Foreign Comanies with a presence in India and being taxed on their business profits should have reason to cheer after a recent ruling of the Mumbai Bench of the Income-Tax Appellate Tribunal (the tribunal).
In the case of ITO vs Decca Survey Overseas, the tribunal held that the foreign companies' Indian tax rate should be at par with those applicable to an Indian company.
The facts of the case were that the taxpayer, a company resident in the United Kingdom, contended [for the Assessment Year (AY) '88-89], that it should be taxed at the rate applicable to domestic companies in view of the non-discrimination Article (Article 23) in the Double Tax Avoidance Agreement (DTAA) between India and the UK.
The assessing officer (AO) did not accept this contention but the Commissioner of Income-Tax (Appeals) [CIT (A)] ruled in the company's favour and set aside the order of the AO.
The AO appealed to the Mumbai Bench of the tribunal against the order of the CIT (A). The tribunal dismissed the appeal, by its order dated July 22, '02 on the ground that this issue had already been decided in the company's favour in the appeal for AY'89-90 (ITA No. 8489 / Bom / 91, 1988).
The tax authorities subsequently filed a miscellaneous application (MA No 201/Mum/2003) drawing the attention of the tribunal to the explanation below Section 90(2) of the Income-Tax Act, 1961 (I-T Act), introduced by the Finance Act, 2001 with retrospective effect from April 1, '62.
The tax authorities contended that the tribunal had not considered this explanation while passing the order dated July 22, '02, which was a mistake apparent from the record. Accepting this contention of the tax authorities, the tribunal recalled its earlier order and put up the matter for a fresh hearing.
In its order dated September 11, '03, the tribunal also observed that it would not like to examine the controversy as to whether any arrangements have been prescribed for declaration of dividends or not and whether Rule 27 of the Income-Tax Rules, 1962 (the Rules) is applicable or not. In the fresh hearing, the tribunal examined whether the explanation to Section 90(2) of the I-T Act made any difference to the tribunal's order for AY '89-90.
In the said order, the tribunal had considered the DTAA between India and UK and held that the I-T Act discriminated on the grounds of nationality-in the sense, that a foreign company was assessed to tax at a much higher rate as compared to a similarly placed in Indian company.
The tribunal also held that the provisions of the DTAA would prevail over those of the I-T Act. The explanation to Section 90(2), inserted with retrospective effect from April 1, '62 states that merely because a higher rate of tax has been prescribed for a foreign company, compared to the tax rate for a domestic company, it cannot be construed as discriminating between the two. However, this provision is hedged by a condition that the foreign company should not have made the prescribed arrangements for declaration and payment of dividends within India payable out of its income in India.
The tribunal considered and accepted the contention of the taxpayer company that the explanation has not been activated by the legislature by framing rules as to what would amount to the 'prescribed' arrangements for distribution of dividends and thus, the explanation cannot be applied at all.
Rule 27 of the Rules, to which the tax authorities drew the tribunal's attention, lays down the prescribed arrangements for declaration of dividends within India, was only for the purpose of Sections 194 and 236 of the I-T Act.
The said rule did not refer to Section 90. Tax authorities were also not able to draw the tribunal's attention to any rule in the Rules, framed for the purpose of Section 90 listing out the prescribed arrangements within the meaning of that section.
The Tribunal held that the explanation thus remained a dead letter and the tax authorities could not place any reliance on it. Therefore, the order of the tribunal for AY '89-90 continued to govern the case for the year in question.
Following its own order for the AY '89-90, the tribunal confirmed the direction of the CIT (A) to tax the company at the rate applicable to a domestic company and dismissed the appeal of the tax authorities.
This decision indicates that the tribunal has upheld the rule of the provisions of treaty overriding those of the Indian domestic tax law. This may reduce the apprehensions caused by the insertion of the 'explanation' to Section 90 of the Act.
India's tax treaties usually provide for a mechanism for obtaining credit for tax paid in the country of source as a measure of elimination of juridical double taxation. So, credit of Indian tax paid by a PE of a foreign company on its profits is usually available to the foreign company against the tax payable by it in its home country.
Such credit is normally limited to the home country's tax on the profits taxed in India. To illustrate, if a country X (home to the foreign company) has a tax rate of, say, 45% and India levies tax on the PE of such foreign company at the rate of 40%, credit for the entire Indian tax paid should normally be available to the foreign company against the 45% tax payable by it in country X. In such a situation, the higher tax being levied in India may not have any overall cost impact for the foreign company (only a cash-flow timing difference may result). The tribunal's decision may, therefore, make a cost difference to those foreign companies whose home country tax rate is lower than 40%.
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