Foreign tax credit – (Part 6)

Various unresolved issues –

Issues that are arising in context of Foreign tax credit (‘FTC’) are –

• In accordance with the provisions of the convention –

Country of residence shall grant credit of foreign taxes paid only if the income is taxed in the Source country ‘in accordance with the provision of the Convention’.

Madras High Court in the case of CIT v. Lakshmi Textile Exporters Ltd. ( held
that, where profits of a PE are exempt from tax in the Country of residence the Country of residence has to accept a finding of the source Country that a Permanent Establishment exists in the source Country. Also, if the source Country chooses to give exemption to such income under its laws then also such income would be treated as “taxed in accordance with the convention” and the Country of residence would not have the right to tax such income.

• May be taxed –

Whereever, the Model convention uses the language that gains arising may be taxed in either of the contracting state, it appears that no contracting state is given the exclusive jurisdiction to tax the gains.

CIT vs. Sr.S.R.M Firm (208 ITR 400) in Madras High Court held that the contention on behalf of the revenue that wherever the enabling words such as words ‘may be taxed’ are used there is no prohibition or embargo upon the authorities from assessing the category of income, cannot be countenanced as of substance or merit. The court held that the revenue cannot take advantage of such enabling language to claim it as a right to bring to assessment the income covered by such clauses.

It may be held that if any income or gain is taxed in one Country, the same cannot be taxed in the other Country. However, this view may be subject to review as DTAA cannot take away the right of the other Country to tax the income. The object of DTAA is not to take away the right of the other Country to assess any receipt as income and purpose of DTAA is to minimize the tax burden by allowing credit for tax paid.

• Inclusion of surcharge in computing FTC – Bangalore Tribunal in the case of Infosys Technologies Ltd. (108 TTJ 282) interpreted the terms ‘tax’ and ‘Indian tax payable’ in Article 23 of the India Canada tax treaty and held that while computing the Indian tax on doubly taxed income, ‘tax” should include surcharge and a credit in India for Canadian tax was available only after first computing the Indian tax including surcharge.

• Impact of loss in Country of residency in computing the extent of FTC If loss in the Country of residence is higher than the foreign income, then tax in India would be nil. Similarly, if loss in India is lower than foreign income then tax in India would be only available on part of foreign income. Mumbai Tribunal in the case of JCIT v. Digital Equipment India Ltd (94 ITD 340) had examined the issue with reference to Article 25 of the Indo-US DTAA. It was held that no refund shall be allowed to the tax payer since the assessee had loss after set-off of foreign income against the income in the Country of residence (India).The reason cited by the Tribunal was that tax in India was nil on the doubly taxed income.
• Timing mismatch – Various issues arises with regard to the period for which foreign tax credit should be allowed. Reference in this regard can be placed on the paragraph 32.8 of the OECD commentary on Article 23 states that since both Articles 23A and 23B require for relief to be granted where an item of income or capital may be taxed by the source Country in accordance with the provisions of the Convention, it follows that such relief must be provided regardless of when the tax is levied by the source Country. The State of residence must therefore provide relief of double taxation through the credit or exemption method with respect to such item of income or capital even though the State of source taxes it in an earlier or later year.

Also, Mumbai Tribunal in the case JCIT v. Petroleum India International , though in the context of section 91 of the Act, wherein it was held that it is not required that payment of taxes outside India shall be made during relevant previous year itself to provide relief for the same.

• Carry forward/carry back of excess FTC – Whenever taxes paid in foreign country is greater than the taxes paid in India on that foreign source income, some countries allows for carry forward/ carry back of excess FTC.

• FTC in traingular cases –
  A detailed guideline is required to enable the taxpayers to claim credit for taxes paid in more than two jurisdictions. Non-discrimination article under the tax treaties needs to be analysed to determine whether the PE can avail credit of taxes paid in the third country.

Foreign tax credit – (Part 5)

Credit method (continued)

Tax sparing credit method –

Under this, taxpayer will get credit of the amount of tax which would have been paid in the source country had there been no exemption from tax under the domestic laws of the source country.

That means here that benefit is provided by the residence state even though actual taxes has not been paid in the source state.

Types of tax credit –

• Tax sparing granted with respect to general tax incentives
• Tax sparing granted with respect to specified sections/ enactments
• Deemed tax credit

Example of tax sparing clause in India-Canada DTAA –

Relevant extract of the India-Canada DTAA –

In the case of Canada, double taxation shall be avoided as follows :

a. Subject to the existing provisions of the law of Canada regarding the deduction from tax payable in Canada of tax paid in a territory outside Canada and to any subsequent modification of those provisions – which shall not affect the general principle hereof – and unless a greater deduction or relief is provided under the laws of Canada, tax payable in India on profits, income or gains arising in India shall be deducted from any Canadian tax payable in respect of such profits, income or gains.

Some of the other tax treaties that have tax sparing clause are India-China DTAA, India-Japan DTAA etc.

Underlying tax credit method –

Under this method, credit on account of foreign taxes paid is given, in Country of residence for the tax paid on the underlying profits out of which the dividend is paid by a company in the source Country.

DTAAs generally prescribe minimum shareholding required to be eligible for claiming credit under UTC method.

However, under India-Singapore DTAA, India provides UTC to a company resident in India deriving dividend from Singapore Company for the taxes paid by Singapore Company in respect of the profits out of which such dividend is paid. Article 25 of the said DTAA reads as under:

“2. Where a resident of India derives income which, in accordance with the provisions of this Agreement, may be taxed in Singapore, India shall allow as a deduction from the tax on the income of that resident an amount equal to the Singapore tax paid, whether directly or by deduction. Where the income is a dividend paid by a company which is a resident of Singapore to a company which is a resident of India and which owns directly or indirectly not less than 25 per cent of the share capital of the company paying the dividend, the deduction shall take into account the Singapore tax paid in respect of the profits out of which the dividend is paid. Such deduction in either case shall not, however, exceed that part of the tax (as computed before the deduction is given) which is attributable to the income which may be taxed in Singapore.”

Some of the other DTAAs wherein underlying tax credit clause are available India-UK DTAA, India-Mauritius DTAA, India-Japan DTAA etc.

Foreign tax credit – (Part 4)

Credit method – Country of residence retains the right to tax the foreign income but credit is allowed for the taxes paid in the source state. India follows credit method for most of its tax treaties. The loss of revenue in this method to the residence country is lower vis-a-vis the other menthods.

• Full credit method –

Country of residence allows full credit for taxes paid in the source country in respect of income taxed in the country of residence. India does not follow full credit method for giving credit to its residents except in case of Namibia DTAA where full credit is provided in respect of taxes paid in Namibia. Relevant clause of India-Nambia DTAA reads as under –

Where a resident of India derives income or capital gains from Namibia, which, in accordance with the provisions of this Convention may be taxed in Namibia, then India shall allow as a deduction from the tax on the income of that resident an amount equal to the tax on income or capital gains paid in Namibia, whether directly or by deduction.

• Ordinary credit method –

Country of residence allows a deduction of the total taxes paid in the source Country, But, maximum deduction is restricted to the extent the taxes that would have been paid on such income in country of residence. Hence, if any excess taxes has been paid in the country of source (i.e. over and above taxes paid in country of residence), the excess taxes shall not be refunded in the country of residence. Relevant extract from India-USA DTAA reads as under –

2 (a) Where a resident of India derives income which, in accordance with the provisions of this Convention, may be taxed in the United States, India shall allow as a deduction from the tax on the income of that resident an amount equal to the income-tax paid in the United States, whether directly or by deduction. Such deduction shall not, however, exceed that part of the income-tax (as computed before the deduction is given) which is attributable to the income which may be taxed in the United States.

Foreign tax credit – (Part 3)

Bilateral tax credit – Relief provided pursuant to DTAA between the two countries are known as Bilateral tax credit.

Exemption method – It refers to a situation wherein the Country of residence gives away the right to tax certain income in favour of source country. Mainly used by the developing countries as it wants to promote investments/ attract inflow of capital.

• Full exemption method –

Indian treaties in which such clause is found –

• India-Brazil DTAA : Full exemption method is applied in realtion to dividend income. Article 23 (3) and (4) of the said DTAA reads as under :

ARTICLE 23 – Methods for the elimination of double taxation – 3. Where a company which is a resident of a Contracting State derives dividends which, in accordance with the provisions of paragraph 2 of Article 10 may be taxed in the other Contracting State, the first-mentioned State shall exempt such dividends from tax.

4. Where a resident of India derives profits which, in accordance with the provisions of
paragraph 5 of Article 10 may be taxed in Brazil, India shall exempt such profits from tax.

• India-Greece DTAA : Full exemption method is applied in realtion to dividend income. However, the same is not found in Elimination of double taxation article rather it is found in dividend article.

‘Dividends paid by a company which is a resident of one of the territories to a resident of the other territory may be taxed only in the first-mentioned territory‘

Exemption with progression method – Many DTAA which India has signed follows exemption with progression method. Some of the DTAA’s are – (Malaysia, Italy, Australia, Canada, China, Denmark, Hungary etc.)

Wordings from India-Singapore DTAA are –

“6. Income which, in accordance with the provisions of this Agreement, is not to be subjected to tax in a Contracting State, may be taken into account for calculating the rate of tax to be imposed in that Contracting State.”

Illustration explaining both the methods –

Foreign tax credit – (Part 2)

Unilateral tax credit –

Section 91 of Income Tax Act, 1961 (‘Act’) enables its residents to avail unilateral tax credit for foreign taxes paid outside India in a country with which India has not signed any tax treaty. Following conditions are required to be satisfied by the for availing unilateral tax credit –

• Person claiming credit must be resident in India for the said previous year
• Income is from a source outside India. In other words, income shall not be deemed to accrue or arise in India
• Tax has been paid in the foreign country << The taxpayer should be able to prove that he/ she has paid income tax on such income in the foreign country>>
• Absence of agreement under section 90 for the relief or avoidance of double taxation.

Computation of unilateral tax credit –

• Determination of the amount/ income that has been double taxed
• On the doubly taxed income, tax shall be calculated at the Indian rate of tax as well as at the foreign rate of tax
• Tax relief granted shall be lower of following – (Amount of tax calculated at the Indian rate of tax or the Amount of tax calculated at the foreign rate of tax)

Further, for the purpose of calculation of unilateral tax credit, credit is only available for the foreign income that is taxable in India (i.e. only proportionate credit for the taxes paid in foreign country shall be available)

Illustration –

Certain vexed issues –

• Aggregation of income/losses from several foreign countries – In Bombay Burmah Trading Corpn. Ltd. (126 Taxman 403), it was held that relief under section 91(1) is provided by way of reduction of tax (i.e. by deducting the tax paid abroad) on such doubly taxed income from tax payable in India. Hence, the relief can be worked out only if it is provided Country-wise.
• DTAA in place with foreign country but the taxes paid in the foreign country is not covered by the DTAA – a. In Tata Sons Ltd. v. DCIT (10 taxmann.com 87(Mum)), Tribunal examined the allowability of state taxes as deduction under section 37(1) vis-à-vis eligibility of relatable credit under section 90/91 of the Act. It was concluded that the tax credit would be allowed under section 91 of the Act since the treaty does not refer to State/Federal taxes. In other words, provisions of treaty or the Act (section 91) whichever, is more beneficial for the assessee should be applied. b. In Manpreet Singh Gambhir [2008] 26 SOT 208 (Delhi) , the Delhi Tribunal declined to allow a credit for state income tax paid in the US without examining section 91 of the Act. The Tribunal held referring to Article 2 of the India-USA DTAA that the taxes covered under the DTAA are in respect of taxes paid in the United States only for the Federal Income-tax imposed by internal revenue code and not the State Income-tax.
• Timing of payment of taxes outside India not relevant for claiming credit – In JCIT v. Petroleum India International (26 SOT 105), assessee had claimed relief under section 91(1) of the Act on taxes paid in Kuwait. However, the Assessing Officer disallowed the assessee’s claim of relief under section 91(1) of the Act for the reason that the assessee had not paid taxes in Kuwait before the end of the previous year and had made actual payment of taxes in five installments in subsequent year. The Mumbai Tribunal in the above case held that the language of section 91(1) of the Act is unambiguous and provides that where the assessee proves that in respect of his income, which accrued or arose during the previous year outside India, he had paid tax in any Country with which there is no agreement under section 90 for the relief or avoidance of double taxation, he shall be entitled to deduction from the Indian income tax payable by him of a sum calculated on such doubly taxed income. Nowhere in the provision of section 91(1), is it provided that the payment of taxes outside India shall be paid during the relevant previous year itself. The purpose of provision of section 91(1) is to provide relief in a case where assessee has paid taxes outside the Country and not to subject such assessee to double taxation on the same income. The assessee had discharged its onus of proving that it had in fact made the payment of taxes in a foreign Country in subsequent periods.

<I will discuss Bilateral tax credit mechanism in the coming parts>

Foreign tax credit – (Part 1)

Since, each nation have differenent rules of taxing persons, the same income may get taxed more than once (often referred to as residence-source conflict). Hence, resident country has to grant credit for the taxes paid in the other country.

Also, it is difficult to lay down uniform mechanism for allowability of Foreign tax credit because of the differences in determination of taxes especially deductions, allowances etc. There are different mechanism of providing foreign tax credit. Double taxation may arise because of Juridical or economic double taxation. These mechanisms of providing credit are –

a. Bilateral credit mechanism – This comes from section 90 of the Income tax Act, 1961 (‘Act’). Relevant extracts are reproduced below –

90 (1) The Central Government may enter into an agreement with the Govern- ment of any country outside India or specified territory outside India —

(a) for the granting of relief in respect of—
(i) income on which have been paid both income-tax under this Act and income-tax in that country or specified territory, as the case may be, or (ii) income-tax chargeable under this Act and under the corresponding law in force in that country or specified territory, as the case may be, to promote mutual economic relations, trade and investment…………………………………….

Hence, when Double taxation avoidance agreement (‘DTAA’) is in place between two countries, then method of relief is provided in the DTAA. The DTAA provides for the manner, mode and quantum of tax relief to be allowed in relation to the doubly taxed income in the hands of the taxpayer. Further, depending on the wordings of the Article on ‘Methods of allowing relief from double taxation’, the methods of granting bilateral relief mechanism may vary. The methods can be exemption method, credit method, tax sparing method or underlying tax credit method.

b. Unilateral credit mechanism – This comes from section 91 of the Income tax Act, 1961 (‘Act’). Relevant extracts are reproduced below –

91. (1) If any person who is resident in India in any previous year proves that, in respect of his income which accrued or arose during that previous year outside India (and which is not deemed to accrue or arise in India), he has paid in any country with which there is no agreement under section 90 for the relief or avoidance of double taxation, income-tax, by deduction or otherwise, under the law in force in that country, he shall be entitled to the deduction from the Indian income-tax payable by him of a sum calculated on such doubly taxed income at the Indian rate of tax or the rate of tax of the said country, whichever is the lower, or at the Indian rate of tax if both the rates are equal.

It provides for the grant of FTC to a resident taxpayer in respect of foreign taxes paid on his income earned from a country with which India does not have DTAA.

(I will discuss each method of granting FTC in detail in coming parts)

Non-discrimination clause in tax treaties – Select issues and recent developments – Part 6

In part 5 of the series, I have discussed Article 24(4) which deals with deduction non-discrimination in detail. In this part, I will discuss Article 24(5) which deals with ownership based non-discrimination and Article 24(6)

This paragraph prohibits a contracting State to give less favourable treatment to an enterprise, the capital of which is owned or controlled, wholly or partly, directly or indirectly, by one or more residents of the other contracting State.

For ex. – Enterprise in State ‘A’ which is wholly or partly owned or controlled, directly or indirectly by residents of State ‘B’ should not be subjected in State ‘A’ to any taxation or connected requirement which is other or more burdensome than taxation or connected requirement to which another Enterprise in State ‘A’, in the same circumstance, is subjected to.

Hence, the purpose of this clause is to safeguard an equal treatment to an enterprise in State A which is discriminated solely on account of foreign ownership.

Article 24(5) of the OECD and UN model is reproduced below –

Conditions to be satisfied –

• Presence of Enterprise X in the contracting state A, the capital of which are owned by one or more residents in other contracting state B
• The enterprise is subject to tax in State A to any taxation or other connected requirement thereto
• The taxation is more burdensome than taxation etc. to which the other enterprise in State A may be subjected to the taxation or connected requirement to which a similar enterprise may be subject to in that State

Pertinent to note, that the object of comparison in this clause is ‘similar enterprise’. Reference in this regard can be drawn from OCED Discussion Draft (2007) on Application and Interpretation of Article 24 para 88, which reads as under –

‘ 88. The Working Group reached the conclusion that the right comparator for the purposes of paragraph 5 was a domestic enterprise owned by residents but agreed that there was no need to clarify this issue in the Commentary as long as there was no practical reason to do so. ‘

Illustrative list of situations in which Clause 24(5) cannot be invoked –

• If the domestic tax law of one State allows a resident company to consolidate its income with that of a resident parent company, paragraph 5 cannot have the effect to force the State to allow such consolidation between a resident company and a non-resident parent company
• Withholding tax obligations that are imposed on a resident company with respect to dividends paid to non-resident shareholders but not with respect to dividends paid to resident shareholders cannot be considered to violate paragraph 5
• Information requirement imposed by the contracting state on the Company during the time of transfer pricing assessments
• Deferral of a deduction for interest expense accrued to the foreign related party until such interest is paid

Indian Judicial Pronouncements –

• An Indian resident company having foreign parent company cannot be discriminated from Indian resident company having resident parent company (Daimler Chrysler India Pvt Ltd v DCIT (2009)29 SOT 202 (Pune))

Ruling in brief – In this case, by invoking article 24(4) of India-Germany tax treaty, Tribunal held that Indian subsidiary of the German company, shares of which are listed on German stock exchange is to be treated as ‘company in which public is substantially interested’ under section 2(18) of the India Income tax Act. The reason for this was that an Indian company having foreign parent company should not be discrimianted with an Indian company having Indian parent company shares of which are listed in India stock exchange.

Article 24(6) of the Model convention reads as under –

This means that Article 24 is applicable to taxes of every kind and description notwithstanding the provisions of Article 2 of the convention.

Further, this clause does not appears in all the DTAA’s entered into by India, except for few like South Korea, Australia, Portugal etc. Generally the wordings found in Indian DTAA in are –

‘ the term “taxation” means taxes which are the subject of this Convention ‘

Singapore tax series – Part 14

Trusts, Settlements and Estates

a. Trusts – These are arrangements under which the doner/ settler transfers property to trustees who is under a duty to deal with such property for the benefit of the beneficiaries. Generally, trusts are set up for specific purposes.

Different types of trusts structure in Singapore –

• Real estate investment trust
• Designated unit trusts and CPF approved unit trusts
• Approved unit trust
• Trust funds
• Foreign trusts
• Philanthropic purpose trusts
• Prescribed locally administered trusts
• Registered business trusts

Taxation mechanism – Income from trade/ business will be taxable at the prevailing corporate tax rate at the trust level and any distributions from such taxed income will not be taxable on the beneficiary.

b. Settlements – A settlement is normally set up to transfer the income or capital of a person (the settlor) to another person (the beneficiary). Example – Transfer of money by parent to his child’s account.

The settlor by transferring the amount tries to reduce his/ her tax liability. Income arising from the following settlement is deemed to be the income of the setter, thereby negating the tax benefit –

Settlement for minor child, Settlement containing power of revocation or Settlor or any relative of the settlor or any of his/ her relatives makes use of any income or accumulated income from the settlement to which he/ she is entitled

c. Estates –An estate is generally formed on the death of an individual. If there is a will, the individual is said to have died testate and if no will was made, he/ she is said to have died intestate. An executor is appointed to administer the estate until the estate is finally distributed to the beneficiaries.

In the year there will thus two basis periods, one for the deceased (from 01 January to the date of death) and another for the estate (from the date of death to 31 December).

Taxation mechanism – For Income upto the date of death – The executor must ascertain the income of the deceased and is responsible for paying the tax due by using the funds from the estate.For Income accruing during the administration period – The chargeable income of the estate shall be determined in accordance with the provisions of the tax laws and will be taxed at prevailing corporate tax.

Non-discrimination clause in tax treaties – Select issues and recent developments – Part 5

In part 4 of the series, I have discussed Article 24(3) which deals with PE non-discrimination in detail. In this part, I will discuss Article 24(4) which deals with deductibility based non-discrimination.

As per this clause, there should be no discrimination on the basis of the recipients of disbursements between a resident and non-resident as regards deductibility of amounts paid as interest, royalties and other disbursements by an enterprise to the residents of the other Contracting State.

Example – Where a resident of State ‘A’ pays interest, royalties or other disbursements to a resident of State ‘B’, then, the rules for deductibility of such payments in computing taxable profits of the resident of State ‘A’ should be the same as areapplicable in respect of the payments made to another resident of State ‘A’ itself.

Wordings of Article 24(4) as per the Model Convention is mentioned below –

Certain points to be considered  –

• Payment of interest, royalties or other disbursements made by a resident of contracting state to the resident of other contracting state

• Hence, not only interest or royalties, in view of the expression ‘other disbursements’, clause 4 also prohibits discrimination in the allowance of other deductions, being reasonable allocation of the executive and general administrative expenses, research and development expenses and other expenses incurred for the benefit of a group of related persons that includes the person incurring the expenses. Reference in this regard can be placed on US technical explanation

• Any denial of deductions on account of ALP application is not subject to non-discrimination

• This paragraph equally applies to debts for the purposes of determining the taxable capital. However, this part may not be relevant for India as there is no tax on capital

Principles emanating from certain Indian judicial pronouncements –

• Section 40(a)(i) provides for a disallowance of payment made to a non-resident where withholding is not deducted on such payment. However, where such similar payment are made to the resident, no such disallowance (now though 30% is disallowed for payments to residents also) is made. Deduction non-discrimination clause of the tax treaty seems to neutralize such dis-allowance on payments to non-residents (CIT vs Herballife International India (P.) Ltd.(2016) 384 ITR 276 (Delhi)/ DIT vs Citibank NA (2015) 377 ITR 69 (Delhi)/ Mitsubishi Corporation India Pvt. Ltd. V DCIT (ITA No. 5402/Del/11)) <<Pertinant to note, Protocol to the India-Spain DTAA provides that payments by way of interest, royalties and FTS made by an enterprise of India to a resident of Spain, shall not be allowed as a deduction for the purpose of determining the taxable profits of such Indian enterprise unless tax has been paid or deducted at source from such payments under Indian law and in accordance with the provisions of the said DTAA>>

• ‘Other disbursements’ connotes something other than ‘interest and royalties’. If the intention was that ‘other disbursements’ should also be in the nature of interest and royalties then the word ‘other’ should have been followed by ‘such’ or ‘such like’. (CIT vs Herballife International India (P.) Ltd.(2016) 384 ITR 276 (Delhi))

Series on Singapore tax laws – Part 13

Partnership firms and its taxation

General partnership – A partnership is an unincorporated body of the following, excluding a Hindu joint family, who have agreed to combine their skills and labour for the purposes of carrying on a business and sharing the profits between:

• two or more individuals;
• one or more individuals and one or more corporations; or
• two or more corporations

The maximum number of members of a partnership is 20. Singapore follows The Partnership Act of 1890 of United Kingdom.

Features –

• Partnership is not regarded as a separate entity for legal and tax purposes
• Liability of each of the partners is unlimited
• If any partner ceases, or is about to cease, to be a partner, the partners present in Singapore are obliged to give 1 month’s written notice to the tax authorities before the partner actually ceases to be a partner

Taxation mechanism –

• Partnership is not charged to tax as an entity but the adjusted income is allocated between the partners and directly included in their taxable income
• Return to be filed in Form P of its income for every year of assessment

Limited liability partnership – Limited liability partnership (LLP) gives its owners the flexibility of operating as a partner while giving them limited liability. It combines the benefits of a partnership with those of private limited companies.

Features –

• For tax purposes an LLP will be treated as a partnership and not as a separate legal entity, i.e. each partner will be liable to tax on his share of income from an LLP
• If the partner is an individual, his share of income from the partnership will be taxed based on the prevailing individual income tax rate. If the partner is a company, its share of income from the partnership will be taxed at the prevailing corporate income tax rate
• LLP is required to report the capital contribution of its partners in the tax retur

(IRAS has issued Circular setting out the income tax treatment of limited liability partnership, The circular gives guidance on tax treatment related to reduction in contributed capital of partner, LLP in liquidation, property sold to or by LLP, LLP that carries on business of making investment etc.)

Limited partnership –

An LP is a business structure that allows a business to operate and function as a partnership without a separate legal personality from the partners. It must consist of one or more general partners who have unlimited liability and one or more limited partners who enjoy limited liability.

A partnership is deemed to be a general partnership unless one or more partners of the partnership are registered as limited partners under the LP Act. LPs are generally taxed in the same way as LLPs, except in certain cases.