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Case Study on Foreign Tax Credit : Exemption or Deduction?

Harshad Natu 
Updated on 25 February 2019

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Who doesn't like to save taxes? Or who wouldn't like to stay in a tax haven where you don't need to pay any taxes on income? While paying taxes is almost an inevitability, globalization a few years ago gave rise to another interesting problem - that of double taxation. If you are working in a country where you are not a resident, it is entirely possible that you could end up paying taxes in both the country where you work, and in the country of which you are a resident. To avoid such a situation, countries enter into double taxation avoidance agreements with each other. Under these, income can only be taxed in one country and a person does not have to suffer the agony of paying taxes on the same income twice.

However, sometimes a unique case will present itself to flummox a DTAA. Such was the issue dealt with in the case of Wipro Ltd. vs. DCIT. In the said case, the primary issue that arose was -

Whether credit for income tax paid in a country outside India in relation to income eligible for deduction under Section 10A would not be available under Section 90(1)(a)?

Whether Total Income shall include Export Turnover?

Section 10A of the Income-tax Act, 1961 provides for 100% deduction of profits and gains derived by an undertaking from export of articles or things or computer software manufactured or produced by it. Section 90 says that credit can be claimed in respect of income on which Tax has been paid under both the income tax Act of India and the relevant taxation law in the foreign country. Section 4 empowers Central Government to charge tax in respect of the total income of the previous year of every person and section 5 of the act defines the scope of total income which says that the total income of any previous year of a person who is a resident includes all income from whatever source derived, which accrues or arises to him outside India during such year.

In the case of Commissioner of Income Tax and another Vs. Yokogawa India Ltd., it was held that the phrase Total income has been used in the IT Act in several places with different connotations and shades. The phrase total income used in Sec 10A is one such variant. A business might have several undertakings and Sec 28 does not envisage computation of income of each such undertaking. In other words, the profits of the business of the undertaking cannot be computed in isolation. The phrase total income used in Section 10A(1) is, therefore, to be understood as the total income of the STP unit. This is clear from the first proviso to Section 10A(1) which makes a reference to the total income of the undertaking and not to the total income of assessee. Such a phrase, in the context of Section 10A, means profits and gains of the STP undertaking as understood in its commercial sense.

The relief under Section 10A is in the nature of exemption, although termed as deduction, and the said relief is in respect of commercial profits, such income is neither subject to charge of income tax nor is it includible in the total income

Section 14 provides for classification of income under various heads for the purposes of charging income-tax and computation of total income. The purpose of classification of income under a head is to compute the same. The twin conditions of Section 14 are that income is subject to charge of income-tax and is includible in the total income. As the relief under Section 10A is in the nature of exemption, although termed as deduction, and the said relief is in respect of commercial profits, such income is neither subject to charge of income tax nor is it includible in the total income. Therefore, the twin provisions of Section 14 are not operative in the case of income of an STP undertaking, and accordingly such income is not liable to be

computed under Chapter IV. Therefore, the correct view would be that the relief under Section 10A will have to be given before computation under Chapter IV. The deduction shall be given first and process of computation of profits and gains of business or profession begins thereafter. Allowing deduction at the earliest stage of business income computation almost blurs the difference between the commercial profits and tax profits.

In the case of Wipro Infotech Limited full credit for foreign taxes was granted by applying Article 25 of the India-US DTAA even though 50% deduction of the eligible income under Section 80-O of the Act was allowed. The said relief was granted by the CIT(A) which the Department had accepted.

The Apex Court in the case of CIT vs- Williamson Financial Services & Ors.(297 ITR 17) dealing with computation of deduction under Section 80HHC in respect of profits from export of tea held that Section 10 groups in one place various incomes which are exempt from tax. In respect of incomes on which deductions under Chapter VI-A are allowed, such incomes are wholly or partly tax free incomes. Section 10-A provides deduction out of the total income and it is not the income which is exempt from tax.

Benefit U/S 10A is in the nature of Exemption or Deduction?

The Judiciary has held that the term gross total income is defined in section 80B(5) to mean the total income computed in accordance with the provisions of this Act, before making any deduction under Chapter VI-A. In other words, the gross total income would be arrived at after considering section 10A deduction. Therefore, it would be inappropriate to conclude that section 10A deduction is to be given effect to after Chapter VI-A deductions are exhausted. The profits are computed under the head profits and gains of business or profession, as under the above head, the income from business as a whole has to be computed. The phrase total income used in Section 10A(1) is, therefore, to be understood as the total income of the STP unit. Section 10-A provides deduction out of the total income and it is not the income which is exempt from tax. Hence, the deduction which is allowed under Section 10-A is an item of income on which tax is not paid. In respect of incomes on which deductions under Chapter VI-A are allowed, such incomes are wholly or partly tax-free incomes.

The deduction which is allowed under Section 10-A is an item of income on which tax is not paid. In respect of incomes on which deductions under Chapter VI-A are allowed, such incomes are wholly or partly tax-free incomes.

Judiciary pointed out that Section 14A of the Act categorically states that no deduction shall be allowed in respect of expenditure incurred in relation to income which does not form part of the total income. The total income specified in Sections 4 and 5 chargeable to income tax is also subject to the provisions of the DTAA.

If Parliament had intended that the relief under section 10A should be by way of deduction in the normal course of computation of total income, it could have placed the same in Chapter VI- A which houses sections like 80HHC, 80-IA, etc. Parliament was aware of the various restrictions and limitations of provisions like section 80A and section 80AB which are in Chapter VI-A, and the same do not appear in Chapter III. The fact that even after its recasting, the relief has been retained in Chapter III indicates that the intention of Parliament is for it to be regarded as an exemption and not a deduction.

Judiciary pointed out that Section 14A of the Act categorically states that no deduction shall be allowed in respect of expenditure incurred in relation to income which does not form part of the total income. The total income specified in Sections 4 and 5 chargeable to income tax is also subject to the provisions of the DTAA. The statute by itself is not granting any relief. But, by virtue of the statute, if an agreement is entered into providing for such relief, then the assessee would be entitled to such relief. Hence, the court reached a verdict in favour of the assessee in this case.

Written by Harshad Natu, Manager Sales & Marketing @Riverus

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