2020 (12) TMI 776 - AT - Income Tax

Tax credit under article 23(2) of India Japan Double Taxation Avoidance Agreement 'Indo Japanese tax treaty' - withheld Tax by its clients fiscally domiciled in Japan - HELD THAT - A position well visualized by the multilateral bodies, developing the treaty provision in question, that in all the cases in which the interpretation of the residence country about the applicability of a treaty provision is not the same as that of the source jurisdiction about that provision, and yet the source country has levied taxes - whether directly or by way of tax withholding, the tax credit cannot be declined. To put a question to ourselves, what could possibly be the situations in which views of the source and residence jurisdictions may differ about the applicability of a treaty taxation provision, and yet the residence country could still provide the related tax credits. In our humble understanding, for the detailed reasons set out above, these are the cases in which the treaty partner source jurisdiction has taken a reasonable bonafide view which is not manifestly erroneous- even though it is not the same as is the view taken by the residence jurisdiction. That aspect alone, however, is not the sole determinative factor in the present context since we have already held that, on the peculiarities of Indo Japanese tax treaty provisions, the legal fees paid to a partnership firm of lawyers can indeed be subjected to levy of tax under article 12 as the exclusion clause under article 12(4) does not get triggered for payments to persons other than individuals, and the provisions of article 14 are required to be read in harmony with the provisions of article 12(4).

Issues Involved:
1. Whether the authorities were justified in declining tax credit under Article 23(2) of the Indo-Japanese tax treaty for taxes withheld by Japanese clients.
2. Whether the assessee should be allowed a deduction for the withheld taxes if tax credit is declined.

Issue-wise Detailed Analysis:

1. Declining Tax Credit under Article 23(2) of the Indo-Japanese Tax Treaty:

The core issue in this appeal is whether the authorities were justified in denying the tax credit for ?80,55,856 withheld by Japanese clients under Article 23(2) of the Indo-Japanese tax treaty. The assessee, an Indian law firm, had claimed a foreign tax credit for the taxes withheld by its Japanese clients. The Assessing Officer (AO) denied this credit, arguing that the income earned by the assessee could only be taxable under Article 14 for 'independent personal services' and not under Article 12 for 'fees for technical services' since the assessee did not have a fixed base in Japan, a condition precedent for taxability under Article 14. The AO cited precedents from Maharashtra State Electricity Board Vs DCIT, Dy. CIT v. Chadbourne & Parke LLP, and Ershisanye Construction Group India (P.) Ltd. Vs DCIT to support his view. The Commissioner (Appeals) upheld the AO's decision, noting that the taxes withheld by the Japanese clients were contrary to the Indo-Japanese tax treaty scheme.

Upon review, the Tribunal emphasized the fundamental legal position under Article 23(2)(a) of the Indo-Japanese tax treaty, which allows for a deduction from the tax on the income of an Indian resident for taxes paid in Japan, provided the income is taxed in Japan "in accordance with the provisions" of the treaty. The Tribunal analyzed the connotations of "in accordance with the provisions" and referred to the Nav Bharat Vanijya Vs CIT case and the OECD Model Convention Commentary, which allows the AO to determine whether the taxes withheld in the treaty partner jurisdiction conform to the treaty provisions.

The Tribunal examined Articles 12 and 14 of the Indo-Japanese tax treaty. Article 12 pertains to 'royalties and fees for technical services,' while Article 14 covers 'independent personal services.' The Tribunal noted the overlapping areas in the definitions of fees for technical services and professional services. It highlighted that Article 12(4) excludes payments to individuals for independent personal services under Article 14, implying that Article 14 applies only to individuals. The Tribunal concluded that the exclusion clause under Article 12(4) does not apply to entities other than individuals, such as partnership firms. Therefore, the payments in question were rightly subjected to tax withholding in Japan.

The Tribunal also considered the importance of uniformity in tax treaty interpretation across jurisdictions, citing Lord Denning in Corocraft and the Canadian Federal Court in Canadian Pacific Ltd. v. Queen. It emphasized that unless the view of the treaty partner jurisdiction is wholly unreasonable or manifestly erroneous, it should be adopted by the other treaty partner. The Tribunal found that the Japanese tax authorities' decision to tax the legal fees under Article 12 was reasonable and not manifestly erroneous.

In light of these discussions, the Tribunal held that the assessee was wrongly denied the tax credit of ?80,55,856 and directed the AO to grant the said tax credit.

2. Deduction for Withheld Taxes:

As the Tribunal upheld the assessee's plea for the admissibility of the foreign tax credit, it found no need to address the alternate plea for a deduction of the withheld taxes in the computation of its income.

Conclusion:

The Tribunal allowed the appeal, directing the AO to grant the tax credit for ?80,55,856 withheld by the Japanese clients. The judgment emphasized the importance of interpreting tax treaties in a holistic manner and maintaining uniformity in tax treaty interpretation across jurisdictions.

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