Delhi High Court: Taxpayer Entitled To Tax Credit on Income from Foreign Subsidiary under DTAA

Delhi High Court: Taxpayer Entitled To Tax Credit on Income from Foreign Subsidiary under DTAA

States that the mechanism was engrafted to incentivize investment for economic development

The Delhi High Court has upheld the Income Tax Appellate Tribunal (ITAT) order allowing tax credit to an Indian company on its dividend income from a Thai subsidiary based on the concept of tax sparing under the Double Taxation Avoidance Agreement (DTAA).

The Division Bench comprising Justice Rajiv Shakder and Justice Tara Vitasta Ganju ruled, “Ordinarily, the term ‘tax payable’ means the tax owed or due, although not paid. However, the intent of the contracting states must be ascertained from the term, as contained in the India-Thailand DTAA, and not what would ordinarily be the meaning of a given expression or term.”

Under Articles 23(3) and 23(5) of India-Thailand DTAA, the credit for notional tax is granted as a fillip and/or incentivize economic development/activity. The decision is taken by treaty Partners and unless there is ambiguity, the interpretation of ‘Thai tax payable’ or ‘Indian tax payable’ should be based on those provisions.

The Judges stated that the provisions exemplified mutuality of interests in giving stimulus to investment for securing economic development in both countries. Referring to Prof. Klaus Vogel's commentary, the Court highlighted that tax sparing as a concept existed and remarked, "There are critics of such provisions, but this is a decision which lies with the contracting states."

The batch of appeals pertained to the Income Tax Return (ITR) of Polyplex Corporation Ltd, for the Assessment Years 2010-2011 to 2013-2014. It included dividend income from its Thai subsidiary and claimed credit of the tax it would have ordinarily paid in Thailand i.e. 10 percent. But for the statutory regime in Thailand, it was exempted dividend from levy of such tax.

However, the revenue department declined the tax credit as the tax on dividends was not paid by the assessee.

On appeal, the ITAT observed that to obtain a benefit under Article 23, it was not necessary that the assessee must pay tax. The relevant part was whether it was liable to pay tax.

The Income Tax Department argued that the promotion certificate issued to the Thai subsidiary permitted the latter to not pay tax on the dividend distributed by it. However, in the hands of the assessee, the dividend became an income, hence, the assessee could not rely on exemption under the Thai law to claim tax credit in India.

Considering the provisions under the DTAA, the High Court stated they were configured to incentivize investments in Thailand by granting tax credit on tax payable in Thailand. But it was not paid due to exemption or reduction granted under the Thai law.

The Court negated the stance of the revenue department that the issue of eligibility of dividend income to tax and its exemption, being the subject matter of foreign law must be remitted to the assessing officer (AO).

It observed, “Even though the foreign law raises an issue, which requires proof of the given fact, no proof is required in the instant case, as the foreign law is referred to, specifically, in the DTAA which is being executed by contracting states.”

The bench elaborated that dividends were distributable profits and if the net profit was exempt from corporate income tax, the dividends could not possibly be amenable to tax. Regarding the promotion certificate not mentioning dividends, the Court said it alluded to an exemption of dividends distributed from the levy of corporate income and the revenue department never made this submission before the lower authorities.

The Judges emphasized on the concept of tax sparing as embedded in several DTAAs executed by India, including France, Jordan, and Oman.

On the India-Thailand DTAA, the Court stated that credit for tax sparing worked for residents of Thailand and India. The mechanism was engrafted to incentivize investment for economic development. Thus, interdiction of the provisions would be detrimental to the larger interest of the public.

While advocate Kunal Sharma appeared for the revenue department, the assessee was represented by advocate Ved Jain.