India: The Ahmedabad Bench Of Income Tax Appellate Tribunal Holds That Foreign Tax Credit Is Eligible On The Basis Of Income And Not On Gross Receipts

Last Updated: 1 February 2017
Article by SKP  

In a recent case[1] , the Ahmedabad Tribunal ruled that for determining the quantum of income which is to be treated as doubly taxed for the purpose of computing admissible tax credit, taking gross receipts as a basis is not a right approach. That interprets the term income as income embedded in the gross receipts and not the gross receipt itself. Furthermore, it restricts the Foreign Tax Credit (FTC) basis as the tax payable in India. Since the taxpayer (Indian company) was liable to pay the tax on its book profits under the provisions of Minimum Alternate Tax (MAT), FTC was restricted to tax payable on book profits.

Background

A resident of India receiving income from a country outside India can claim the credit for foreign taxes paid, if any, in the source country. The credit of foreign taxes paid in the country with which India has a Double Tax Avoidance Agreement (DTAA), shall be as per the provisions of DTAA.

Generally, provisions of the DTAA allows the credit of foreign taxes from the Indian tax liability subject to a condition that credit shall not exceed the part of tax in India which is attributable to the doubly taxed income. Basically, taxpayers need to compute the doubly taxed income first to arrive at the eligible tax credit. While no clear guidance is available in the DTAAs on how to compute such doubly taxed income, the decision of Ahmedabad Tribunal assumes significance.

Brief facts of the case

  • Elitecore Technologies Private Limited (taxpayer) is engaged in the business of software development and products.
  • For the Assessment Year (AY) under consideration, the taxpayer was liable to pay taxes on book profits under the provisions of MAT of the Income Tax Act, 1961 (ITA).
  • During the AY, the taxpayer has some receipts from the contracts in Singapore and Indonesia for the sale of software license and Annual Maintenance Contract (AMC). As per the laws of those countries, the receipts were subjected to withholding tax. The taxpayer claimed full credit for the taxes paid in those countries against the tax payable in India.
  • However, during the revenue audit, the Tax Officer (AO) did not approve the said claim. The AO was of the view that credit would be allowed only to the extent of the corresponding income being taxed in India. He computed the doubly taxed income by dividing the actual MAT liability in the ratio of foreign receipts to the overall turnover.
  • It was contended by the taxpayer that none of the tax treaties prescribes the manner, as adopted by the AO, of deriving net income or any method of computing the net income. It was contended that the entire receipt should be considered as doubly taxed, looking at the interpretation and scheme of the tax treaties.
  • The taxpayer also submitted a separate calculation of income earned out of those transactions, claiming that no expenditure has been incurred in the current year in respect of foreign receipts as all expenses were incurred in the development phase and have been charged in the earlier year.
  • The Commissioner of Income Tax (Appeals) (CIT(A)) rejected the taxpayer's submission by holding that when the company is taking several projects at a time and the profitability has not been worked out for of each project or products, the global profitability has to be adopted for computing the proportionate profit. 

Issue before the Income Tax Appellate Tribunal (ITAT)

The ITAT was saddled with two issues given below:

  • The manner of determining the quantum of doubly  taxed income; and
  • The manner of computing the eligible tax credit. 

Observations of ITAT 

  • ITAT stated that with respect to the manner in which the quantum of doubly taxed income is to be computed, there was no guidance available in the treaties. However, it has been expressed that the term used in treaties was income and not a gross receipt, which essentially implied income embedded in gross receipts and not the gross receipt itself.
  • ITAT observed that same approach was reflected in the United Nation (UN) Model Convention Commentary as well Organisation for Economic Co-operation and Development (OECD) Model Convention Commentary. UN Model Convention Commentary states "Normally the basis of calculation of income tax is total net income, i.e. the gross income less the allowable deductions. Therefore, it is the gross income derived from the source state less any allowable deductions (specific or proportional) connected with such income which is to be exempted."
  • ITAT thus held that it was incorrect to take the gross receipts into account for the purpose of computing doubly taxed income.
  • It was held that when an income received from foreign operations was not separately computed, the same ought to be done on a reasonable basis. Only in the absence of reasonable basis, averaging on the basis of overall revenues and profits or on the basis of some other ratio analysis would apply.
  • However, in view of the peculiar fact of the case, the ITAT agreed that there was a merit in the taxpayer's argument that the said earnings were passive in nature and no part of the costs incurred in India could be allocated to earnings from Singapore or Indonesia. When an additional user is added by the customer, it does result in revenue to the seller but it does not add to the additional cost. It was only additional revenue to the seller without any incremental cost. Hence, computation of income by the taxpayer was held to be fair and reasonable.
  • ITAT clarified that its decision cannot be the authority for the general proposition that only marginal or incremental costs incurred in respect of foreign income should be taken into account and the overheads cannot be allocated thereto.
  • ITAT further stated, "Allocation of proportional deductions can be justified in some situations, such as when business operations are somewhat evenly or even in a significant manner, spread over the residence and source jurisdiction."
  • ITAT clarified that FTC for both the jurisdictions would be computed separately. As in the present case, for tax paid under the MAT provisions, the tax credit was allowed by apportioning the actual tax paid under MAT in the same ratio as doubly taxed income to overall profit.

Footnotes

[1] Elitecore Technologies Private Limited Vs. DCIT – ITA No. 623/Ahd/2015

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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