India: Capping rate of dividend distribution tax to the beneficial rates provided under the Tax Treaty

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​published on 20 November 2019 | Reading time approx. 2 minutes

 

The Delhi Tax Tribunal in the ongoing case of Maruti Suzuki India Ltd. [ITA No. 961/Del/2015 [AY 2010-11]] admitted the question raised by the company to examine whether beneficial tax treaty rates on dividend distribution to a non-resident shareholder can be applied as against higher tax rates provided under the Indian domestic tax law. The tribunal’s decision which is expected to be issued in the course of next year may have a huge cash tax impact on foreign invested companies.

 

 

Historically, India used to levy tax on dividend income (just like any other income) in the hands of recipient shareholder.  In the year 1997, a concept of Dividend Distribution Tax (DDT) was introduced in the domestic tax law. Under this system, domestic company is required to pay tax on the amount of dividend distributed. Corresponding dividend income in the hands of the recipient shareholder was made exempt (tax free). This was done to facilitate administrative convenience of collection of tax and better monitoring.

 

Interestingly, DDT is payable in addition to the income-tax charged on the taxable income of the company. Further, no tax deduction or credit is allowed either to the payer company or to the shareholders of such DDT.

 

Currently, a domestic company paying dividend to its shareholder is required to pay DDT at the rate of 15 per cent. This is further required to be grossed-up, taking the effective rate of tax to 20.56 per cent.

Rate of tax on dividend under the Tax Treaty

India's tax treaties with various countries provides for much lower rates of tax on dividend income. For instances, India-Germany, India-Austria and India-Switzerland Tax Treaties provide for tax rates of 10per cent on dividend income in the hands of shareholders.

 

In India, it was generally understood that DDT is a tax on the payer company and is not a tax on dividend income for recipient shareholder (which is tax free). Accordingly, companies did not restrict the DDT rates to such beneficial tax rates provided under the respective Tax Treaty.

 

Due to such higher rate of DDT (as against lower rate of tax on dividend income under the tax treaty), a foreign group having a subsidiary in India have a huge cash tax impact. This is explained as under:

 

  

Recent Delhi ITAT decision

Maruti Suzuki India Ltd., during the course of hearing before the Delhi Tax Tribunal, has raised an additional ground contending that DDT on the dividend distributed to a non-resident shareholders (Suzuki Motor Do., Japan) ought to have been restricted to 10 per cent in terms of India-Japan Tax Treaty as against higher rate charged under the domestic tax law. Delhi Tax Tribunal has admitted this question and would examine the applicability of beneficial tax treaty rates.

 

Delhi Tax Tribunal in the interim order passed has observed that the DDT paid by the payer company “is a tax on income” (basis a decision of Supreme Court in the case of Tata Tea Co. Ltd. Supreme Court [[2017] 85 taxmann.com 346 (SC)]).  Earlier in 2017, Mumbai Tax Tribunal in the case of SGS India Private Limited [[2017] 83 taxmann.com 163 (Mumbai – Tribunal)] observed that there is a scope for examining whether DDT being a tax on dividend, would be covered under Article 10 of India-Switzerland tax treaty even if such dividend is payable by the domestic company. The matter has been sent back to lower appellate authority for re-adjudication on this question.

 

It would be interesting to see how Delhi Tax Tribunal interprets this issue. As this would be one of the earliest decisions on this issue and would have a huge tax cash impact on any foreign company having a subsidiary in India – it becomes crucial to watch out for this closely (especially, for companies falling under Delhi jurisdiction).
 

Our Comments

In light of the recent decision by the Indian judiciary, many corporates have already started revisiting their tax positions around DDT.

 

Looking at the legislative history of the DDT provisions as well (such as, shifting the incidence of tax on dividend from company paying the dividend to the shareholders) one may argue that that the economic incidence of DDT is in the hands of shareholders and it is only for the ease of administration convenience, burden to discharge the DDT has been shifted on the company distributing the dividends.

 

Having said the above, the position is litigious and any shortfall in payment of DDT may result into interest and penalty. Thus, it is important to strategize and ring fence the tax positions to avoid any tax consequences.

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