Dividend taxation puts India in quandary; is it justified to impose additional tax on dividends?
October 21, 2020 11:34 AM
Foreign shareholders have been given a specific exemption under the Indian Tax Laws when DDT is paid by the Indian company.
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India’s dividend taxation policy has witnessed many changes over the years, guided by varied policy objectives and administrative convenience. India introduced a very unique way to tax dividends by levying Dividend Distribution Tax (DDT) on the companies declaring dividends rather than shareholders, way back in 1997 (leaving one intervening year). We have now from April 2020 reverted to the classical regime of taxing dividends in the hands of shareholders and it is a sweet coincidence that the first major and direct ruling on DDT is out just when we reverted to this classical system.
While some sporadic litigation was going on at various levels, it was always perceived that a tax treaty may not be relied upon for reducing the rate of DDT, and accordingly, no treaty benefit was to be given for dividends paid to foreign companies/non-residents. However, in a path-breaking, landmark ruling pronounced last week, Delhi ITAT in the case of Giesecke & Devrient [India] Pvt Ltd. held that beneficial rate of tax on dividend under DTAA shall prevail over DDT rate under the domestic law. The ruling traces the historical journey of DDT up to the Finance Act, 2020, concludes that it was a tax on shareholders, the levy of which was shifted upon dividend-paying companies for administrative convenience.
By accepting the applicability of the tax treaty rates to DDT, it has opened up a floodgate which many companies will now want to exploit. Several legal and procedural options would have to be evaluated to take the benefit of this ruling for the past years. Clearly, the judgment will be litigated further right up to the highest level, but the current round has gone in favour of taxpayers.
While the companies with FDI from overseas will want to take advantage of the judgment, those having NRI / FII investment will have different challenges. We will also have the issue of whether the refund of DDT, when received, would be to the benefit of the payer company or the concerned shareholders? Lastly, this would result in substantial financial implications for the Government – perhaps more substantial than any other tax dispute India has witnessed.
Quite a few possibilities opening up here and we are in for exciting times ahead. There was always a murmur in the industry revolving around how far the government is justified to impose an additional tax on dividends under the disguise of tax on distributed income of the company. The decision of the Delhi Tribunal could be path-breaking and would pave the way for many other additional claims from taxpayers across the industry. The judgment clearly highlights that it would be unfair to read the unilateral amendment into the treaties signed before the introduction of the DDT regime to restrict the advantage of beneficial provisions. This also poses a question on the availability of benefits in respect of the Treaty signed post the introduction of DDT.
While this decision would be welcomed with open arms by the taxpayers, it is expected that Tax Authorities would appeal this matter to the highest level. Taxpayers adopting this position while relying on the above decision may also have to consider the following aspects:
Foreign shareholders have been given a specific exemption under the Indian Tax Laws when DDT is paid by the Indian company. Also, there are few treaties (like India-USA, India-Mauritius, etc.) that provide underlying tax credit in the home country in respect of the income-tax paid to India by or on behalf of the distributing company with respect to the profits out of which the dividends are paid. In a case where foreign companies have claimed a tax credit in the home country, then restricting the rate may result in a double benefit.
In the majority of the tax treaties (including the India-Germany Tax Treaty), the Dividend article specifically provides that “This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid”. Where DDT is considered as a tax on distributed profits, the beneficial rate provided for taxation of dividends in the tax treaty may not apply based on the language of the Tax Treaty itself.
Treaties with few countries (like India-Cyprus) also clarify that dividend is exempt in India and hence, a lower rate of tax is not relevant. This also indicates that shareholders are not impacted by the DDT tax. It may be difficult to claim an exemption in the case of such Treaties.
We seem to be at a precipice of an interesting battle. It would be important for taxpayers to analyse its facts thoroughly before lodging a claim.
Maulik Doshi is Senior Executive Director at Nexdigm (Formerly SKP). Views expressed are the author’s personal.