Brief:- Section 91 of the Income Tax Act, 1961 allows credit for Federal & State taxes, the DTAA allows credit only for Federal taxes. The result is that the Section 91 is more beneficial to the assessee & by virtue of Section 90(2) it must prevail over the DTAA. Though Section 91 applies only to a case where there is no DTAA, a literal interpretation will result in a situation where an assessee will be worse off as a result of the provisions of the DTAA which is not permissible under the Act. Section 91 must consequently be treated as general in application and must prevail where the DTAA is not more beneficial to the assessee. Accordingly, even an assessee covered by the scope of the DTAA will be eligible for credit of State taxes u/s 91 despite the DTAA not providing for the same. ITAT observed that:
Citation: – Tata Sons Limited Vs. Deputy Commissioner of Income Tax
Court: – Income Tax Appellate Tribunal, Mumbai
ITA No: 4978/Mum/04
Assessment year: 2000- 01
O R D E R
Per Pramod Kumar:
1. This appeal, filed by the assessee, is directed against CIT(A)’s order dated 29th March 2004 in the matter of assessment under section 143(3) of the Income Tax Act, 1961, for the assessment year.
2. While hearing in this appeal was concluded on 11th November 2010, along with Assessing Officer’s cross appeal against the same CIT(A)’s order – which has since been disposed of vide our order dated 24th November 2010 (now reported as DCIT Vs Tata Sons Limited, 43 SOT 27) , the matter was listed for certain clarifications, in respect of assessee’s claim of tax credit in respect of State Income Taxes paid in the USA and Canada, on 4th February 2011. As this issue regarding tax credit for State Income Taxes is intricately linked to the issue regarding deduction of taxes paid abroad, which has been elaborately dealt with in our order dated 24th November 2010 on the cross appeal, and for the sake of continuity, we will take up this issue first. The relevant ground of appeal, i.e. ground no. 4 in assessee’s appeal, is that the “ CIT(A) erred in not granting DIT relief in respect of taxes paid in various states in USA and Canada”.
3. In the original hearing, the assessee had not pressed the ground of appeal seeking credit in respect of state income tax paid in United States, but had claimed deduction in respect of the same under section 37(1). The reason, for not pressing this ground of appeal, was stated to be that the assessee was content with CIT(A)’s having granted the deduction in respect of these taxes, as the claim for tax credit was anyway not admissible in terms of the Indo US tax treaty. The Assessing Officer was also in appeal before us in respect of the deduction having been granted by the CIT(A). For the detailed reasons set out in our order dated 24th November, 2010, we upheld the grievance of the Assessing Officer and held that deductions in respect of any income tax paid abroad, whether state or federal, were not admissible. One of the arguments before us was that at least deduction in respect of US and Canada state income taxes should be allowed, since the US and Canada state income tax payments did not entitle the assessee to any tax credit, and either an income tax payment is to be allowed as deduction or it is to be taken into account for giving tax credit. We were also taken through the provisions of India-USA Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion [ 187 ITR (Statute) 102 – hereinafter referred to as ‘Indo US tax treaty], to show that the tax credits under the India US tax treaty are restricted to credits in respect of federal income tax paid in the United States. It was also submitted that under the India Canada Double Taxation Avoidance Agreement, tax credits are admissible only in respect of tax paid under the ‘Income Tax Act of Canada’ whereas state income taxes are levied under separate provincial legislations. It could not, according to the learned counsel, result in a situation in which an income tax payment cannot have any tax implication – neither as a charge on income, nor as an allocation of income. While rejecting these arguments, and allowing the appeal of the Assessing Officer on this issue, we had, inter alia, observed as follows:
20. Learned counsel has also contended that in any event, we must allow deduction in respect of state income-taxes paid in USA and Canada as relief is not admissible in respect of the same in respective tax treaties. We have been taken through India USA tax treaty to point out that tax credits are admissible only in respect of Income-tax levied by the federal Government and not by the State Governments. It is contended that since no relief is admissible in respect of state taxes under section 90 or section 91, these taxes will continue to be tax deductible, and to that extent, decisions of the coordinate benches will hold good. We are unable to see legally sustainable merits in this submission either. Apart from the fact that such a claim of deduction is clearly contrary to the law laid down by Hon’ble jurisdictional High Court in Lubrizol India Ltd.’s case (supra), there is another independent reason to reject this claim as well. The reason is this. It is only elementary that tax treaties override the provisions of the Income-tax Act, 1961, only to the extent the provisions of the tax treaties are beneficial to the assessee. In other words, a person cannot be worse off vis-a-vis the provisions of the Income-tax Act, even when a tax treaty applies in his case. Section 90(2) states that even in relation to the assessee to whom a tax treaty applies “the provisions of this Act shall apply to the extent they are more beneficial to that assessee”. Undoubtedly, title of section 91 as also reference to the countries with which India has entered into agreement, suggests that it is applicable only in the cases where India has not entered into a double taxation avoidance agreement with respective jurisdiction, but the scheme of the section 91, read along with section 90, does not reflect any such limitation, and section 91 is thus required to be treated as general in application. The scheme of the Income-tax Act is to be considered in entirety in a holistic manner, and each of the section cannot be considered on standalone basis. It is important to bear in mind the fact that so far as section 91 is concerned, it does not discriminate between taxes levied by the Federal Governments and taxes levied by the State Government. The Income-tax levied by different States in USA usually ranges from 3 per cent to 11 per cent, and the aggregate Income-tax paid by the assessee in USA will range from 38 per cent to 46 per cent. Therefore, on the facts of the present case and bearing in mind the fact that the Federal Income-tax in USA at the relevant point of time was lesser in rate at 35 per cent vis-a-vis 38.5 per cent Income-tax rate applicable in India, the admissible double taxation relief under section 91 will be higher than relief under the tax treaty. It will be so for the reason that State Income-tax will also be added to Income-tax abroad, and the aggregate of taxes so paid will be eligible for tax relief – of course subject to tax rate on which such income is actually taxed in India. The tax relief under section 91 thus works out to at least 38 per cent, as against tax credit of only 35 per cent admissible under the tax treaty. In such a situation, the assessee will be entitled to relief under section 91 in respect of federal as well as state taxes, and that relief being more beneficial to the assessee vis-a-vis tax credit under the applicable tax treaty, the provisions of section 91 will apply to state Income-taxes as well. The state Income-tax is also, therefore, covered by Explanation 1 to section 40(a) (ii), and deduction cannot be allowed in respect of the same. Finally, in view of Hon’ble Bombay High Court’s judgment in S. Inder Singh Gill’s case (supra), Income-tax abroad cannot be allowed as a deduction in computation of income and this judgment does not discriminate between federal and state taxes either. Interestingly, state Income-taxes paid in USA, subject to certain limitations, are deductible in computation of income for the purposes of computing federal tax liability in USA, but that factor cannot influence deductibility of these taxes, particularly in the light of the provisions of Explanation 1 to section 40(a) (ii) and in the light of Hon’ble Bombay High Court’s judgment in S. Inder Singh Gill’s case (supra), in computation of business income under Indian Income-tax Act. For all these reasons, we are unable to uphold the plea of the assessee seeking deduction of at least state Income-tax paid in USA.
4. Having so held that deduction in respect of state income tax paid is not admissible, when we took up the appeal of the assessee and noticed that the assessee has not pressed grievance against tax credit in respect of state income tax paid in USA and Canada, for the stated reason that the same is not admissible in terms of the Indo US and Indo Canada tax treaty provisions, we deemed it appropriate to once again hear the parties on this issue. In our considered view, it is indeed an incongruous position that payment of state income taxes in US and Canada are not allowed deduction as these are treated as in the nature of taxes on income, in terms of the provisions of domestic tax law in India, and these payments are also not being taken into account for granting credit for taxes paid abroad by the assessee, as only federal income tax is eligible for tax credit in terms of the Indo US and Indo Canada tax treaty. If this approach is adopted, the assessee does not get a deduction for state taxes so paid abroad, nor does he get the tax credit for the same, and if these two propositions are correct, there is clearly an inherent contradiction in these propositions on tax treatment for state income taxes paid abroad. There cannot obviously be a tax payment which is neither treated as admissible expenditure, because it is treated as an income tax, nor is it taken into account for tax credits, because it is not to be treated as income tax. However, as we have observed in our order on the cross appeal, extracts from which are reproduced in the preceding paragraph, it is incorrect to proceed on the assumption that state income tax paid in USA, or for that purpose paid in Canada, cannot be taken into account for the purposes of computing admissible tax credits. It is so for the elementary reason that the provisions of a tax treaty, based on which tax credits are said to be inadmissible, cannot be pressed into service to decline a benefit to the assessee which is otherwise available to him, even in the absence of such a tax treaty, under the provisions of the Income Tax Act.
5. Even as we have held that, in principle, state income taxes paid in USA are eligible for being taken into account for the purpose of computing admissible tax credit under Section 91, we are alive to the fact that Section 91 refers to a situation in which the assessee has paid tax “in any country with which there is no agreement under section 90 for the relief or avoidance of double taxation” and that there is indeed an agreement under section 90 with United States of America, as also with Canada. If we adopt a literal interpretation of this provision, and bearing in mind the undisputed position that tax credit provisions under section 91 are more beneficial to the assessee vis-à-vis the tax credit provisions in related tax treaties inasmuch as while section 91 permits credit for all income taxes paid abroad – whether state or federal, relevant tax treaties permit credits in respect of only federal taxes, it will result in a situation that an assessee will be worse off as a result of the provisions of tax treaties. That certainly is not permissible under the scheme of the Income Tax Act. Circular 621 dated 19-12-1991 [(1992) 195 ITR (Statutes) 154] issued by the Central Board of Direct Taxes, which is binding on the Assessing Officer under section 119(2) of the Act, inter alia , observes that “Since the tax treaties are intended to grant relief and not put residents of a Contracting State at a disadvantage vis-a-vis other taxpayers, section 90 of the Income-tax Act has been amended to clarify any beneficial provision in the law will not be denied to a resident of a contracting country merely because corresponding provision in a tax treaty is less beneficial”. In the case before us, however, tax credit provisions in Indo US tax treaty are admittedly less advantageous to the assessee, but just because there is a tax treaty between India and USA, the benefits of the domestic law provisions are being declined to the assessee. That is an interpretation which leads to absurdity and calls for an interpretation harmonious with the scheme of the Income Tax Act. In case of any conflict between the provisions of the agreement and the Act, the provisions of the agreement would prevail over the provisions of the Act, as is also clear from the provisions of section 90(2) of the Act. Section 90(2) makes it clear that “where the Central Government has entered into an agreement with the Government of any country outside India for granting relief of tax, or for avoidance of double taxation, then in relation to the assessee to whom such agreement applies, the provisions of the Act shall apply to the extent they are more beneficial to that assessee” meaning thereby that the Act gets modified in regard to the assessee in so far as the agreement is concerned if it falls within the category stated therein. It would thus appear that the treaty override is only restricted to the extent it is beneficial to a taxpayer. In other words, the fact that a taxpayer is entitled to make a particular claim, in accordance with a tax treaty provisions, does not disentitle him to make the claim in accordance with the provisions of the Act. In this view of the matter, and further to the observations made by us in our order on the cross appeal, in our considered view, the provisions of Section 91 are to be treated as general in application and these provisions can yield to the treaty provisions only to the extent the provisions of the treaty are beneficial to the assessee; that is not the case so far as question of tax credits in respect of state income taxes paid in USA are concerned. Accordingly, even though the assessee is covered by the scope of India US and India Canada tax treaties, so far as tax credits in respect of taxes paid in these countries are concerned, the provisions of Section 91, being beneficial to the assessee, hold the field. As Section 91 does not discriminate between state and federal taxes, and in effect provides for both these types of income taxes to be taken into account for the purpose of tax credits against Indian income tax liability, the assessee is, in principle, entitled to tax credits in respect of the same. Of course, as is the scheme of tax credit envisaged in Section 91, tax credit in respect of foreign income tax is restricted to actual income tax liability in India, in respect of income on which taxes have been so paid abroad,
6. During the course of hearing on 4th February 2011, learned representative, appearing for the assessee, fairly accepts that the tax credit, for state income taxes paid in USA and Canada, will not be of any use to the assessee since the tax credit available to the assessee, even without taking into account the state income taxes paid in USA and Canada, are more than assessee’s tax liability in respect of such foreign income. It is for this reason, according to him, that the assessee does not wish to pursue the claim for tax credit in respect of state income taxes paid in USA and Canada. In this view of the matter, the grievance raised by the assessee is wholly academic and infructuous on the facts of this case, and is dismissed as such.
7. Ground No. 4 is thus dismissed.
8. Coming back to ground no. 1, i.e. regarding allocation of interest expenses to dividend income and regarding not permitting capitalization of such expenses to enhance cost of acquisition of shares, these grounds of appeal were not pressed by the assessee. The same are accordingly dismissed for want of prosecution.
9. Ground No. 1 is also dismissed.
10. In ground no. 2, the assessee has raised a grievance against CIT(A)’s not accepting the assessee’s contention to the effect that foreign dividends are liable to be taxed, on net basis, after deducting foreign taxes withheld abroad.
11. Learned representatives fairly agree that the issue is covered in favour of the assessee, by Hon’ble Bombay High Court’s judgment in the case of CIT Vs Ambalal Kilachand (210 ITR 844). In the said judgment, Their Lordships have, inter alia, observed as follows:
…….What, therefore, accrues to an assessee in respect of shares held by him in the United Kingdom is the dividend as actually distributed to him. The amount initially available for distribution by the U.K. company cannot be considered as income accruing to the assessee, because the assessee does not have any right to receive the amount so initially declared. He does not have any right to claim any credit for the tax which is deducted on that amount. Therefore, under no circumstances can he claim that the gross amount available for distribution has accrued to him. The company in the United Kingdom is liable to pay certain tax on that amount before the money goes to the hands of its shareholders. A shareholder outside the United Kingdom cannot claim any credit for the tax paid by the company. Therefore, the only entitlement of a shareholder outside the United Kingdom is to receive dividend as reduced by the deduction of the corporation tax…..
12. Respectfully following the esteemed views of Hon’ble jurisdictional High Court, we uphold the grievance of the assessee in principle and direct the Assessing Officer to grant relief in accordance with the principles laid down in Ambalal Kilachand’s case (supra).
13. Ground No. 2 is allowed in the terms indicated above.
14. In ground no. 3, the assessee is aggrieved that the CIT(A) erred in confirming the exclusion on account of maintenance of software and technical support, from the export turnover, to arrive at the deduction under section 80 HHE.
15. The short reason for which receipts in respect of software maintenance and technical support have been not been taken into account for the purpose of computing deduction under section 80 HHE was that deduction under section 80 HHE is restricted to receipts in respect of ‘development and production of software’. The CIT(A) has approved the stand so taken by the Assessing Officer. The assessee is not satisfied and is in appeal before us.
16. We have heard the rival contentions, perused the material on record and duly considered factual matrix of the case as also the applicable legal position.
17. We find that the connotations of ‘software maintenance’ are quite distinct and separate in scope than ‘maintenance’ per se. It is in view of this distinction that the coordinate bench, in the case of Direction Software Solutions Vs ITO (28 SOT 35 URO), has observed as follows :
7.2 In the software development life cycle, maintenance is known as last phase of development and, therefore, it is inherent part of such development. It is necessary to distinguish ‘software maintenance’ from ‘maintenance’ as understood in common parlance, i.e. maintenance of a tangible asset like plant and machinery. ICAI in its publication ‘Information System Audit Reference Book’ Modules 4 to 7 which describe the recommended steps for systems development methodology, defines, ‘system maintenance’, as the last part of the system development life cycle, which is preceded by feasibility study, requirement definition, software acquisition, programming, testing and implementation. It is clearly stated herein that ‘maintenance’ is nothing but ongoing development which continues till the system is replaced or discontinued. While the term ‘maintenance’ in relation to a tangible asset would mean those activities which are required to keep it useful, ‘maintenance’ of a software is a part of its development for enhancing its capabilities and correcting errors. In Chapter XXII of the same reference book, which discusses alternative systems development methodologies like data oriented system development, object oriented system development, prototyping, rapid application development, re-engineering, reverse engineering and structured analysis, it is stated that a system is never static and system maintenance is a part of ongoing development. Information Systems Audit and Control Association of USA, which is considered the topmost professionally recognized body, prescribing standards for systems audit and audit of business application software development, has in its 2004 CISA review manual, in Charter 6 under the heading ‘System change procedure and program migration process” given as follows : “Following the implementation and stabilization of a system, it enters into the ongoing development or maintenance stage.” Thus ongoing development of a software system is nothing but its ‘maintenance’. Or in other words, in the world of computer systems and software, maintenance is a part of ongoing development. Maintenance of software, especially when it involves ERP modules, or bought out software’s would require routines and sub-programs for interfacing it with other legacy systems and also for migration from other legacy systems to new system and building in new functionalities, which could vary from user to another user.
7.3 Thus, every maintenance or modification or bug repairing would require independent code and each such independent code/procedure including codes written of interfacing and specific problem solving relating to legacy programme would still be software’s and nothing else. This being the case and taking the totality of the services rendered by the assessee, as can be made out from the description of work given in the agreement, which inter alia mentioned corrections of bugs in OVISS, customizing programmes developed, code change in OVISS would all be nothing but manufacture/production of computer software. This being the case, we are of the opinion, that for the export thereof, assessee would be very much eligible for deduction under section 10A.
18. In this view of the matter, and having noted that there is no direct decision to the contrary, we direct the Assessing Officer to take receipts, in respect of ‘software maintenance’, into account for the purpose of computing deduction under section 80 HHE. To this extent, grievance of the assessee is upheld.
19. However, as far as receipts for technical support services are concerned, we uphold the action of the authorities below, but, in view of the special bench decision in the case of ITO Vs Sak Soft Ltd (121 TTJ 865), direct the Assessing Officer to exclude these receipts, both from the export turnover and from the total turnover, which are the numerator and the denominator, respectively, in the formula. The assessee will get the relief accordingly.
20. Ground No. 3 is thus partly allowed in the terms indicated above.
21. In the result, appeal is partly allowed. Pronounced in the open court today on 23rd day of February, 2011