative expenses dis allowance of Rs 1.58 crores; and- second, against CIT(A)’s deleting the dis allowance of Rs 67.89 crores in respect of overseas taxes paid.
2. We will first take up the issue regarding deduction of overseas taxes paid. The relevant ground of appeal is as follows:
On the facts and in the circumstances of the case and in law, the learned CIT(A) has erred in deleting the amount of Rs 67,89,30,514 in respect of overseas taxes paid.
3. The issue in appeal is set out in a narrow compass of material facts. While the assessee is mainly an investment company in the sense that it holds major investments in equity shares of Tata Group of companies, the assessee is also engaged in the business of exports of software through one of its division, namely Tata Consultancy Services, and in engineering consultancy through its other division. On 30th November, 2000, the assessee filed return of income disclosing an income of Rs 110.26 crores. During the course of the assessment proceedings, it was noticed by the Assessing Officer that the assessee has debited an amount of Rs 85,36,04,000 in its profit and loss account in respect of overseas taxes paid, out of which Rs 24,89,36,449 represented overseas tax liability which has remained unpaid. In the course of assessment proceedings, the assessee restricted the deduction to Rs 67,89,30,5 14 on determination of actual overseas tax liability. As noted by the Assessing Officer, “the assessee also claimed DIT relief amounting to Rs 60,86,92,067 under sections 90/91 of the Act”. During the course of assessment proceedings, it was, inter alia, explained by the assessee that the deduction was admissible to the assessee in view of Tribunal’s decisions, in assessee’s own cases for the assessment years 1978-79,79-80,80-81, 81-82, 82-83 and 83-84, 84-85 and 85-86, and in view of the fact that Hon’ble Bombay High Court has rejected the reference, under section 256(2) vide ITA No. 89 of 1989, and thus put a seal of finality to the stand so taken by the Tribunal. The assessee also submitted that even though section 43 B has no application in respect of payments of foreign taxes, and, therefore, the deduction in respect thereof need not be restricted to the actual payments during the relevant previous year, the assessee has claimed deduction only in respect of the amounts actually paid. In effect, thus, it was submitted that the assessee has claimed lesser deduction that the deduction admissible to the assessee. The assessee claimed deduction of taxes paid abroad as normal business expenditure incurred to earn the income which has been offered to tax in India.
4. The Assessing Officer, however, was not impressed by the stand so taken by the assessee. He was of the view that income tax represents sovereign’s share in the profits of the assessee, and whether income tax is paid in India or abroad, it is only an application of income and not a charge on income. The Assessing Officer was also of the view that under the scheme of the Act, the taxes paid abroad are eligible for admissible tax credit under the applicable double taxation avoidance agreement, if any, under section 90 of the Act, or for appropriate tax relief under section 91 of the Act in case there are no such agreements in existence with the respective country. Section 90, it may be mentioned, deals with the relief from double taxation of an income in India as also in some other country, through the mechanism of double taxation avoidance agreements between India and such other country, and Section 91 deals with relief from similar double taxation of an income in India as also in a country with which India does not have a double taxation avoidance agreement. The Assessing Officer took note of these statutory provisions and held that under the scheme of the Act, the income tax paid abroad are entitled to relief under section 90 or under section 91, and that these taxes cannot be allowed as deduction under section 37 of the Act. The Assessing Officer further observed that, “in any case, foreign income tax cannot be allowed as a deduction under section 37 and, as such, foreign income tax are levied at a rate or as proportion of income earned abroad, such amounts paid are also hit by Section 40(a)(ii)”. Section 40(a)(ii) incidentally places a restriction on deductibility of “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” in computation of business income of an assessee. The Assessing Officer thus disallowed the claim of deduction amounting to Rs 60,46,67,551 on account of income tax paid overseas. Aggrieved by the disallowance so made by the Assessing Officer, assessee carried the matter in appeal before the CIT(A). The CIT(A) upheld the claim of the assessee in view of Tribunal’s decisions, in assessee’s own cases for the earlier assessment years, and in view of the fact that Hon’ble Bombay High Court has rejected the reference, under section 256(2) vide ITA No. 89 of 1989, against Tribunal’s orders, putting a seal of finality to the stand so taken by the Tribunal. The Assessing Officer is aggrieved of the stand so taken by the CIT(A) and is in appeal before us.
5. When this appeal was called out for hearing, learned counsel for the assessee initially submitted that this issue is no longer res integra inasmuch as there are direct decisions, by co ordinate benches of this Tribunal in assessee’s own case – against which Hon’ble High Court has declined to entertain reference under section 256(2) of the Act, in favour of the assessee. Learned counsel also filed a list of judgments by which the issue is covered, and also filed copies of these judicial precedents. However, in response to bench’s questions, he fairly admitted that these decisions have not taken into account Explanation 1 to Section 40(a) (ii), inserted by Finance Act, 2006, and, that the reasoned order was passed well before this legislative amendment was brought about. We may mention that Explanation 1 to Section 40 (a)(ii) provides that, “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”. Learned counsel also fairly accepts that while Hon’ble Bombay High Court’s judgment was passed on 2nd April 2004, the relevant Explanation to Section 40(a)(ii) was inserted much later in 2006. He, however, hastens to add that there are decisions of this Tribunal, even after the said Explanation 1 was introduced, such as order dated 4th June 2007, for the assessment years 1997-98 to 1999-2000, wherein the Tribunal has followed the same view, as was taken earlier, and held that the taxes paid abroad constitute admissible deduction. Without prejudice to this argument, he further submits that the said Explanation 1 only deals with such taxes which are eligible for relief under section 90 or section 91, and since states income taxes paid in USA and Canada are not eligible for relief under either of these sections, the earlier judicial precedents will continue to have binding effect so far as deductibility of states income taxes paid in USA and Canada are concerned. Learned Departmental Representative submits that the earlier decisions of the Tribunal, on which reliance has been placed by the learned counsel, are clearly contrary to the basic scheme of the Act and this fact has been unambiguously brought out by insertion of Explanation 1 to Section 40(a)(ii) which, though introduced in 2006, is clarificatory in nature. Learned Departmental Representative also invites our attention to extracts from Chaturvedi & Pithisaria’s commentary on Income Tax Law which, according to him, show that, even without this legislative amendment, income tax paid abroad does not constitute admissible deduction in computation of income. It is vehemently argued, with the help of an elemental analysis of scheme of the Act, that a deduction in respect of foreign income tax is contrary to the fundamental scheme of the Indian Income Tax Act, and it also submitted that the doubts, if any, have been set at rest by the insertion of Explanation 1 to Section 40 (a)(ii). We were urged to deviate from the judicial precedents cited by the assessee, and decide the matter on merits. Learned counsel for the assessee then submitted that while he does not have any objection to the matter being adjudicated afresh on merits, so far as deductibility of overseas taxes in respect of which relief under section 90 or section 91 is concerned, without being bound by the earlier judicial precedents which admittedly donot take into account the legal position as it prevails now, we must follow the earlier decisions with regard to deductibility of overseas taxes in respect of which relief under section 90 or section 91 is not admissible. In other words, state income taxes paid in USA and Canada must be held to be admissible deduction under section 37(1). There is no change in law, according to the learned counsel, so far as deductibility of overseas income tax, other than taxes in respect of which relief under section 90 or section 91 is available. In substance thus, learned representatives agree that the question of deductibility of overseas income taxes is to be decided afresh, though earlier decisions will continue to fold field to the limited extent of admissibility of deduction under section 37(1) in respect of taxes paid abroad for which no relief is admissible under section 90 or 91 of the Act. Learned counsel also prays that in case we are to hold that the other income taxes paid abroad are not deductible in computation of income, we may direct the Assessing Officer to grant tax credit in respect of the same in computation of assessee’s tax liability. Learned Departmental Representative, as also learned counsel for the assessee, then addressed us on the merits, and reiterated their respective stands.
6. We have given our careful consideration to the rival submissions, perused the material on record and duly considered factual matrix of the case as also the applicable legal position.
7. Let us deal with some fundamentals first. The payment of income tax in overseas tax jurisdictions, in addition to taxability in the home jurisdiction, is an inevitable corollary of inherent conflict between the source rule and residence rule. This conflict develops when a person resident in one of the tax jurisdictions earns income which is sourced from another tax jurisdiction. As per the residence rule, irrespective of the geographical location of a place where a person earns income, the income is taxable in the tax jurisdiction in which a person is resident. The source rule, however, lays down that an income earned in a tax jurisdiction, irrespective of the residential status of the person earning the said income, is liable to be taxed in the tax jurisdiction where the income is earned. Therefore, a tax object, i.e., the income which is to be taxed, as a rule attracts tax ability in the source jurisdiction, and a tax subject, i.e. the person who is to be taxed, is taxed in the residence jurisdiction. These competing claims put the taxpayer to risk of being taxed more than once in respect of the same income, and a solution to avoid such double taxation is thus to be found within the four corners of tax systems. While source rule as also the residence rule continue to be integral part of most of the tax systems, a mechanism is provided in the domestic tax legislation to relieve a taxpayer of such double taxation. In ‘Tax Law Design and Drafting”, an International Monetary Fund publication (ISBN 90-411-9784-2), Prof Richard Vann, at page of 756 of Volume II, deals with this issue by observing as follows :
It is necessary to distinguish among four basic methods in this area. The first is for a country not to assert jurisdiction to tax foreign-source income of residents (either at all or for selected types of income). This territorial approach to taxation (taxing only income sourced in the country) means that the country is not following the usual international norm of worldwide taxation of residents and so is not strictly a method for relieving double taxation as residence-source double taxation will simply not arise for its residents.
The second method is the exemption system, under which foreign-source income is exempted in the country of residence. If the exemption is unconditional and the exempted income does not affect in any way the taxation of other income, then in substance the result is the same as a purely territorial system. Most exemption systems are not of this kind and so are to be distinguished from territorial systems. Most countries using an exemption system adopt exemption with progression, under which the total tax on all income of a resident is calculated, and then the average rate of tax is applied to the income that does not enjoy the exemption. Exemption systems are also increasingly subject to various conditions to ensure satisfaction of the assumption underlying the system (that the income has been taxed in the source country at its ordinary rates).These conditions can consist of subject-to-tax tests (including the specification of tax rates) or selective application of exemption to foreign countries under domestic law or tax treaties. In particular, the exemption is usually not given where the source tax has been reduced or eliminated by a tax treaty. The result is that there are no countries asserting jurisdiction to tax worldwide income that give an exemption for all kinds of foreign income; where a country is referred to as an exemption country, this generally means that it provides some form of exemption to business income, dividends received from direct investments in foreign companies, and often employment income, with a credit being used in other cases.
The third system is the foreign tax credit system under which a credit against total tax on worldwide income is given for foreign taxes paid on foreign income by a resident up to the amount of domestic tax on that income. This limit is designed to ensure that foreign taxes do not reduce the tax on the domestic income of residents and is calculated by applying the average rate of tax on the worldwide income before the credit to the foreign-source income. In its simplest form, this limit is applied to foreign income in its entirety, without distinguishing the type of income and the country where it is sourced.
The fourth system is to give a deduction for foreign income taxes in the calculation of taxable income. While this system is used in some countries, often as a fall back from a foreign tax credit where the credit may not be of use to the taxpayer, it is not widely accepted as a method for use on its own and, more specifically is not used in tax treaties.
It can be argued that relief of double taxation in either credit or exemption form involves a number of complexities that are best avoided by developing or transition countries. Pure territorial taxation, however, simply invites tax avoidance through the moving of income offshore, and once qualifications on the pure territorial principle are admitted, such as limiting it to certain kinds of income, it is hard to see that any great simplicity is achieved as problems of characterization of income arise, as well as incentives to convert income from one form to another. Similar difficulties arise when a conditional exemption system is used. For this reason, a simple foreign tax credit system is probably suitable for most such countries—it asserts the worldwide jurisdiction to tax income of residents and does not require significant refinements of calculation. It leaves open the greatest scope for elaboration of the system by domestic law and tax treaties in the future without having to repeal or modify any exemption (often a difficult process politically because of entrenched interests). Given that tax treaties are premised on an item-by-item foreign tax credit limit, rather than on a worldwide limit aggregating all foreign income of the taxpayer, the item-by item limit is probably easiest to use in domestic law.
Whichever double tax relief system is adopted, some method of apportioning deductions between domestic and foreign income will be necessary. Where deductions allocated to foreign income exceed that income, the loss should not be available for use against domestic income.
8. There are thus four methods in which relief can be granted to a taxpayer in the residence country in respect of income tax paid abroad. It is also important to bear in mind the fact that these four methods are mutually exclusive methods in the sense that each one of these methods, on standalone basis, is meant to grant requisite relief from double taxation of an income. Application of more than one of these methods, in a particular situation, can thus only result in granting relief greater than the double taxation itself. To sum up even at the cost of an element of repetition, these methods are as follows:
