Tax Treaty Rate Benefit Instead Of DDT? Emphatic Yes, Says Delhi ITATBloombergQuintOpinion
It could be termed as the ruling of the year 2020, certainly going by the amount of money that could get under litigation. The Delhi Income Tax Appellate Tribunal held that in years when DDT was applicable, the taxpayer, in respect of dividends paid to non-resident shareholders, can take benefit of the lower rates of tax under the respective tax treaties. If this is further affirmed by other tribunals or courts, and if more taxpayers make similar claims, this could snowball into perhaps the biggest tax dispute India would witness.
A dividend is the income of the shareholder and hence the primary liability of the tax on dividend is that of the shareholder. However, back in 1997, India had shifted the burden of dividend tax onto the companies by charging Dividend Distribution Tax on amounts distributed as dividends and exempting the dividend income in hands of shareholders. Later on, in 2016, India also introduced a 10% tax on individual shareholders earning dividend income of more than Rs 10 lakh.
The DDT regime was unfavorable for foreign investors, mainly because:
- DDT paid by an Indian company was not allowed as a tax credit in the foreign investor's home country, resulting in double taxation.
- The benefit of the beneficial dividend tax rate provided under the tax treaties was disregarded.
The Indian government abolished DDT with effect from April 1, 2020, and went back to the conventional method of dividend taxation, whereby dividend is taxed in the hands of shareholders.
However, with respect to the DDT regime, there was a battle going on between corporates and Indian tax authorities. Companies like Maruti Suzuki, SGS India had lodged a claim before the tax tribunal for the refund of DDT to the extent the same was paid in excess, in respect of non-resident shareholders where the lower rate under the tax treaty was applicable for dividend taxation. The tax tribunal had admitted the additional claim made but directed the matter to the lower level tax authorities for fresh examination. However, no legal finding was pronounced on the matter. Recently, the Delhi Income Tax Appellate Tribunal, in the case of Giesecke & Devrient [India] Pvt. Ltd. pronounced a path-breaking judgment favoring the taxpayer. Considering the intent of the introduction of DDT, the tax tribunal has held that the DDT rate would be restricted to the tax treaty rate provided for dividend taxation.
The Delhi tribunal’s judgment is likely to result in corporates lining up for refunds of DDT for the past years.
This would result in substantial financial implications for the government – perhaps more substantial than any other tax dispute India has witnessed.
So, it is expected that tax authorities will fight tooth and nail on this matter right up to the highest level.
The Indian tax treaty rate on dividend varies in the 5%-25% range (majority coming under 5-15% range), whereas the DDT in past years has increased from 17% to 20.56%. Accordingly, most of the companies having foreign investors would be eligible to lodge a claim for most of the past years. The impact of this decision would be huge.
As we speak, there are companies that have lodged similar claims, either by way of filing a refund application as provided under Section 237 of the Income Tax Act, 1961 or making an additional claim in the tax proceedings which are pending with tax authorities. This would result in large refund claims and increase overall litigation on the matter.
Companies seeking to claim the refund of additional taxes collected on account of DDT may have to evaluate all legal and procedural options, primary among which are:
- An additional claim in all earlier years where the matter is pending under litigation before any forum with tax or appellate authorities;
- Make an additional claim in the tax assessment proceedings;
- Revision of tax return for the financial year 2018-2019 (time available up to Nov. 30, 2020);
- Making a claim for the financial year 2019-2020 in the tax return to be file by Jan. 31, 2021;
- Application to tax authorities for revision of order (Section 264 of the Income Tax Act, 1961);
- Application before the Authority for Advance Ruling.
Each of these options would have to be evaluated on a case-to-case basis by the companies.
The following aspects could be considered when these companies evaluate their case in detail before lodging the claim with the authorities.
Refund by virtue of lower rate under the tax treaty can be claimed by the company only when the shareholder receiving the dividend is a tax resident of the respective country and it is the Beneficial Owner of the dividend. The company would have to ensure that relevant documentation like Tax Residency Certificate, Beneficial Owner declaration, etc. is available.
Even though the decision favors the taxpayers, several important aspects have been left untouched by the tribunal. The companies should factor in the following arguments while deciding on the tax position it wants to adopt:
1. It would be interesting to note that the India-Hungary tax treaty is a single salutary treaty that was amended through a protocol in 2003—post-re-introduction of DDT—to provide that even where the tax on dividend is paid by a resident company on distributed profits the same would be considered as tax in the hands of the shareholder and hence the rate cannot exceed treaty rate. To some extent, the benefit of the India Hungary tax treaty can be extended to countries having Most-Favoured Nation clauses like Netherlands, France, Belgium, Spain, etc.
For the other tax treaties, this can be interpreted adversely that since no specific amendment was made in other treaties after DDT, the treaty rate cannot be applied. Nearly all the tax treaties provide that the agreement shall apply to any identical or substantially similar taxes which are imposed after the date of signature in addition to, or in place of, the existing taxes.
2. In a majority of the tax treaties, 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 dividend in the tax treaty may not apply based on the language of tax treaty itself.
3. A few treaties (like India-Cyprus) also clarify that dividend is exempt in India and hence the 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 case of such treaties.
In our view, it would be worthwhile for companies to carry out a cost-benefit analysis before lodging a claim with the tax authorities and also evaluate the litigation risks considering the above aspects. We are pretty sure that while taxpayers are rejoicing this decision, the tax authorities would have started their preparation to take this to the next level. It would be an interesting battle.
Maulik Doshi is Partner - Direct Tax and Transfer Pricing Services, Nexdigm and Nishit Parikh is Partner - Direct Tax & Regulatory Services, Sudit K Parekh & Co. LLP.
The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.