Dividend Distribution Tax, Treaty Benefits And The Chaos
The Delhi tax tribunal may have just given ammunition to Indian companies with foreign shareholders to claim DDT refunds from the tax department.
While determining Dividend Distribution Tax, a non-resident shareholder will get the benefit of the lower tax rate under a treaty, the Delhi bench of the Income Tax Appellate Tribunal has ruled. This is likely to create significant chaos, experts told BloombergQuint.
"The principle laid down by the ITAT will prompt domestic companies having non-resident shareholders to claim refunds on DDT they’ve paid in the past," Ajay Rotti, partner at Dhruva Advisors, said.
Given the huge consequences of this ruling, the tax department will surely appeal the ITAT’s decision before the high court, Daksha Baxi, head of international taxation at Cyril Amarchand Mangaldas, said.
Indian Company, German Parent
Prior to April 2020, an Indian company distributing dividends to its shareholders was required to pay an effective 20.5% DDT. This tax liability had to be discharged by companies, irrespective of whether the shareholder receiving the dividend was a resident or non-resident.
Where the shareholder was a non-resident of a treaty country, Rotti explained, there’s been a school of thought that DDT should be restricted to the rate specified in the relevant double taxation avoidance agreement.
A view Giesecke & Devrient India Pvt. Ltd. took before the tribunal with respect to dividends paid by it to its parent company in Germany. It said that under the India-Germany tax treaty, the withholding tax on dividends is 10%. The company argued that this beneficial rate should be applicable to it and that it’s entitled to claim the excess DDT paid as refunds, having paid the tax at the 20.5% rate earlier.
Administrative Necessity Vs Economic Burden
The Delhi ITAT examined the memorandum to the Finance Bills of 1997, 2003 and 2020 and pointed out that the liability of DDT was placed on companies to ease the compliance burden. It was an "administrative necessity" and not a legal one. The economic burden of DDT anyway fell on the shareholders rather than on the company, as the amount of distributed profits available for shareholders stand reduced to the extent of the DDT, the ITAT said.
And so, if the shareholder is a non-resident, then the tax liability on her income has to be determined as per the tax treaty. Between the income tax law and a treaty, the latter will prevail if it’s more beneficial to a taxpayer, the tribunal concluded.
It’s unlikely that the revenue department will concede, experts said, pointing to some of the grounds of challenge.
The Income Tax Act clearly excludes dividend from the scope of "total income", Baxi said. Also, she explained, if DTAA has to be applied for each non-resident shareholder, the company paying the dividend will need to get all the documentary evidence to conclude that the non-resident is eligible for treaty benefits, that it is the beneficial owner.
This by itself would make the implementation of DDT more complex and defeat the purpose of its replacement [via Finance Act, 2020]. Further, if dividend for non-residents is taxable under DTAA, would the same logic not apply in case of resident shareholders?Daksha Baxi, Head - International Taxation, Cyril Amarchand Mangaldas
It would be unfair treatment under erstwhile DDT regime if a non-resident shareholder is permitted to be taxed as per the treaty rate but the resident shareholder is taxed at rates higher than the tax rate applicable to her, Baxi said.
The ruling will prompt companies who have paid DDT at a higher rate to pursue refunds, and it’ll benefit those who have already filed such claims and the department has not processed them, Rotti said.
There will be a rush to file refund claims. All treaties have a lower tax rate for dividends. For instance, Mauritius DTAA provides for a 5% rate. The thinking of applying the beneficial treaty rate was always there among taxpayers and professionals, and the ITAT ruling has only reaffirmed it.Ajay Rotti, Partner, Dhruva Advisors
But the department is likely to challenge the tribunal’s decision given the significant stakes involved, he said.