Claim Credit for State Tax Paid Even if DTAA Applies to Only Federal Law !

Like in India , there are taxes paid in States in USA and there are taxes paid to USA government under Federal Tax law i.e Code 26 . It is well known that under Income Tax Act , the taxes paid are not allowed as business expense. However Double Taxation Agreement does allow the scope of claiming tax credit for any tax paid in USA on an income which is included in India . However , the DTAA agreement applies on income tax in India and federal income tax in USA . Thus , if you pay any state tax on any income under the state tax laws, the issue is whether in India , if that income is being taxed , you can claim tax credit of state tax paid in USA on such an income .

ITAT Mumbai Answers in Affirmative

The issue is quite complex , but we have the benefit of a judgment of ITAT , Mumbai in Tata Sons Ltd vs DCIT [43 SOT 27] in which the ITAT decided on the plea of the assessee that  US and Canada State Income-tax payments must be allowed  either  as deduction or it was to be taken into account for giving tax credit of the tax payments u/s 91.

Facts of the case was that the assessee in respect of its business carried out in US and Canada paid State Income-taxes in those countries . The assessee had claimed deduction with respect to its States taxes u/s 37(1) while the federal tax was claimed u/s 9o of the Income Tax Act.

The A.O did not allow the state tax paid in USA and Canada u/s 37(1) stating that the tax can not be claimed as expenditure deduction. . CIT(A) allowed the claim of the assessee. The A.O filed cross objection on the relief granted by the CIT(A)  . On that , ITAT, Mumbai , favoured A.O by holding that that tax payments which were to states of USA and Canada were to be treated as in the nature of taxes on income, and, thus not allowable under section 37(1).

The assessee filed a petition to ITAT for clarification on the issue that when the expenditure in form of tax payments to states in USA and Canada held only tax and therefore not allowable as expenditure u/s 37(1) , should that not be given tax credit under section 91 of the Income Tax Act.

ITAT Clarification : Yes , Section 91 Overrides DTAA  !

ITAT first noted that as per section 90  either  DTAA or the I.T.Act which ever is more beneficial to assessee shall be applicable. In the case of assessee,  DTAA is not beneficial because it restricts benefits only in respect of Federal Tax . So, I.T.Act will prevail over DTA , if there is any provision under I.T.Act which is more beneficial. It was noted that section 91 is a general provision under which there is no discrimination about the nature of tax paid i.e whether it is a federal tax or state tax.   Therefore , section 91 should be applicable in case of assessee and tax credit for payment made to states of USA and Canada should be allowed .

Relevant Extract are as under :

[infobox style=”alert-success”]It was indeed an incongruous position that payment of State Income-taxes in US and Canada were not allowed deduction as those were treated as in the nature of taxes on income, in terms of the provisions of domestic tax law in India, and those payments were also not being taken into account for granting credit for taxes paid abroad by the assessee, as only Federal Income-tax was eligible for tax credit in terms of the Indo-US and Indo-Canada tax treaty. If that approach was adopted, the assessee would not get a deduction of State taxes so paid abroad, nor would he get the tax credit for the same, and if those two propositions were correct, there was clearly an inherent contradiction in those propositions on tax treatment for State Income-taxes paid abroad. There cannot obviously be a tax payment which is neither treated as admissible expenditure, because it is treated as an Income-tax, nor is it taken into account for tax credits, because it is not to be treated as Income-tax. It was incorrect to proceed on the assumption that State Income-tax paid in USA, or in Canada, cannot be taken into account for the purposes of computing admissible tax credits. It was so for the elementary reason that the provisions of a tax treaty, based on which tax credits are said to be inadmissible, cannot be pressed into service to decline a benefit to the assessee which is otherwise available to him, even in the absence of such a tax treaty, under the provisions of the Income-tax Act. [Para 4]


Even as it was held that, in principle, State Income-taxes paid in USA are eligible for being taken into account for the purpose of computing admissible tax credit under section 91, but the fact that section 91 refers to a situation in which the assessee has paid tax ‘in any country with which there is no agreement under section 90 for the relief or avoidance of double taxation’ and that was indeed an agreement under section 90 with United States of America, as also with Canada, could not be ignored. If one adopts a literal interpretation of such provisions, and bearing in mind the undisputed position that tax credit provisions under section 91 are more beneficial to the assessee vis-a-vis  the tax credit provisions in related tax treaties inasmuch as while section 91 permits credit for all Income-tax paid abroad – whether State or Federal, relevant tax treaties permit credits in respect of only Federal taxes, it will result in a situation that an assessee will be worse off as a result of the provisions of tax treaties. That certainly is not permissible under the scheme of the Income-tax Act. Circular No. 621, dated 19-12-1991 issued by the Central Board of Direct Taxes, which is binding on the Assessing Officer under section 119(2), inter alia, observes that “Since the tax treaties are intended to grant relief and not put residents of a Contracting State at a disadvantage vis-a-vis other taxpayers, section 90 of the Income-tax Act had been amended to clarify any beneficial provisions in the law will not be denied to a resident of a contracting country merely because corresponding provisions in a tax treaty is less beneficial. In the instant case, however, tax credit provisions in Indo US tax treaty were admittedly less advantageous to the assessee, but just because there was a tax treaty between India and USA, the benefits of the domestic law provisions were being declined to the assessee. That was an interpretation which led to absurdity and called for an interpretation harmonious with the scheme of the Income-tax Act. In case of any conflict between the provisions of the agreement and the Act, the provision of the arrestment would prevail over the provision of the Act, as is also clear from the provision of section 90(2). Section 90(2) makes it clear that ‘where the Central Government has entered into an agreement with the Government of any country outside India for granting relief of tax, or for avoidance of double taxation, then in relation to the assessee to whom such agreement applies, the provisions of the Act shall apply to the extent they are more beneficial to that assessee’ meaning thereby that the Act gets modified in regard to the assessee insofar as the agreement is concerned if it falls within the category stated therein. It would thus appear that the treaty override is only restricted to the extent it is beneficial to a taxpayer. In other words, the fact that a taxpayer is entitled to make a particular claim, in accordance with a tax treaty provisions, does not disentitle him to make the claim in accordance with the provisions of the Act. In such view of the matter it was held that the provisions of section 91 are to be treated as general in application and these provisions can yield to the treaty provisions, only to the extent the provisions of the treaty are beneficial to the assessee; that was not the case so far as question of tax credits in respect of State Income-taxes paid in USA were concerned. Accordingly, even though the assessee was covered by the scope of India US and India Canada tax treaties, so far as tax credits in respect of taxes paid in those countries were concerned, the provisions of section 91, being beneficial to the assessee, held the field. As section 91 does not discriminate between State and Federal taxes, and in effect provides for both the types of Income-taxes to be taken into account for the purpose of tax credits against Indian Income-tax liability, the assessee is, in principle, entitled to tax credits in respect of the same. Of course, as is the scheme of tax credit envisaged in section 91, tax credit in respect of foreign Income-tax is restricted to actual Income-tax liability in India, in respect of income on which taxes have been so paid abroad. [Para 5]


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