Losses abroad to reduce taxable income in India

FOREIGN ENTERPRISE

A large number of Indian companies have set up offices outside India. The profits or losses of such offices are liable to be taxed in the foreign country. But how such profits or losses should be treated in India is a vexed question. A recent judgment of Pune Tribunal clarifies the legal position.

An Indian company engaged in computer software business set up a trading office in Japan. The company's Japan branch suffered loss, which it claimed as deduction from profits earned in India. The assessing officer, however, held that "since the profits of the trading office are taxable in Japan only, any loss incurred by the firm in respect of its trading office is not allowable as deduction from the income which is taxable in India."

The Commissioner of Income Tax (Appeals) accepted assessee's contention that the loss suffered by its Japan office should be allowed as deduction while computing the taxable income in India because an Indian resident pays tax in India on its global income. The global income will obviously take into consideration the loss incurred in Japan.

The Income Tax Tribunal (ITA No. 726/Pune/205) in its judgment, dated June 29, 2007, held that the assessee was eligible to claim taxation on a worldwide basis, and, in effect claim deduction of loss incurred by the trading office of the assessee in Japan.

The tribunal in its far reaching judgment considered the two schools of thought on this issue. One prevailing view is based on Section 5(1) of the Income Tax Act which categorically states that the total income of a resident assessee includes "all incomes from whatever source derived." Such an income will be calculated after setting off the loss incurred in Japan. The other view is that "since the profit of the said trading office is taxable in Japan only, any loss incurred by the assessee in respect of this trading office is not allowable as deduction from the income which is taxable in India."

While the former view is based on the interpretation of the Indian Income Tax Act, the latter is based on the tax treaty between India and Japan.

The hon'ble tribunal following the observations of the apex court in the case of Azadi Bachao Andolan (263 ITR 706) held that in view of specific provisions of Section 90(2), which provides that when the Government of India enters into a double taxation avoidance agreement with the government of any other country, "in relation to an assessee to whom such agreement applies, the provisions of this Act shall apply to the extent they are more beneficial to that assessee."

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.

It is true that if the assessee makes profit in Japan in the subsequent year, the loss incurred earlier might be allowed to be set off against such profit. And therefore, if the Japanese loss is allowed to be set off against his Indian income, in effect, the loss is deducted twice. But the Hon'ble Tribunal boldly held that: "This position may be unintended or even undesirable, as evident from the global concern to neutralise such dual benefits in the international taxation, but that is an inevitable corollary to the legal position existing now."

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