Hon’ble High Court of Delhi
In the matter of
The Assessee earned dividend income from its subsidiary company based in Thailand. Assessee was liable to pay Income Tax @ 10% on such dividend income in Thailand. However, tax was exempted due to the statutory regime obtained in Thailand. While filing ITR in India, Assessee disclosed such income and claimed the credit of tax @ 10% which was payable in Thailand but not paid due to exemptions.
The Income Tax department contended that tax was not paid by the assessee on dividend received from its subsidiary Company. Therefore, it could not be granted tax credit of tax which is not actually paid.
Hon’ble High Court held that as per Article 23(3) of Indo-Thai DTAA, “Thai Tax Payable” includes tax which would have been otherwise payable, but for an exemption or reduction of tax granted for that year or any part thereof, under the two statutory enactments of Thailand. Further, Article 23(6) provides that tax credit can be accorded by the rate of tax which would have been applicable, if income exempted from tax in accordance with the provisions of Indo-Thai DTAA, had not been so exempted.Under Article 23 of Indo-Thailand DTAA, credit for notional tax is granted to incentivize economic development/activity.In accordance with Article 23, it is clear the assessee was entitled to claim tax credit on dividend income received from its Thai subsidiary, in respect of “Thai Tax Payable”, which it would have to pay. Therefore, if exemption is not available, the dividend income would have to suffered tax @ 10% in Thailand.
1. Brief facts of the case
- M/s Polypex Corporation Limited (“The Respondent” or “The Assessee”) has earned Dividend income from its subsidiary company based in Thailand.
- Such dividend income was taxable in the country in which the income emanated i.e., Thailand. However, such tax was not paid because of the statutory regime operating in that country.
- The Assessee included such income in its return of Income filed in India.
- However, The assessee claimed the tax credit in respect of tax, which it would have to ordinarily pay in Thailand on such dividend income. However, such tax was exempted from levy due to the statutory regime obtained in Thailand.
- The Assessee claimed credit of tax payable in Thailand in pursuant to Article 23 of Double Taxation Avoidance Agreement (DTAA) entered between India and Thailand even though such tax is not paid in Thailand.
- The Assessee claimed that it is entitled to claim credit tax, which it was spared from paying in Thailand.
- The Assessing Officer disagreed with the stand taken by the respondent and declined the tax credit sought in Return of Income.
- The Assessee carried the matter before the Commissioner of Income Tax (Appeals). The CIT(A) rejected the preferred appeals.
- In the Tribunal, however, the assessee was successful. It was able to persuade the Tribunal that, having regard to the tax sparing concept embedded in Indo-Thai DTAA, it was entitled to tax credit at the rate of 10%, on the dividend income received from the Thai subsidiary
2. Legal Extracts
Relevant extract of Double Taxation Avoidance Agreement (DTAA) is reiterated below for ready reference:
“Article 23: Elimination of Double Taxation
1. The laws in force in either of the Contracting State shall continue to govern the taxation of income in the respective Contracting States except where provisions to the contrary are made in this Convention.
2. The amount of Thai tax payable, under the laws of Thailand and in accordance with the provisions of this Convention, whether directly or by deduction, by a resident of India, in respect of profits or income arising in Thailand, which has been subjected to tax both in India and in Thailand, shall be allowed as a credit against the Indian tax payable in respect of such profits or income provided that such credit shall not exceed the Indian tax (as computed before allowing any such credit) which is appropriate to the profits or income arising in Thailand. Further, where such resident is a company by which surtax is payable in India, the credit aforesaid shall be allowed in the first instance against income-tax payable by the company in India and as to the balance, if any, against surtax payable by it in India.
3. For the purposes of the credit referred to in paragraph (2), the term “Thai tax payable” shall be deemed to include any amount which would have been payable as Thai tax for any year but for an exemption or reduction of tax granted for that year or any part thereof under the provisions of the Investment Promotion Act (B.E. 2520) or of the Revenue Code (B.E. 2481) which are designed to promote economic development in Thailand, or which may be introduced hereafter in modification of, or in addition to, the existing laws for promoting economic development in Thailand.
6. Where under this Convention a resident of a Contracting State is exempt from tax in that Contracting State in respect of income derived from the other Contracting State, then the first-mentioned Contracting State may, in calculating tax on the remaining income of that person, apply the rate of tax which would have been applicable if the income exempted from tax in accordance with this Convention had not been so exempted.”
3. Contention of the Applicant
The Income Tax Authority (“The Applicant”) contented that:
- The tax was not paid by the assessee on dividend received from its subsidiary Company. Therefore, it could not be granted tax credit on dividend income as the same taxable in India at the rate of 30% plus surcharge and cess, as applicable.
- The Tribunal held that to obtain benefit under Article 23(2) of the Indo-Thai DTAA, it was not necessary that the assessee should have paid tax. Relevant point is whether it was liable to pay tax or not. However, this was an erroneous conclusion, as it went beyond the scope and ambit of the Article 23 of the Indo-Thai DTAA.
- The Assessee was not granted exemption under Article 23(2) of the Indo-Thai DTAA.
- The Assessee failed to furnish proof of such exemption being accorded to it. Thus, the Tribunal erroneously concluded that tax had not been paid in view of the exemption extended under the statutory regime prevailing in Thailand.
- The assessee did not pay tax, for reasons other than those provided in Article 23(2) of the Indo-Thai DTAA
- The exemption relied upon by the assessee was actually available to its Thai subsidiary. The exemption permitted the Thai subsidiary to not pay tax on the dividend distributed by it. However, income distributed and remitted to the Assessee became its income, and hence, the assessee cannot be allowed to rely upon the exemption under Thai law, to claim tax credit in India, under the Indian Income Tax Act.
- Therefore, the respondent could have claimed benefit of Article 23(2) of the Indo-Thai DTAA, only if he had paid tax in Thailand.
- Since the respondent/assessee had not paid tax in Thailand, it was rightly declined tax credit by the AO.
4. Contention of the Respondent
The Assessee contended that:
- The concept of tax-sparing credit is given under several DTAAs including India-Thai DTAA. Under tax sparing provisions, tax credit may be claimed even for tax which, though payable, is exempted on account of incentives granted by the source country.
- Benefit under Article 23 of the Indo-Thai DTAA is available to the recipient of income in India, as well as those who reside in Thailand.
- The Thai subsidiary was granted an exemption from corporate income under the Investment Promotion Act. Besides this, the dividend distributed by the Thai subsidiary is also exempted from tax under the provision of Section 34 of the Investment Promotion Act.
- Section 70 of the Revenue Code of Thailand levies tax at the rate of 10% on companies incorporated under foreign law, qua assessable income which emanates from, or is received in Thailand.
- Tax could only be levied, as per the Indo-Thai DTAA, on the dividend distributed by the Thai company, in Thailand.
- Since the dividend income received by the assessee has been offered to tax in India, at a higher rate i.e., 30% (exclusive of surcharge and cess), the respondent/assessee is entitled to tax credit at the rate of 10%, in accordance with Article 23 of the Indo-Thai DTAA.
5. Analysis by Hon’ble High Court
Hon’ble High court analyzed the provisions of Article 23 of Indo-Thai DTAA as follows:
a. Interpretation of Article-23 of DTAA
- Article 23(1): As per Para 1 of Article 23, provisions of the contracting state shall apply. However, in case of any conflict between provisions of contracting state and provisions of DTAA, the provisions of the Indo-Thai DTAA would prevail.
- Article 23(2) allows tax credit of “Thai Tax Payable” against the tax payable in India. However, Paragraph 2 specifies the caveat that tax credit cannot exceed the amount of Income tax payable in India (as computed before allowing any such credit) on income arising in Thailand.
- As per Article 23(3), “Thai Tax Payable” includes tax which would have been otherwise payable, but for an exemption or reduction of tax granted for that year or any part thereof, under the two statutory enactments of Thailand. Para 3 also alludes to the fact that the said statutes are designed to promote economic development in Thailand.
- Provisions of Article 23(3) are configured to incentivize investments in Thailand, by granting tax credit of the amount which was payable as tax to the Thai state, but was not paid due to exemption or reduction granted under the said enactments.
- Article 23(4) and (5) are a mirror image of Paragraphs 2 and 3 of Article 23
- Article 23(6) provides a clue as to the rate at which tax credit can be accorded by, inter alia, providing that it would be that rate of tax which would have been applicable, if income exempted from tax in accordance with the provisions of Indo-Thai DTAA, had not been so exempted.
- Ordinarily the term “tax payable” would mean tax, which is owed or due, although not paid. However, the meaning of the term has to be found in the treaty executed between two Contracting States. The intent of the Contracting States has to be considered and not the ordinary meaning of the term.
- Therefore, the meaning of the expression “Thai tax payable” or “Indian tax payable” has to be found in the definition embedded in the DTAA/treaty.
- Under Article 23 of Indo-Thailand DTAA, credit for notional tax is granted to incentivize economic development/activity. This is a decision which is taken by Contracting States and therefore, unless there is ambiguity, the interpretation which is to be given to the expression “Thai tax payable” or “Indian tax payable” is to be based on a plain reading of what is provided in paragraphs 3 and 5 of Article 23.
- The said paragraphs exemplify mutuality of interests in giving stimulus to investment for securing economic development in both countries.
- That tax sparing as a concept exists is discernible from the following extract set forth in Klaus Vogel on Double Taxation Conventions2 commentary:
- Whenever the credit method is applicable to income from foreign sources, tax benefits offered by the source State for economic or social policies, especially in the form of incentives to encourage economic development, are siphoned off by the State of residence State.
- Rather than benefiting the taxpayer, the incentive benefits the residence State’s revenue authorities (always provided that, as usual, the amount of tax collected by the source State is lower, at least on account of the reduction, than the residence State‟s tax). The tax incentive is thus cancelled out.
- That effect can be avoided by the residence State calculating the credit as if the tax in the source State remained at the unreduced level.
- A credit for notional taxes is typically granted in tax treaties concluded between developed and developing countries. Many developing countries insist on the inclusion of a tax sparing provision during tax treaty negotiations in order to attract FDI and promote economic growth by granting tax incentives.
- Some countries are willing to grant a tax sparing provision to allow their resident enterprises to compete in the source State under nearly the same conditions as other investors. Tax sparing conditions come close to facilitating capital import neutrality. ….”
- In accordance with Article 23, it is clear the assessee was entitled to claim tax credit on dividend income received from its Thai subsidiary, in respect of “Thai Tax Payable”, which it would have to pay. Therefore, if exemption is not available, the dividend income would have to suffered tax @ 10% in Thailand.
Hon’ble High Court of Delhi concluded the following points:
- The revenue’s appeals are based on the proposition that tax credit as claimed, could not be extended to the assessee, because it had not paid tax in Thailand, i.e., that benefit under Article 23 of the Indo-Thai DTAA could only be extended in a situation where the tax had actually been paid.
- With respect to Indo-Thailand DTAA, credit for tax sparing works for residents of Thailand, as well as India. This is a mechanism which is engrafted in DTAAs to incentivize investment for economic development.