International Tax Updates

published on 31 January 2024 I reading time approx. 4 minutes

1. Foreign Tax Credit (‘FTC’) allowed as per US-France tax treaty despite restriction in domestic tax laws

In the instant case, a married couple both US citizens were tax residents of France. The couple earned, inter-alia, foreign source passive income which was exclusively taxed in France and were also subject to Net Investment Income Tax (‘NIIT’) in the US. The couple did not claim the FTC in the original tax return filed in US, however, subsequently they filed an amended tax return and claimed FTC in it, thereby claiming a refund of the taxes already paid. 

The US tax authorities denied the claim for FTC as there was lack of availability of an FTC under the US domestic tax laws. Also, US tax authorities argued that code for NIIT was introduced in domestic tax post signing of the US-French tax treaty and interpreted that FTC should not be allowed for the NIIT under US-French tax treaty. The courts allowed the claim of FTC to the taxpayers under Article 24(2)(b) of US-French tax treaty as the tax treaty does not include the reference and restrictions of the domestic tax law. It was held by the court that claim of FTC under tax treaties are not bound by the restrictions imposed under domestic tax laws. 

Allowability of FTC on foreign sourced income is a matter of debate in India too. While there are rules and relevant forms issued for claiming FTC, Indian tax authorities often dispute the claim of FTC on legal grounds; like the amount that can be claimed as FTC, eligibility of FTC claim in case of delay in filing of relevant forms, eligible persons for claiming FTC in India based on the residential status, relief for FTC against State Taxes, allowability of FTC where income is exempt from tax in India, claim of FTC as a business deduction etc.

2. Indian Supreme Court on applicability of the Most Favoured Nation (‘MFN’) clause in Protocol of tax treaties

In a path breaking decision in the case of Nestle SA, the Indian Supreme Court interpreted the MFN clause found in the Protocols to Indian tax treaties. The tax treaties with Netherlands, France and Swiss Confederation were majorly in discussion.

The MFN clause provides for a lower rate of withholding tax or a more restricted scope of taxation of dividends, interest, royalties or fees for technical services (‘FTS’), based on provisions found in a tax treaty with a third country, which is a member of the Organisation for Economic Cooperation and Development (‘OECD’). 
It usually reads as under: “In respect of Dividends, Interest and Royalties, fees for technical services and payments for the use of equipment, if under any Convention, Agreement or Protocol signed after 1-9-1989, between India and a third State which is a member of the OECD, India limits its taxation at source to a rate lower or a scope more restricted than provided for in this Convention, the same rate or scope shall apply under this Convention, with effect from the date on which the Convention enters into force later”.

Having regard to the above clause, two questions were framed by the Supreme Court:
  • Whether taxpayers have a right to invoke the MFN clause when the third country with which India entered into a tax treaty was not a member of OECD at the time of entry into force of the tax treaty? 
  • Whether the MFN clause is required to be given effect to automatically or pursuant to a specific Notification issued in this regard?

The Supreme Court ruled in favour of the Indian tax department and opined as follows:
  • A specific Notification is necessary to give effect to a protocol which has the effect of altering the existing provisions of treaty.
  • Merely because a later treaty with an OECD member country gives better tax treatment in respect of certain items of income, does not automatically lead to integration of same terms into a tax treaty with a first country through the Protocol. In such event, the earlier tax treaty is required to be amended through a separate notification under the provisions of Income Tax law.
  • The interpretation of the expression “is a member” in the Protocol has importance. Relying on the same, the Supreme Court accepted the Indian tax department’s stand that when a third country enters into a tax treaty with India, it should be an OECD member state, and only such tax treaty can be referred to for invoking the MFN clause by the earlier country.

The decision has far reaching impact on the tax positions adopted by Indian taxpayers as regards application of withholding tax provisions and unsettles a matter which was considered as a fairly settled one and has therefore been widely debated.  Based on information available in public domain, review petitions are filed against this decision before Supreme Court for reconsideration of the matter on various aspects, of interpretation of tax treaty in law and in practice, earlier precedents of the Supreme Court, etc.

3. Mumbai ITAT upholds taxability of reimbursements as FTS in the absence of evidence of cost-allocation and actual incurrence

In the instant case, a US tax resident received certain amount towards cost allocation i.e., recovery of expenses which was not offered to tax as it was pure reimbursement without any mark-up. In the absence of documentary evidence for cost allocation, the Revenue authorities ascertained the receipts to be technical in nature i.e., FTS being in the areas of general management, internal audit, communication, human resources etc. and also satisfy “make available” clause as per DTAA.

ITAT after taking into consideration the concerned service agreement remarks that Taxpayer merely agreed that markup of 0 percent shall be applied to cost of support services, does not mean anything unless document supporting the same explaining how the costs to be considered as reimbursement. ITAT further observes that the Taxpayer did not even submit any details of cost allocation by the respective cost centres and relevant cost factors for allocation. Also notes that the agreement explains that the annual invoice amount will be determined by reference to the company’s actual cost incurred prior to the preparation of the cost allocation exercise which shows that the charges for support services are only determined based on the respective cost centres’ cost allocation. However, no such information was provided by the Taxpayer. ITAT thus held the reimbursements to be in the nature of FTS and accordingly taxable.

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