Decision of Bombay HC needs Review: Deduction of Taxes paid Abroad

The foreign corporate tax written off in the books is not an allowable deduction

In this regard, it is pertinent to note that the deductibility of the foreign tax has to be interpreted with reference to section 37(1) r.w. section 40(a)(ii) of the Income Tax Act, 1961.

Understanding of the facts

A view can be taken that the corporate tax paid abroad is eligible for double taxation relief under section 90 or section 90A or section 91, as the case may be. However, due to restrictions in the said sections, the assessee may not be able to get relief of the entire amount of taxes paid abroad. The assessee thereby books the Amount of taxes paid abroad Less Relief obtained as expense in its Profit and loss account.

For Example:

Amount of corporate tax paid Abroad : 100 Crores

Amount of double taxation Relief : 80 Crores

Amount of Foreign corporate tax debited in the P&L as expense : 20 crores (100 crores – 80 crores)

Issues Concerned

The major issue is whether the mount of foreign corporate tax debited in the P&L i.e. 20 crores, as said in the above example is eligible for deduction or not.

It is crystalline clear that out of 100 crores of corporate tax paid abroad, relief for Rs. 80 crores has been received and hence no deduction can be claimed for Rs. 80 crores. Thereby the moot question is whether Foreign corporate tax of Rs. 20 crore is eligible or deduction or not.

Foreign tax paid abroad doesn’t qualifies for deduction under section 37(1)

In this regard, attention may be kindly invited towards section 37(1) of the Act which interalia reads as follows,

37. (1) 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”.

[Emphasis Added]

On the kind perusal of the said section, it can be seen that for the amount being eligible for deduction under section 37(1) it has to be necessarily laid out or expended wholly and exclusively for the purposes of the business or profession of the assessee.  The corporate taxes cannot be an expense incurred wholly and exclusively for the purpose of the business and hence the same doesn’t qualify the condition of being allowable under section 37(1) of the Act.

The above view finds support from the decision in the case of CIT -vs.- Kerala Lines Ltd. (1994) 72 Taxman 3 (Mad.) wherein the Hon’ble Madras High Court held that the payment of foreign tax would not be regarded as an expenditure incurred by the assessee for earning profits. The taxes paid by the assessee could at best be considered as an application of profit earned by the assessee. The payment made by the assessee could not be treated as having been expended for earning profit. It is a diversion or application of profit and cannot be equated to an expenditure wholly and exclusively laid out for business purposes and such payment could not be considered to be an allowable expenditure under section 37 of the Act.

Further, in the case of Kirloskar Electric Co. Ltd. Ltd. -vs.- CIT (1997) 228 ITR 676 (Kar.) the Hon’ble Karnataka High Court held that section 40(a)(ii) of the Act in the unambiguous terms states that for computing income chargeable under the head “Profits and gains of business” the sums paid on account of tax levied in Malaysia could not be claimed as deduction.

In the case of Jeewanlal (1929) Ltd. -vs.- CIT (1963) 48 ITR 270 (Cal.) the Hon’ble Calcutta High Court held that the business profits tax paid in Burmah is neither deductible as business expense under the Business Profits Tax Act nor under the Income tax Act in India.

Foreign tax paid abroad doesn’t qualifies for deduction under section 40(a)(ii)

In this regard, attention may be kindly invited towards section 40(a)(ii) of the Act which interalia reads as follows,

“Amounts not deductible.

40. 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“,—

(a) in the case of any assessee—

…..

(ii) 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;”

[Emphasis Added]

On the reading of the said section, one can be argue that the foreign tax is not covered under the ambit of ‘tax’ as defined section 2(43) of the Act and hence, section 40(a)(ii) is not applicable only on domestic tax and not domestic tax. However, before coming to any conclusion one must re-read the provisions of the said section.

on the joint reading of the pharse, “any rate or tax levied on the profits or gains” as provided in the said section along with its interpretation as held by the Hon’ble Supreme Court in the case of Smithkline and French India Limited -vs.- CIT (1996) 219 ITR 581 (SC),  the words ‘any’ goes to both ‘rate’ as well ‘tax’. Therefore if any sum is qualified as a tax or as a rate, then the sum is not eligible as a deduction under section 40(a)(ii).

Therefore, it can be said that even if the foreign tax doesn’t falls under the ambit of  ‘tax’ then also it is not eligible for deduction as it falls under the term ‘rate’.

The said view finds support from the decision of the Hon’ble Mumbai bench of the ITAT in the case In the case of DCIT -vs.- Tata Sons Ltd. (2011) 43 SOT 27 (Mum.) wherein, the Tribunal after considering the scope of expression ‘tax’ in the context of section 40(a)(ii) and after analyzing of the rider ‘unless the context otherwise requires’ as provided in section 2 of the Act and in view of the Hon’ble Bombay High Court’s decision in the case of Inder Singh Gill -vs.- CIT (1963) 47 ITR 284 (Bom.), held that taxes paid abroad could not be allowed as deduction in the computation of total income.

The Decision of the Hon’ble Bombay High Court needs review

It is pertinent to note that in the case of Reliance Infrastructure Ltd. -vs.- CIT (2016) 76 taxmann.com 257 (Bom.) the Hon’ble Bombay High Court held that if the benefit of double taxation relief is not available on the foreign tax paid, the said amount is to be allowed as an expenditure. The Hon’ble High Court further held that foreign tax does not come under the purview of the definition of ‘tax’ as defined in section 2(43) and therefore it was held that the same would be an allowable expense.

It may be kindly noted that the Hon’ble Court interpreted section 2(43) and 40(a)(ii) and held, foreign tax does not fall under section 2(43) since ‘tax’ includes tax payable under the provisions of the Act and foreign tax being not payable under the provisions of the Act the same is not tax. Further, explanation to section 40(a)(ii) provides that tax benefit availed under section 90/91/90A shall be deemed to be tax payable in India. However, when assessee is not eligible to avail benefit under section 90/91/90A then foreign tax should not be considered as tax within the meaning of section 40(a)(ii) and further, since the same is also not ‘tax’ within the meaning of section 2(43) the Hon’ble Court held, it is an allowable expense.

The said view needs review since there is no express provision of the Act which justifies the stand taken by the Hon’ble Court. Further, the High Court has also not considered the its earlier decision in the case of Lubrizol (India) Ltd -vs.- CIT (1991) 187 ITR 25 (Bom.) wherein it was held that the words ‘any’ as provided in section 40(a)(ii) goes to both ‘rate’ as well ‘tax’. Thus, it can be concluded that even if foreign tax is not covered as ‘tax’ within the meaning of section 2(43) then also it falls under the term ‘rate’. The said view is supported by the decision of the Hon’ble Apex Court in the case of Smithkline and French India Ltd. (supra.).  Thus, the decision in the case of Reliance Infrastructure Ltd. may not be a good law.

On the contrary, the decision in the case of DCIT -vs.- Elitecore Technologies (P.) Ltd. (2017) 80 Taxmann.com 6 (Ahm.) may be considered a good law. The Hon’ble Ahmedabad bench of the ITAT held that the words “any rate or tax” as defined in section 40(a)(ii) would have to be assigned the meaning any kind of tax levied or leviable 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. Accordingly, it was held that no deduction under section 37(1) could be allowed in respect of any income tax withheld abroad as the same would be hit by the disabling provisions of section 40(a)(ii).

The ITAT distinguished the decision of Reliance Infrastructure Limited by placing reliance on the cases of Smithkline and French India Limited -vs.- CIT (1996) 219 ITR 581 (SC) and Lubrizol (India) Ltd -vs.- CIT (1991) 187 ITR 25 (Bom.)

Inference

On the basis of the above, it can be inferred that the foreign corporate tax is not an eligible deduction and thereby the decision of the Hon’ble Bombay High Court in the case of  Reliance Infrastructure Ltd. needs review.

Hope it helps!!

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