Assessee entitled to tax credit of USA federal as well as state taxes u/s 91 – ITAT

Double taxation is the levy of tax by two or more countries on the same income, asset or financial transaction. This double liability is mitigated in many ways, one of them being a tax treaty between the countries in question.

A tax treaty between two or more countries to avoid taxing the same income twice is known as Double Taxation Avoidance Agreement (DTAA). When a tax-payer resides in one country and earns income in another country, he is covered under DTAA, if those two countries have one in place.

If a person who is resident in India in any previous year, in respect of his income, accrued or arose outside India has paid tax on such income in any country outside India, he shall be entitled deduction from the Income Tax payable by him of a sum calculated on such doubly taxed income:

• Under section 90 of the Income Tax Act, if the country in which tax is paid has entered double taxation avoidance agreement with the Government of India.
• Under section 91 of the Income Tax Act, if the country in which tax is paid has not entered into any agreement with the Government of India.

Relief allowed under section 90/ 91 is lower of following accounts:

• Tax paid on double-taxed income outside India.
• Tax payable on double-taxed income under Income Tax Act.

Lets us refer to the case of Aditya Khanna Vs DDIT (ITAT Delhi), where the issue under consideration was whether assessee was entitled to foreign tax credit of state taxes also or was credit u/s 91 confined to federal taxes only?

Facts of the case:

• Assessee was employed with M/s. Allen & Co., LLC, USA and had declared income under the head ‘salaries’ on a proportionate basis.
• Taxable income in India = Total income *230/365 i.e. Rs.1,12,76,036*230/365 = Rs. 71,07,337. Accordingly, the total income offered to tax in India was Rs. 71,07,337.
• In the original ITR the assessee had computed his tax liability at Rs. 4,69,704 which was paid as self-assessment tax. However, in the revised return, the amount of Rs.4,69,504 was claimed as refund.
• It was the assessee’s contention that he was claiming relief for double taxation with respect to the taxes paid in United States in respect of salary earned/ taxed in India.
• The proportionate tax credit being claimed by the assessee for the period of stay in India was for 230 days and it was calculated at Rs. 21,35,813 but was restricted to the amount of the Indian income tax liability.
• It was the assessee’s plea that the assessee should be given credit of Federal as well as State taxes paid in the United States.
• However, the Assessing Officer (AO) was of the opinion that only the Federal income tax paid in the USA would be covered for the purpose of credit of tax paid abroad.

Appeal before Commissioner of Income Tax (Appeals) [CIT(A)]

• Aggrieved, the assessee approached the CIT(A) challenging the action of the AO and submitted before the CIT (A) that there was an error in the computation of number of days of his stay in India which was 223 days and not 230 days.
• It was further submitted that the assessee should be allowed the credit of State taxes paid in India and that the assessee’s claim should be allowed u/s 91 of the Income Tax Act, 1961.
• CIT (A) rejected the assessee’s appeal and denied the credit of State taxes paid in USA.
• CIT(A) also held that since the assessee was not ordinarily resident in India during the year under consideration, the benefit of provisions of section 91 would not be available to him.
• The assessee appealed before the Income Tax Appellate Tribunal (ITAT) challenging the findings of the CIT (A)

Appeal before ITAT

In the case the assessee was a “resident but not ordinarily resident” assessee. The assessee claimed the credit for taxes paid of federal as well as state income tax in United States of America. The following 2 questions arose before the ITAT:

1. whether the assessee can claim tax relief u/s 91 of the income tax act with respect to the federal tax and state income tax or not.
2. Whether the assessee who is not a “resident” but “resident and not ordinarily resident” can also claim relief/deduction u/s 91 or not.

Whether the benefit conferred u/s 91 can be extended to the income tax paid in foreign jurisdictions pertaining to the federal tax and state tax?

The question was answered by the Karnataka High Court in case of Wipro Ltd vs Deputy CIT wherein it was held as under:

• The said provision provided for deduction of the tax paid in any country from the Indian Income-tax payable by him of a sum calculated on such doubly taxed income even though there was no agreement under section 90 for the relief or avoidance of double taxation.
• Explanation (iv) that defined Income-tax in relation to any country, included any excess profit tax or business profits tax charged on the profits by the Government of any part of that country or a local authority in that country.
• Therefore, the intention of Parliament was very clear. The Income-tax in relation to any country included Income-tax paid in any part of the country or a local authority.
• It applied to cases where in a federal structure a citizen was made to pay federal Income-tax and also the State income tax.
• The Income-tax in relation to any country included Income-tax paid not only to the Federal Government of that country, but also any Income-tax charged by any part of that country meaning a State or a local authority, and the assessee would be entitled to the relief of double taxation benefit with respect to the latter payment also.
• Therefore, even in the absence of an agreement under section 90, by virtue of the statutory provision, the benefit conferred under section 91 was extended to the Income-tax paid in foreign jurisdictions.
• India had entered into an agreement with the federal country and not with any State within that country.
• In order to extend the benefit of relief or avoidance of double taxation, the aforesaid Explanation made it clear that Income-tax in relation to any country included the Income tax paid to the Government of any part of that country or a local authority in that country.
• Therefore, even though, India had not entered into any agreement with the State of a country and if the assessee has paid Income-tax to that State, the Income-tax paid in relation to that State was also eligible for being given credit to the assessee in India.

The Co-ordinate Bench of ITAT in the case of Tata Sons Ltd vs. DCIT (2011) (Mum), decided the issue in favour of the tax payer. While doing so, the ITAT observed as follows:

• 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) 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 AO in appeal before ITAT in respect of the deduction having been granted by the CIT(A).
• ITAT was taken through the India USA tax treaty to point out that tax credits were admissible only in respect of Income-tax levied by the federal Government and not by the State Governments.
• It was contended that since no relief is admissible in respect of state taxes under section 90 or section 91, these taxes would continue to be tax deductible, and to that extent, decisions of the coordinate benches will hold good.
• ITAT was unable to see legally sustainable merits in this submission either.
• 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 visa-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”.
• Section 91 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 alongwith section 90, does not reflect any such limitation, and section 91 is thus required to be treated as general in application.
• As 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% to 11%, and the aggregate Income-tax paid by the assessee in USA will range from 38% to 46%.
• 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% vis-a-vis 38.5% 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 worked out to at least 38%, as against tax credit of only 35% admissible under the tax treaty. In such a situation, the assessee would 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.
• Even though ITAT had held that, in principle, state income taxes paid in USA were eligible for the purpose of computing admissible tax credit under Section 91, ITAT was aware of 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.
• 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.
• In the case before us, tax credit provisions in Indo US tax treaty were less advantageous to the assessee, but just because there is a tax treaty between India and USA, the benefits of the domestic law provisions were being declined to the assessee.
• 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 section 90(2).
• 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”.
• It would thus appear that the treaty override is only restricted to the extent it is beneficial to a taxpayer.
• 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 was 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 did 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.

Observations of the ITAT in the current case

• ITAT noted that the CIT(A) declined to follow the decision of the ITAT even though he was fully aware of the same.
• Merely because a judicial precedent is challenged in further appeal, the precedence value of such a judicial precedent does not get diluted.
• The stand of the CIT(A), was conscious disregard of a binding judicial precedent.
• ITAT saw no reason to take any other view of the matter than the view so taken by the co-ordinate bench.
• ITAT upheld the plea of the assessee in respect of the credit for the state tax paid in the USA.
• This was, however, subject to the fact that the credit for all taxes paid abroad in any case cannot exceed the Indian income-tax liability in respect of the same income.
• ITAT thus held that assessee was entitled for tax credit of federal as well as state taxes paid by him u/s 91.

Whether the assessee being “resident but not ordinarily resident” in India was entitled to tax relief u/s 91?

• Provisions of section 91 (1) provided relief/deduction of taxes paid with respect to a person who was a resident in India.
• Section 91(2) also dealt with the person who was a resident in India.
• The provisions of section 91 (3) dealt with the person who was a non-resident.
• The revenue contended that as the assessee was not a resident therefore he was not entitled to benefit of section 91.
• The provisions of section 6 of the income tax act provides for qualification of the persons who are residents in India.
• The provisions of section 6 (6) carves out another category of person in Residents, who is said to be “not ordinarily resident” in India. However, such persons are also resident.
• The category is also called a “resident but not ordinarily resident” in India. Therefore, persons who are “resident but not ordinarily resident” in India are forming larger group of the persons who are resident in India.
• In view of this, ITAT rejected the contentions of the revenue that benefit of section 91 (1) did not apply to a person who was not ordinarily resident in India.

In conclusion, an assessee is entitled for tax credit of federal as well as state taxes paid by him u/s 91 and benefit of Section 91(1) also applied to a person who was not ordinarily resident in India.

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