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13 May 2021

Indian Tax Tribunal applies beneficial treaty rate to dividend distributed during the dividend distribution tax regime

Executive summary

The Indian Tax Tribunal1 ruled on 30 April 2021 that tax on dividend income earned by a nonresident shareholder during the dividend distribution tax (DDT) regime must be limited to the applicable in-force tax treaty rate. The Tribunal ruled that dividend income was subject to tax in the hands of shareholders even during the DDT regime, as the imposition of tax was merely shifted to the company distributing the dividends for administrative convenience, and therefore, the tax treaty rate takes precedence over the domestic DDT rate.

The Indian tax law was amended with effect from 1 April 2020 to abolish the DDT and introduce dividend taxation for shareholders receiving dividend income. This ruling could be relevant for taxpayers seeking tax refunds for DDT paid on dividends distributed by Indian companies prior to 1 April 2020.

This Alert summarizes the Tribunal ruling and implications for taxpayers.

Detailed discussion

Background

Dividend taxation under the Indian domestic tax law has been subject to various amendments. Pre-1997, a classical system of the taxation of dividend income applied where dividends were taxed in the hands of shareholders and the companies paying the dividends were required to withhold tax on such dividend income. From 1997 to 2020 (apart from April 2002 to March 2003), the DDT regime was in force, under which the company paying the dividends was liable to pay DDT, and such dividend income was exempt in the hands of shareholders. Recently, with effect from 1 April 2020, India abolished the DDT regime, and the classical system of the taxation of dividend income was restored. The legislative intent of the adoption of the DDT regime stated that the classical system of taxation involved administrative inconvenience and the DDT provided an efficient single point of taxation.

Facts of the case

The taxpayer, an Indian company, distributed dividends to its nonresident shareholder (a Malaysian company) during the tax years 2012/13 and 2013/14. Under the India-Malaysia tax treaty, dividends paid by an Indian company to a Malaysian resident who is the beneficial owner of the dividends is subject to withholding tax at 5% in India. During its general tax appellate process, the taxpayer raised an additional ground for appeal to restrict the DDT rate (15% plus applicable surcharge and cess) to the 5% tax treaty rate prescribed under the India-Malaysia tax treaty.

Tribunal ruling

The Tribunal permitted the admission of the additional ground of appeal and ruled that the DDT rate must be restricted to the beneficial 5% rate prescribed under the India-Malaysia tax treaty. The reasoning behind the ruling is outlined below.

  • Under the Indian domestic tax law, taxes need to be withheld at the “rates in force,” i.e., rates under Indian domestic tax law or the applicable tax treaty, whichever is more beneficial to a nonresident taxpayer.
  • Under the Indian domestic tax charging provisions, a dividend is chargeable as income of the shareholders; the tax payment obligation was shifted to the company paying the dividends only for administrative convenience.
  • If dividend income is taxable, the taxability has to be considered from the perspective of the recipient, not the payer of the dividend. This principle is also approved by earlier rulings of the Indian Supreme Court.2
  • Under the DDT regime, while the tax on dividend income was borne by the payer, the DDT was only a mechanism through which tax was collected from the perspective of the recipient of the dividend income.
  • Reliance was also placed on another Tribunal ruling,3 which ruled that the DDT rate must be restricted to the treaty rate, if the treaty rate is more favorable.

Implications

The Tax Tribunal ruling is of utmost relevance to multinational enterprises with Indian affiliate companies that have discharged DDT liabilities on past dividend distributions.4 Businesses should review the possibility of seeking refunds of excess DDT paid over the applicable tax treaty dividend withholding rates.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (India)

Ernst & Young LLP (United States), Indian Tax Desk, New York

Ernst & Young LLP (United States), Indian Tax Desk, San Jose

Ernst & Young Solutions LLP, Indian Tax Desk, Singapore

Ernst & Young LLP (United Kingdom), Indian Tax Desk, London

Ernst & Young LLP (United States), Asia Pacific Business Group, New York

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ENDNOTES

  1. Kolkata Income-tax Appellate Tribunal.
  2. Godrej & Boyce (394 ITR 449) and Tata Tea (398 ITR 260).
  3. Giesecke & Devrient (TS-522-Tribunal-2020). See EY Global Tax Alert, Indian Court rules on interaction between tax treaty provisions and Indian dividend distribution tax, dated 22 October 2020.
  4. Applicable for distributions made prior to 1 April 2020 as the DDT was abolished on dividends declared and paid after 1 April 2020.

Document ID: 2021-0975

 

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