The case of Patni Computer Systems Ltd, which came up before the Pune Income Tax Appellate Tribunal (ITAT) not long ago, was about losses amounting to Rs 54 lakh Patni incurred in its Japan branch. The question was whether the losses were to be taken into account while computing the company's income taxable in India.

According to the Assessing Officer (AO), Patni's profit of the trading office in Japan is taxable in that country only, as per the DTAA (double taxation avoidance agreement); any loss incurred by the assessee in respect of that trading office is not allowable as deduction from the income which is taxable in India, the AO reasoned.

When Patni appealed against that decision, the Commissioner of Income Tax held that "the company is resident in India and its global income/loss is taxable in India only". Loss arising to Japan office should be allowed as deduction while computing the income of the appellant for the year, said the CIT(A).

The case reached the tribunal. There, the Department's representative argued that, in terms of the provisions of the India-Japan DTAA or treaty, profits and losses of the Japanese permanent establishments (PEs) of Indian companies are subject to taxation only in Japan. He feared that accepting Patni's claim would lead to "an absurdity inasmuch as while profits of the assessee's PE in Japan will be taxed in Japan, the losses incurred by its PE in Japan will be set off against incomes taxable in India."

In response, the stand of the company's counsel was that nowhere in the tax treaty it is provided that the profit of the PE of an Indian company in Japan will not be taxed in India. He said that as per the clear provisions of the Income-Tax Act, all profits and losses of an Indian resident, irrespective of wherever they arise, will be taxed in India.

So, what did the ITAT say? It said that the provisions of Section 90(2) of the Indian Income-Tax Act are quite unambiguous and categorical in this regard. "Section 90(2), inter alia, provides that when the Government of India has entered into a double taxation avoidance agreement with Government of any other country, `in relations to the assessee to whom such agreement applies, the provisions of this Act shall apply to the extent these are more beneficial to that assessee'. Section 90 only grants relief; it does not impose any liability. Even without such provisions, courts in the US and Germany, as indeed in other parts of the world, have held that a treaty cannot act to the disadvantage to the taxpayer," reads the text of the tribunal's order posted on www.taxindiaonline.com.

The scheme of the DTAA cannot, therefore, be thrust upon the assessee, said the ITAT. "In this particular case, it is obviously to the advantage of the assessee that he is taxed in India on the basis of his worldwide income, which includes losses incurred abroad, and not to invoke the provisions of the India Japan tax treaty." The assessee should be free to make the choice each year, said the ITAT.

Can this lead to `double dip' or double benefit on account of losses incurred by the PE? "In international taxation parlance, the question of double dip of losses can arise when the benefit in respect of the loss incurred by the foreign branch is claimed in the residence country by offsetting the same against domestic incomes, and the loss set off is also claimed in the source country by setting off the same against the profits in the subsequent years," explains the text. As per the law that prevails now, a double dip of foreign losses may indeed occur, conceded the tribunal.

"When the assessee incurs losses abroad in a country with which India has entered into a tax treaty, the assessee may as well go for taxation of worldwide income and thus effectively claim deduction of loss abroad from its total income liable to tax in India. The scheme of Section 90(2), as we have discussed above, permits so. When the assessee makes profits in the subsequent years, and whether or not the assessee recaptures loss in the subsequent years, its entire PE income remains outside the scope of `total income' under Section 5 of the Act."

In effect, therefore, the loss of the PE abroad is deducted twice, explained the tribunal. "This position may be unintended or even undesirable, as evident from the global concern to neutralise such dual benefits in international taxation, but that is an inevitable corollary to the legal position existing now," it noted. "The present legal position is also somewhat anomalous inasmuch as the scheme of tax credits under the various tax treaties, which India has entered into, has become unworkable to a large extent due to availability of tax exemption to most of the foreign income of Indian residents, which is taxed in the source country - something which was obviously not envisaged when these treaties were entered into. The remedy, however, does not lie with us."

A topic worth studying in depth.

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