ISSUE FOR CONSIDERATION
Section 40 of the Income Tax Act, 1961 deals with amounts
that are not deductible in computing income under the head ‘Profits and Gains
of Business or Profession’. This section, in particular clause (a)(ii)
thereof, reads as under:
‘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—
(i) ………..
(ia) …………….
(ib) ……………
(ic) …………….
(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.’
Explanations 1 and
2 were inserted with effect from Assessment Year 2006-07. Prior to that there
was much litigation on whether income taxes paid in a foreign country were an
allowable deduction or not. These explanations were added to prevent a double
relief or benefit , since in most cases such foreign taxes for which deduction
was being claimed were also entitled to tax relief under sections 90, 90A or
91. After the amendment, the issue still remains alive insofar as taxes which
are not entitled to the relief or even a partial relief under sections 90, 90A
or 91, and under the rules only a part of the foreign taxes paid may be
entitled to the relief u/s 90 or u/s 90A in some cases.
An issue has arisen
involving the deductibility of the foreign tax paid on account of the profits
or gains of a foreign business or profession in computing the income under the
head ‘profits and gains of business and profession’ under the Income-tax Act,
1961. While there have been conflicting decisions on the subject, of the Ahmedabad
bench of the Tribunal post amendment, to really understand the controversy one
would need to understand the two conflicting decisions of the Bombay High Court
on the issue, one of which was rendered after the amendment but dealt with a
period prior to the amendment.
THE S. INDER SINGH GILL CASE
The issue came up before the Bombay High Court in the case
of S. Inder Singh Gill vs. CIT 47 ITR 284.
In this case,
pertaining to assessment years 1946-47 to 1951-52, under the Income-tax Act,
1922 the assessee was a non-resident. A resident was treated as the assessee’s
statutory agent u/s 43 of the 1922 Act (corresponding to representative
assessee u/s 163 of the 1961 Act).
In the original
assessments, income from certain Bombay properties was assessed to tax in
computing the total income. The Income Tax Officer later found that the
assessee owned certain other properties also in the taxable territories whose
income had escaped assessment, and therefore initiated re-assessment
proceedings. In response to the notice, the assessee filed his return of
income.
In the return,
among other deductions the assessee claimed that in computing his world income,
the tax paid by him to the Uganda government on his Ugandan income should be
deducted. This claim of the assessee was disallowed by the tax authorities. The
assessee’s first appeal was dismissed by the Appellate Assistant Commissioner.
The Tribunal also rejected the contention that tax paid to the Uganda
government on his foreign income should be deducted in determining his foreign
income and in including it in his total world income.
The Bombay High
Court in deciding the issue, noted that the Tribunal had observed as under:
‘We are not
aware of any commercial practice or principle which lays down that tax paid by
one on one’s income is a proper deduction in determining one’s income for the
purposes of taxation’.
The Bombay High
Court held that no reason had been shown to it by the assessee to differ from
the conclusion that the Tribunal had reached. The Court therefore rejected the
reference made to it by the assessee.
A similar view was
taken by the Calcutta High Court in the case of Jeewanlal (1929) Ltd. vs.
CIT 48 ITR 270, also a case under the 1922 Act, where the issue was
whether business profits tax paid in Burma was an allowable deduction.
Again, a similar
view was taken by the Karnataka High Court in Kirloskar Electric Co. Ltd.
vs. CIT 228 ITR 676, prior to the amendment, by applying section
40(a)(ii). Besides, the Madras High Court, in CIT vs. Kerala Lines Ltd.
201 ITR 106, has also held that foreign taxes are not allowable as a
deduction.
THE RELIANCE INFRASTRUCTURE CASE
Recently, the issue
again came up before the Bombay High Court in the case of Reliance
Infrastructure Ltd. vs. CIT 390 ITR 271.
This was a case
pertaining to A.Y. 1983-84. During the year, the assessee executed projects in
Saudi Arabia. The income earned in Saudi Arabia had been subjected to tax in
Saudi Arabia. While determining the tax payable under Indian tax laws, the
assessee sought the benefit of section 91, claiming relief from double taxation
of the same income, i.e., the Saudi income which was included in the total
income of the assessee.
The assessee
claimed the benefit of double taxation relief on the amounts of Rs. 47.3 lakhs,
otherwise claimed as deduction u/s 80HHB, and Rs. 5.59 lakhs on which a
weighted deduction was otherwise claimed u/s 35B. The A.O. dismissed the
assessee’s claim for relief u/s 91 on the ground that the relief u/s 91 would
be possible only when the amount of foreign income on which the foreign tax was
paid was again included in the taxable income liable to tax in India, i.e., the
relief was possible only where the same income was taxed in both the countries.
The Commissioner
(Appeals) rejected the assessee’s appeal, holding that the assessee had, in
respect of his Saudi income,
claimed deductions u/s 80HHB and
section 35B and such income did not suffer any tax in India and was therefore
not eligible for the benefit of relief u/s 91.
Before the
Tribunal, the assessee urged that the Commissioner (Appeals) ought to have held
that in respect of such percentage of income which was deemed to accrue in
India, and on which the benefit of section 91 was not available, the tax paid
in Saudi Arabia should be treated as an expenditure incurred in earning income,
which was deemed to have accrued or arisen in India, and reduced therefrom.
The Tribunal
dismissed the assessee’s appeal, holding that the issue stood concluded against
the assessee by the decision of the Andhra Pradesh High Court in the case of CIT
vs. C.S. Murthy 169 ITR 686. The Tribunal also held that the tax paid
in Saudi Arabia on which even where no double tax relief could be claimed, was
not allowable as a deduction in computing the income under the provisions of
the Income-tax Act. As regards tax in respect of income which had accrued or
arisen in India, the Tribunal rejected the assessee’s contention on two grounds
– that such a claim had not been raised before the Commissioner (Appeals), and
that the disallowance was as per the
decision of the Bombay High Court in S. Inder Singh Gill’s case
(Supra).
It was claimed on
behalf of the assessee before the Bombay High Court inter alia that the
assessee should be allowed a deduction
of the foreign tax paid in Saudi Arabia, once it was held that the benefit of
section 91 was not available for such tax. It was emphasised that the deduction
was claimed only to the extent that tax had been paid in Saudi Arabia on the
income which had been deemed to have accrued or arisen in India.
It was pointed out
to the Bombay High Court that such a
deduction had been allowed by the Tribunal in the assessee’s own case for A.Y.
1979-80 and therefore the principle of consistency required the Tribunal to adopt the same view
as it did in A.Y. 1979-80. It was pointed out that Explanation 1 added to
section 40(a)(ii) with effect from A.Y. 2006-07 was clarificatory in nature, as
was evident from the fact that it began with the words ‘for removal of doubts’.
It should therefore be deemed to have always been there and would apply to the
case before the High Court. It was argued that if it was held that section 91
was not applicable, then the bar of claiming deduction to the extent of the tax
paid abroad would not apply.
Reference was made
on behalf of the assessee to the commentary on ‘Law and Practice of Income
Tax’ by Kanga & Palkhivala (8th Edition), wherein a
reference was made to the decisions of the Bombay High Court in CIT vs.
Southeast Asian Shipping Co. (IT Appeal No. 123 of 1976) and CIT
vs. Tata Sons Ltd. (IT Appeal No. 209 of 2001) holding that foreign tax did not fall within
the mischief of section 40(a)(ii) and that the assessee’s net income after
deduction of foreign taxes was his real income for the purposes of the
Income-tax Act.
It was therefore
argued on behalf of the assessee that the decision of the Bombay High Court in S.
Inder Singh Gill (Supra) would not apply and the tax paid in Saudi
Arabia on the income accrued or arising in India was to be allowed as a
deduction to arrive at the real profits which were chargeable to tax in India.
On behalf of the
Revenue, it was submitted that the issue stood concluded against the assessee
by the decision of the Bombay High Court in S. Inder Singh Gill (Supra).
It was submitted that the real income theory was inapplicable in view of the
specific provision of section 40(a)(ii) which prohibited deduction of any tax
paid. It was submitted that in terms of the main provisions of section
40(a)(ii), any sum paid on account of any tax on the profits and gains of
business or profession would not be allowed as a deduction.
It was argued on
behalf of the Revenue that the Explanation 2, inserted with effect from A.Y.
2006-07, only reiterated that any sum entitled to tax relief u/s 91 would be
covered by the main part of section 40(a)(ii). It did not take away the taxes
not covered by it out of the ambit of the main part of section 40(a)(ii).
The Bombay High
Court held that the Tribunal was justified in not following its order in the
case of the assessee itself for A.Y. 1979-80, as it noted the decision of the
Bombay High Court in S. Inder Singh Gill (Supra) on an identical
issue. The Court observed that the decisions in South Asian Shipping Co.
(Supra) and Tata Sons Ltd. (Supra) were rendered not at
the final hearing but while rejecting the applications for reference u/s 256(2)
and at the stage of admission u/s 260A, unlike the judgment rendered in a
reference by the Court in S. Inder Singh Gill, and therefore
could not be relied upon in preference to the decision in S. Inder Singh
Gill.
Further, the Court
observed that it was axiomatic that income tax was a charge on the profits or
income. The payment of income tax was not a payment made or incurred to earn
profits and gains of business. It could therefore not be allowed as an
expenditure to determine the profits of the business. Taxes such as excise
duty, customs duty, octroi, etc., were incurred for the purpose of doing
business and earning profits or gains from business or profession and
therefore, they were allowable as
deduction to determine the profits of the business. It is the profits and gains
of business, determined after deducting all expenses incurred for the purpose
of business from the total receipts, which were subjected to income tax as per
the Act. The main part of section 40(a)(ii) did not allow deduction of tax to
the extent the tax was levied on the
profits or gains of the business. According to the Court, it was on this
general principle, universally accepted, that the Bombay High Court had
answered the question posed to it in S. Inder Singh Gill in
favour of the Revenue.
The Bombay High
Court went on to observe that it would have followed the decision in the case
of S. Inder Singh Gill. However, it noticed that that decision
was rendered under the 1922 Act and not under the 1961 Act. The difference
between the two Acts was that the 1922 Act did not contain a definition of
‘tax’, unlike the 1961 Act where such term was defined in section 2(43) as
‘income tax chargeable under the provisions of this Act’. In the absence of any
definition of ‘tax’ under the 1922 Act, the tax paid on income or profits and
gains of business or profession anywhere in the world would not be allowable as
a deduction for determining the profits or gains of the business u/s 10(4) of
the 1922 Act, and therefore the decision in S. Inder Singh Gill
was correctly rendered on the basis of the law then prevalent.
Proceeding on the
said lines, the Bombay High Court held
that by insertion of section 2(43) for defining the term ‘tax’, tax which was
payable under the 1961 Act on the profits and gains of business that alone was
not allowed to be deducted u/s 40(a)(ii), notwithstanding sections 30 to 38.
According to the Court, the tax, which had been paid abroad would not be
covered within the mischief of section 40(a)(ii), in view of the definition of
the word ‘tax’ in section 2(43). The Court said that it was conscious of the
fact that section 2, while defining the various terms used in the Act,
qualified it by preceding the definition with the words ‘in this Act, unless
the context otherwise requires’. It noted that it was not even urged by the
Revenue that the context of section 40(a)(ii) would require it to mean tax paid
anywhere in the world and not only tax payable under the Act.
The Court analysed
the rationale for introduction of the Explanations to section 40(a)(ii), as set
out in the Explanatory Memorandum to the Finance Act, 2006, recorded in CBDT
Circular No. 14 of 2006 dated 28th December, 2006. It recorded the fact that some assessees, who
were eligible for credit against the tax payable in India on the global income
to the extent that the tax had been paid outside India u/s 90/91, were also
claiming deduction of the tax paid abroad as it was not tax under the Act. In
view of the above, the explanation would require in the context thereof that
the definition of the word ‘tax’ would also mean tax which was eligible to the
benefit of section 90/91. However, as per the High Court, this departure from
the meaning of the word ‘tax’ as defined in the Act was restricted to the above-referred section 90/91
only and gave no license to widen the meaning of the word ‘tax’ to include all
taxes on income or profits paid abroad for the purposes of section 40(a)(ii).
The Court further
noted that it was undisputed that some part on which tax had been paid abroad
was on income that had been deemed to have accrued or arisen in India. To that
extent, the benefit of section 91 was not available for such tax so paid
abroad. Therefore, such tax was not hit by the Explanation to section 40(a)(ii)
and was to be considered in the nature of an expenditure incurred to earn
income. The Court then held that the Explanation to section 40(a)(ii) was
declaratory in nature and would have retrospective effect.
The Bombay High
Court therefore held that the assessee was entitled to deduction for foreign
taxes paid on income accrued or arisen in India in computing its income, to the
extent that such tax was not entitled to the benefit of section 91.
OBSERVATIONS
Before looking at
the applicability of section 40(a)(ii), one first needs to examine whether
income tax is at all an expenditure, and if so, whether it is a business
expenditure. Accounting Standard 22, issued by the Ministry of Corporate
Affairs under the Companies Act, provides that ‘Taxes on income are
considered to be an expense incurred by the enterprise in earning income and are accrued
in the same period as the revenue and expenses to which they relate.’ It
therefore seems that income tax is an expenditure under accounting principles.
Since only certain
types of business expenditure are allowable as deductions while computing
income under the head ‘Profits and Gains of Business or Profession’, the
question that arises is whether tax is a business expenditure. Accounting
Standard 22 states that ‘Accounting income (loss) is the net profit or loss
for a period, as reported in the statement of profit and loss, before deducting
income tax expense or adding income tax saving.’ Ind AS 12 issued by the
Ministry of Corporate Affairs states ‘The tax expense (income) related to
profit or loss from ordinary activities shall be presented as part of profit or
loss in the statement of profit and loss.’
However, if one
looks at the manner of presentation in the final accounts, it is clear that
income tax is treated quite differently from business expenditure, being shown
separately as a deduction after computing the pre-tax profit. Therefore, it
appears that while tax is an expense, it may not be a business expenditure.
This is supported by the language of AS 22, which states that ‘Accounting
income (loss) is the net profit or loss for a period, as reported in the
statement of profit and loss, before deducting income tax expense or adding
income tax saving.’
Further, the
fundamental issue still remains as to whether such foreign income taxes can
ever be a deductible expenditure under sections 30 to 38. Even on basic
commercial principles, income tax is not an expenditure for earning income; it
is a consequence of earning income. Whether such income tax is a foreign tax or
tax under the 1961 Act is irrelevant – it is still an application of income
after having earned the income. This view is supported by the decision of the
Madras High Court in the Kerala Lines case (Supra),
where the High Court observed that the payment of foreign taxes could not be
regarded as an expenditure for earning profits; they could at best be
considered as an application of profits earned by the assessee.
In the Reliance
Infrastructure case, the decision of the Bombay High Court was primarily
focused and based on the language of section 40(a)(ii), the Explanation thereto
read with the definition of ‘tax’ u/s 2(43). However, it needs to be kept in
mind that section 40 is a section listing out expenses, which are otherwise
allowable under sections 30 to 38, but which are specifically not allowable.
The provisions of section 40(a)(ii) will therefore come into play where an item
of expenditure is otherwise allowable as a business expenditure under sections
30 to 38. If such expenditure is in any case not allowable under sections 30 to
38, the question of applicability of section 40(a)(ii) does not arise.
The Bombay High
Court, in the case of CIT vs. Plasmac Machine Mfg. Co. Ltd. 201 ITR 650,
considered a situation of payment of tax liability of a transferor firm by the
transferee company, where the company had taken over the business of the
transferor firm. It held that the expenditure representing the liability of the
transferor, which was discharged by the transferee, was a capital expenditure
forming part of the consideration for the acquisition of the business and was
therefore not deductible in the computation of income. Hence, the question of
applicability of section 40(a)(ii) did not arise.
Under what clause
would foreign income taxes be allowable under sections 30 to 38? The only
possible provision under which such income taxes may fall for consideration as
a deduction would be section 37(1). Section 37(1) allows a deduction for
expenditure (not being in the nature of capital expenditure or personal
expenses) incurred wholly and exclusively for the purpose of business or
profession. Is a foreign income tax an expenditure incurred wholly and
exclusively for the purpose of business or profession, or is it an application
of the income after it has been earned?
The House of Lords,
in the case of Commissioners of Inland Revenue vs. Dowdall O’Mahoney
& Co. Ltd. 33 Tax Cases 259, had occasion to consider this issue in
the case of an Irish company which had branches in England; it claimed that in
computing the English profits, it was entitled to deduct that proportion of the
Irish taxes attributable to those profits. The House of Lords held that payment
of such taxes by a trader was not a disbursement wholly and exclusively laid
out for the purposes of the trade and this was so whether such taxes were
United Kingdom taxes or foreign or Dominion taxes. The House of Lords further
observed that taxes like these were not paid for the purpose of earning the
profits of the trade; they were the application of those profits when made and
not the less so that they were exacted by a Dominion or foreign government. It
further observed that there was not and never was any right under the
principles applicable to deduct income tax or excess profits tax, British or
foreign, in computing trading profits. According to the House of Lords, once it
was accepted that the criterion is the purpose for which the expenditure is
made in relation to the trade of which the profits are being computed, no
material distinction remained between the payment to make such taxes abroad and
a payment to meet a similar tax at home. A similar view was taken by the Madras
High Court in Kerala Lines (Supra).
In the Reliance
Infrastructure case, the Bombay High Court, while referring to this
basic principle, also accepted by it in the S. Inder Singh Gill
case, did not lay down any rationale for departing from this principle while
deciding the matter. It perhaps was swayed by the Explanation to section 90/91
and section 2(43), both of which had no application on the subject of allowance
of deduction of the foreign tax in computing the business income in the first
place.
The issue of
deductibility of foreign taxes had also come up recently before the Ahmedabad
Bench of the Tribunal, in which the Tribunal took differing views. In both
these cases the assessee had claimed foreign tax credit under section 90/91 on
the basis of the gross foreign income, but was allowed tax credit on the basis
of net foreign income taxable in India. It alternatively claimed deduction for
such foreign taxes not allowed as credit. In the first case, DCIT vs.
Elitecore Technologies (P) Ltd., 165 ITD 153, the Tribunal held, after
a detailed examination of the entire gamut of case laws on the subject, that
foreign taxes were not a deductible expenditure. It pointed out aspects which
had not been considered by the Bombay High Court in the Reliance
Infrastructure case. In the subsequent decision in Virmati
Software & Telecommunication Ltd. vs. DCIT, ITA No 1135/Ahd/2017 dated 5th
March, 2020, the Tribunal took a contrary view, following the Bombay
High Court decision in the Reliance Infrastructure case, that
such foreign taxes not allowed credit u/s 91 were deductible in computing the
income. The Mumbai Bench of the Tribunal, in the case of Tata Motors Ltd.
vs. CIT ITA No. 3802/Mum/2018 dated 15th April, 2019, has
also followed the Bombay High Court decision in Reliance Infrastructure
and held that the deduction for foreign taxes not entitled to relief under
section 90/91 could not be the subject matter of revision u/s 263.
The Mumbai Bench of
the Tribunal, on the other hand, in the case of DCIT vs. Tata Sons Ltd.
43 SOT 27, has, while disallowing the claim for deduction of foreign
taxes u/s 37(1), observed that if it was to be held that the assessee was
entitled to deduction of tax paid abroad, in addition to admissibility of tax
relief u/s 90 or section 91, it would result in a situation that on the one
hand double taxation of income would be eliminated by ensuring that the
assessee’s total income-tax liability did not exceed the income-tax liability
in India or the income-tax liability abroad, whichever was greater, and, on the
other hand, the assessee’s domestic tax liability would also be reduced by tax
liability in respect of income decreased due to deduction of taxes. Such a
double benefit to the assessee was contrary to the scheme of the Act as well as
the fundamental principles of international taxation.
Interestingly, the
Mumbai Bench of the Tribunal, in Tata Consultancy Services Ltd. vs. ACIT
203 TTJ 146, considered a disallowance of US and Canadian state taxes
and held that such taxes were not covered by section 40(a)(ii) and were
therefore allowable.
A question arose in
Jaipuria Samla Amalgamated Collieries Ltd. 82 ITR 580 (SC) where
the assessee, a lessee of mines, incurred statutory liability for the payment
of road and public works cess and education cess, and claimed deduction of such
cess in its computation of income. The A.O. disallowed such claim relying on
section 10(4) of the 1922 Act, corresponding to section 40(a)(ii) of the 1961
Act. In that decision, the Supreme Court held that the words ‘profits and gains
of any business, profession or vocation’ which were employed in section 10(4),
could, in the context, have reference only to profits or gains as determined
u/s 10 and could not cover the net profits or gains arrived at or determined in
a manner other than that provided by section 10. Can one apply the ratio
of this decision to foreign income taxes, which are levied on income computed
in a manner different from that envisaged under the 1961 Act?
Subsequently, the
Supreme Court itself in the case of Smithkline & French India Ltd.
vs. CIT 219 ITR 581 has taken a different view in the context of surtax.
The Supreme Court observed in this case:
‘Firstly, it may
be mentioned, s.10(4) of the 1922 Act or s.40(a)(ii) of the present Act do not
contain any words indicating that the profits and gains spoken of by them
should be determined in accordance with the provisions of the IT Act. All they
say is that it must be a rate or tax levied on the profits and gains of
business or profession. The observations relied upon must be read in the said
context and not literally or as the provisions in a statute…’
This argument
therefore seems to no longer be valid. In this case, the Supreme Court has also
approved the Bombay High Court decision in Lubrizol India Ltd. vs. CIT
187 ITR 25, where the Bombay High Court noted that section 40(a)(ii)
uses the term ‘any’ before ‘rate or tax’. The High Court had observed:
‘If the word “tax” is to be given the meaning
assigned to it by s.2(43) of the Act, the word “any” used before it will be
otiose and the further qualification as to the nature of levy will also become
meaningless. Furthermore, the word “tax” as defined in s.2(43) of the Act is
subject to “unless the context otherwise requires”. In view of the discussion
above, we hold that the words “any tax” herein refers to 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’.
This view is in
direct contrast to the view expressed in the Reliance Infrastructure
case, and having been approved by the Supreme Court in the case of Smithkline
& French (Supra), this view should prevail. Perhaps, the ratio
of the Reliance Infrastructure case was largely governed by the
fact that the non-applicability of section 2(43) to section 40(a)(ii) was never
urged by the Department before it.
Therefore, the better view is that foreign
income taxes are not a deductible expenditure in computing income under the
1961 Act, irrespective of whether they are eligible for credit under sections
90, 90A or 91.
