ITAT Allows Full Foreign Credit Even for Tax Withheld on Non-Taxable Transactions

The leading Indian law firm (the assessee) had received professional fees from its overseas clients in Japan, Malaysia, Brazil, China, and Nepal during AY 2016–17. Taxes were withheld at source in these foreign jurisdictions, and the assessee claimed a total foreign tax credit (FTC) of Rs. 1.08 crore under Section 90 of the Income Tax Act, read with relevant Double Taxation Avoidance Agreements (DTAAs). The Assessing Officer denied this credit, arguing that the services rendered were like “independent personal services” and not taxable in those foreign countries due to the absence of a fixed base, particularly under Article 14 of the India-Japan DTAA.

Aggrieved by this disallowance, the assessee appealed to the CIT(A), who not only upheld the AO’s view but enhanced the assessment by entirely rejecting the FTC claim, stating that the assessee had not filed income tax returns in the foreign countries and thus had not been “subjected to tax“. This was despite the taxes being withheld by the foreign clients and deposited with foreign authorities.

Main Contention: Whether a foreign tax credit should be refused based only on the fact that the assessee failed to file returns in the country of origin, despite the fact that taxes were collected and deposited there.

Tribunal’s Decision: The Tribunal overturned the CIT(A)’s ruling, concluding that a return filed in the country of origin is not required in order to assert FTC under the DTAAs. In the assessee’s own cases for AY 2014–15 and 2017–18, it upheld its previous decisions that professional services provided by a law firm are taxable as “fees for technical services” under Article 12 rather than as “independent personal services” under Article 14. Additionally, the ITAT stressed that tax is considered “subject to tax” and must be credited against Indian tax liability once it is actually withheld in the source country. The Tribunal instructed the AO to provide FTC for taxes withheld in all five countries, citing OECD commentary and earlier ITAT coordinate benches rulings. Thus, the said appeal was allowed in full, and the foreign tax credit was directed to be granted as claimed.

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