The Income Tax Appellate Tribunal’s (“ITAT”) Chennai bench in Zoho Corporation Pvt. Ltd. v. Deputy Commissioner of Income Tax,[1] determined that foreign taxes paid by an assessee, which do not qualify for relief under Sections 90 or 91 of the Income Tax Act, 1961 (“IT Act”), cannot be claimed as business expense deduction under Section 37(1).
Factual Background
Zoho Corporation Pvt. Ltd. (“Assessee”), a prominent Indian software company, sought to claim a portion of taxes paid in foreign jurisdictions as foreign tax credit (“FTC”), eligible for relief under Sections 90 and 91 of the IT Act, read with the relevant provisions of the Double Taxation Avoidance Agreement (“DTAA”). It voluntarily submitted that the remaining portion of the taxes paid in foreign countries would not be eligible for FTC and, therefore, claimed it as business expense under Section 37(1) of the IT Act. The Assessee argued that the foreign taxes it paid were necessary for its overseas business operations and should, therefore, qualify as a tax deductible business expenditure. However, the Assessing Officer (“AO”) disallowed the deduction, citing Section 40(a)(ii) of the IT Act, which explicitly prohibits deductions for taxes on profits or gains of a business.
Aggrieved, the Assessee appealed to the Commissioner of Income Tax (Appeals) (“CIT(A)”), who upheld the AO’s decision, emphasising that taxes on profits and gains of a business or profession, including foreign taxes, are explicitly excluded from tax deductible expenditure permissible under Section 37(1) of the IT Act. The Assessee challenged this decision before ITAT, Chennai.
Decision
The Assessee claimed that foreign taxes should be treated as business expense under Section 37(1) of the IT Act since they were incurred to facilitate overseas operations. However, the ITAT rejected this claim, highlighting that the IT Act provides a specific mechanism for relief from double taxation through foreign tax credits under Sections 90 and 91 of the IT Act.
Section 90 empowers the Indian government to enter into DTAAs with foreign countries to provide relief from double taxation. Taxpayers can claim credit for taxes paid in a foreign country against their Indian tax liability, subject to the DTAA and the IT Act terms. Section 91 provides unilateral relief for taxes paid in countries with which India does not have a DTAA, ensuring that taxpayers are not taxed twice on the same income. The relief is typically computed using the credit method, where the lower of the foreign tax rate or the Indian tax rate is allowed as credit.
The ITAT emphasised that while foreign taxes might be incurred in the course of business, their allowability as deduction must be evaluated in light of specific exclusions under the IT Act. Section 37 permits deductions for business expenditures that are not capital or personal in nature and are incurred wholly and exclusively for business purposes. However, this provision is subject to restrictions outlined in other provisions, notably Section 40 of the IT Act.
Section 40(a)(ii) explicitly disallows deductions for any sum paid on account of any rate or tax levied on the profits or gains of any business or profession. This provision ensures that taxes paid by taxpayers on their income are not treated as deductible business expenses unless specifically permitted. Explanation 1 to this section clarifies that taxes eligible for relief under Sections 90 or 91 are also excluded from allowable business expenses.
The Assessee had argued that the term “tax” used in Section 40(a)(ii) is restricted to taxes paid under the IT Act only and thus, deduction can be allowed for taxes that are not paid under the Indian income tax laws, but are paid offshore. Thus, the restriction on deduction of taxes as business expenses was claimed to be applicable only to taxes paid under Indian laws.
The ITAT rejected this argument and interpreted the term “tax” under Section 40(a)(ii) as encompassing all forms of taxes paid on profits and gains of business and profession, including both domestic and foreign taxes. The ITAT observed that this reasoning was supported by Explanation 1 to Section 40(a)(ii), which includes sums eligible for relief under Sections 90 or 91 (foreign tax credits) within the scope of disallowed deductions.
Basis this reasoning, the ITAT dismissed the Assessee’s appeal, holding that foreign taxes paid, which are not eligible for relief under Sections 90 or 91, cannot be claimed as business expense under Section 37(1). Allowing such a deduction would also render the scheme of graded foreign tax credits under the IT Act as infructuous. Further, the ITAT observed that there is no justification for permitting deduction of foreign taxes as business expense, since the payment of such taxes cannot be considered as contributing to business profits, which is a requirement for qualification as business expense.
Significant Takeaways
It needs to be noted that Sections 90 and 91 of the IT Act have certain limitations. They are based on formula-based credit caps that usually do not fully offset foreign taxes paid by taxpayers. Explanation to Section 40(a)(ii) of the IT Act merely states that the sum of taxes that are eligible for relief under Sections 90 or 91 cannot be claimed as expenditure. Therefore, it can be stated that the sum of taxes that are not eligible for relief under Sections 90 or 91 of the IT Act would not fall within the purview of Section 40(a)(ii) of the IT Act and, hence, can be availed as tax deductible expenditure. However, the ITAT appears to have brushed aside the said line of argument by holding that what cannot be claimed as credit under Sections 90 or 91 of the IT Act should not automatically become eligible for deduction as business expenditure.
The decision did not consider Circular number 14 of 2006, issued by the CBDT, which set out the legislative intent behind the insertion of Explanation to Section 40(a)(ii) of the IT Act. It stated that the said Explanation clause was inserted to prevent taxpayers from claiming FTC as well as claiming expenditure. Therefore, it is possible to contend that foreign taxes that are not eligible for FTC should be allowed as business expenditure.
In Bank of India v. ACIT (2021) 125 taxmann.com 155 (Mumbai-Trib), the foreign tax credit under the DTAA was denied to the taxpayer since it was declaring losses in India and hence, the said income was not doubly taxed (i.e. not taxed in India). However, the ITAT had allowed taxes paid abroad as tax deductible expenditure under Section 37 of the IT Act by relying on the decision of the Bombay High Court in Reliance Infrastructure Ltd v. CIT (2016) 76 taxmann.com 257, wherein the taxes paid in Saudi Arabia were allowed as deductible business expenditure.
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
sr.patnaik@cyrilshroff.com
[1] TS-105-ITAT-2025(CHNY)
