Tax rate as per treaty prevails, even where domestic company liable to dividend distribution tax

However, Finance Act 1997 introduced the concept of Dividend Distribution Tax (DDT) for the first time wherein the taxes to be paid on dividend income were shifted to a single point i.e. to be paid by the Company distributing the dividend. Thus, the incidence of tax shifted from the shareholder (recipient) to the Company (payer). Multiple times thereafter, the taxation of dividend income and incidence of ‘dividend tax’ in the context of DDT has shifted from payer to recipient and vice versa. Ultimately, the Finance Act 2020 abolished DDT and the taxation of dividend income was shifted back in the hands of shareholders.

The rate of DDT prescribed under the ITA has generally been on the higher side, as compared to the tax rate prescribed in the relevant Double Taxation Avoidance Agreements (DTAA) entered by India with its tax treaty partner nations. In the context of cross-border payment of dividends i.e. by an Indian Company to its non-resident shareholders, such non-resident shareholders are able to claim lower tax rate as per applicable treaty provisions. However, the issue had arisen in respect of DDT regime, when domestic companies used to discharge the tax liability and non-resident shareholders were not liable to tax in respect of such dividend income. The question raised was, whether the dividend income should be subject to higher DDT rate as per the ITA, or at the lower beneficial tax rates available in the DTAAs subject to fulfilment of specified conditions. Many Indian companies that had paid dividends  to non-resident shareholders prior to abolition of DDT, had made the claims for refund of excess taxes paid in relation to dividend payment to non-resident shareholders before the various income tax authorities as well as appellate forums. In past, the Mumbai ITAT (Special Bench) ruling in the case of Total Oil India Pvt Ltd[1] had opined negatively on this issue.

Hon’ble Bombay High Court (Goa Bench) has recently pronounced a ruling[2] on this issue. In the said case, the taxpayer had paid dividend of approximately INR 3,650 Million to its UK based foreign shareholder, spread over different Assessment Years prior to 2020. The taxpayer also paid DDT thereon at the rate specified under relevant provisions of ITA. The taxpayer preferred an application for an Advance Ruling before the Board for Advanced Rulings (BFAR), on the question whether taxpayer would be entitled to restrict the tax rate on dividends distributed or distributable by it to its UK based shareholder at 10 per cent as prescribed under Article 11 (Dividends) of the India-UK DTAA. BFAR pronounced a ruling against the taxpayer, by concluding that DDT paid by taxpayer is outside the scope of India-UK DTAA provisions and thus taxpayers’ arguments have no merits. The taxpayer thus preferred an appeal before the Hon’ble Bombay High Court (Goa Bench) against the BFAR ruling.

Conclusion

Hon’ble Bombay High Court has recognized that payment to UK entity is ‘dividend’ as envisaged under provisions of ITA as well as the DTAA. That being the case, the Court observed that there is no change in the concept of ‘dividend’ as such, when it comes to the question of applying the tax rate on ‘dividend’ income. Hon’ble Court noted that all the conditions prescribed in Article 11 of India-UK DTAA were satisfied in the taxpayers’ case, and there was no reason to deny the DTAA benefits to the taxpayer. It was held that the time-to-time shift from classical ‘dividend tax’ in the hands of the shareholders to a DDT-based regime and ultimate abolishment of DDT, was a mere change in incidence of tax on dividend income under the ITA for “administrative convenience” of the Revenue. Upholding the supremacy of DTAA provisions over the ITA, Hon’ble Court held that the effect of an International Treaty must override any provision in the domestic law and hence provisions of the ITA must act as subservient to the DTAA. Referring to Article 31 of the Vienna Convention on Law of Treaties (VCLT), the Court opined that India in good faith was obliged not to tax dividend income at a rate greater than 10 per cent as prescribed under the Article 11 of India-UK DTAA.

It was observed by the Court that any unilateral change in domestic law over the years changing the incidence of tax cannot alter or override the beneficial provisions under the DTAA. Accordingly, the Hon’ble Court held that the taxpayer was entitled to restrict the tax rate on dividends distributed to its UK based holding entity at 10 per cent under Article 11 of India-UK DTAA.

Our Remarks

This is a landmark judgement favoring taxpayers who have wanted to take the view that applicability of tax rate on dividend distribution should be considered qua taxability in the hands of non-resident shareholders who are governed by the favorable DTAA provisions, and not in any other manner which is more detrimental, especially having regards to taxation under DDT regime. Given the stakes involved, the decision is likely to be challenged by the Revenue before the Hon’ble Supreme Court. However, at the moment, this decision may be expected to influence the outcome of any ongoing litigations on this issue in favor of taxpayers, especially at the lower appellate levels, unless there is a conflicting judgement by any other High Court or a ruling rendered by the Hon’ble Supreme Court.

Apart from the fact that the decision would likely be challenged before the Hon’ble Supreme Court, question shall remain about the fate of taxpayers who did not further contest this issue post Total Oil India Pvt Ltd (Special Bench Ruling) by Mumbai ITAT (supra) which was negative on this issue. These taxpayers would need to evaluate any opportunity to explore the possibility to revive DDT refund claim, in view of this favorable decision. Also, given the existing legal and judicial framework for claiming tax refunds, it is important that appropriate strategies for lodging DDT refund claims are evaluated by the taxpayers, if so decided.

[1] Total Oil India (P.) Ltd. IT Appeal No. 6997 (MUM.) of 2019 & Others C.O. No. 57 (MUM.) of 2019

[2] M/s. Colorcon Asia Pvt Ltd [Tax Appeal No. 5 of 2024]