Whether foreign taxes which are not eligible for relief under section ('u/s') 90 and 91 are allowable as expense under the Income-tax Act, 1961 ('the Act')? This issue is debatable for a while now. Of late this issue has been decided both in favour of and against the taxpayers by different Tribunals and High Courts. This article succinctly discusses this issue through the provisions of the Act and judicial pronouncements.

To analyse whether or not said taxes could be allowed as deduction,we should Discuss provisions of

Section 90 - Agreement with foreign countries or specified territories.

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

(a) for the granting of relief in respect of

1. 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
2. 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, or

Most of the treaties generally follows ordinary credit method wherein relief of taxes paid in foreign country would be limited to tax payable on said income in India which would be eligible for relief of tax u/s 90andthe balance would become ineligible for relief of tax u/s 90. Therefore, balance amount of foreign taxes if not allowed as deduction (under any other provision of the Act) would become a cost for the entity, despite being a genuine & legitimate expense incurred wholly and exclusively for the purpose of business.

Section 91 - Countries with which no agreement exists

In view of above, it is clear that the deduction would be allowed at lower rate of tax and if Indian tax rate comes out to be lower, only that much would be eligible for relief of tax u/s 91andthe balance would become ineligible for relief of tax u/s 91.

Section 40(a)(ii)

Whether foreign taxes which are not allowed as relief u/s 90 and 91, attracts any specific disallowance u/s 40(a)(ii) of the Act. To analyse this, the provisions of section 40(a)(ii) are reproduced below:

"40. Amounts not deductible.

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) 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.

In view of above, foreign taxes which are eligible for relief u/s 90/91 attracts a specific disallowance u/s 40(a)(ii) of the Act. This means that those foreign taxes which are not eligible for relief u/s 90 and 91, are specifically excluded by explanation 1 to section 40(a)(ii) and therefore do not attract any disallowance u/s 40(a)(ii) of the Act. Ahmedabad ITAT in the case of Virmati Software (infra) held that the assessee is eligible for deduction for the amount of foreign tax credit which was not allowed as tax relief u/s 91 of the Act.

Meaning of eligible for relief u/s 90/91
If income earned outside India is Rs.100, taxes paid in foreign country on said income is Rs.20 (tax on gross basis ) and 'Tax payable on such income under normal provisions in India' is Rs.3 (tax on net basis), then 'Tax relief available in India' will be lower of Rs.20 and Rs.3 i.e. Rs.3. Thus, as deduction/relief u/s section 90/91 is restricted to Rs.3 then only that Rs.3 could be treated as eligible for relief of tax u/s 90/91. However, entire Rs.20 will be treated as "any sum eligible" in explanation to section 40(a)(ii) and therefore, even if only Rs.3 allowed as deduction, entire Rs.20 attracts disallowance u/s 40(a)(ii).

Section 37(1)

To analyse whether foreign taxes which are not allowed as relief u/s 90 and 91 pass through the test of section 37(1), the provisions of section 37(1) are reproduced below:

Any expenditure not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession"

From perusal of provisions of section 37(1), it is notable that the following four conditions need to be satisfied for any expense to be deductible u/s 37(1) of the Act:

In view of above, the 'foreign taxes which are not allowed as relief u/s 90 and 91' are allowable as deduction u/s 37(1) of the Act as they meet all the conditions prescribed in section 37(1) of the Act and are not specifically disallowed under any other provision of the Act. It is because said foreign tax is paid in the course of the business and the corresponding business receipts are taxed in India.

Section 43B

Taxes paid are specifically allowed as deduction on payment basis under section 43B(a) of the Act. Therefore, unless any tax is specifically disallowed under any provision of the Act, it can be claimed as deduction u/s 37(1) read with section 43B(a) of the Act. Relevant provisions of section 43B(a) are reproduced below:

"Section 43B - Certain deductions to be only on actual payment

Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of —

1. any sum payable by the assessee by way of tax, duty, cess or fee, by whatever name called, under any law for the time being in force,

shall be allowed (irrespective of the previous year in which the liability to pay such sum was incurred by the assessee according to the method of accounting regularly employed by him) only in computing the income referred to in section 28 of that previous year in which such sum is actually paid by him:

The 'foreign taxes which are not allowed as relief u/s 90 and 91', if not allowed as tax deductible expense, would become a cost of running the business. The 'foreign taxes which are not allowed as relief u/s 90 and 91', even if allowed as tax deductible expense, would provide only limited benefit to the extent it reduces the taxable income.

In view of applicable provisions supported by legislative intent and judicial precedents, taxpayers may claim deduction of 'foreign taxes which are not allowed as relief u/s 90 and 91' as business expenditure u/s 37(1) of the Act and no disallowance should be attracted u/s 40(a)(ii) of the Act which has limited application on only that amount which is eligible for relief u/s 90/91.

To provide clarity and to settle this issue once for all, it is better if the Government clarifies it by inserting a suitable explanation, hopefully granting deduction at least once and not letting it to be a non-deductible expense.

Disclaimer:“Information contained herein is for informational purposes only and should not be used in deciding any particular case. The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Though utmost efforts have been made to provide authentic information, it is suggested that to have better understanding and obtaining professional advice after thorough examination of particular situation.”