Indian Income Tax Tribunal Rules Against Using DTAA to Reduce Dividend Tax Liability for Domestic Companies

India’s income tax appellate authority recently made a ruling that domestic resident companies cannot leverage the double taxation avoidance agreement (DTAA) to mitigate their liability towards dividend distribution tax (DDT). Companies should, however, be aware that starting from FY 2021, the DDT has been abolished, and dividends are now taxed in the hands of shareholders. As a result, non-resident shareholders have the option to select the more favorable TDS rate under the Income-tax Act or the relevant DTAA.

Background

On April 20, 2023, the Income Tax Appellate Tribunal (ITAT) in Mumbai made a ruling that domestic resident companies in India are not allowed to use double taxation avoidance agreement (DTAA) provisions to offset their dividend distribution tax (DDT) liability.

The ruling was made in a case involving Total Oil India Pvt Ltd., a resident Indian company with non-resident shareholders in France, who paid DDT to these non-resident shareholders in Assessment Year (AY) 2015-16.

The ITAT clarified that tax treaty rates cannot be used to reduce tax liabilities on dividends paid by Indian companies, as DDT is a tax on the Indian company and not the recipient of the dividend.

This ruling was made in response to multiple petitions filed by appellants such as Maruti Suzuki, Total Gas, and Gujarat Gas, and interveners such as GE Power, Tech Mahindra, Sennheiser Electronics, and Astra Zeneca Pharma India, among others.

It should be noted that with effect from FY 2021, DDT has been eliminated, and the tax on dividends is now charged directly to shareholders. Non-resident shareholders can benefit from lower tax treaty rates in this scenario.

What was the issue in dispute between the Indian income tax tribunal and Total Oil India?

The dispute between the Indian income tax tribunal and Total Oil India was over whether domestic companies should pay additional income tax at the rate specified in Section 115-O or at the rate applicable to non-resident shareholders under the DTAA when they receive dividends from domestic companies.

The case, Dy Cit 11 (3)(1), Mumbai vs Total Oil India Pvt Ltd., involved the payment of DDT in AY 2016 under Section 115-O to non-resident shareholders based in France.

Total Oil India argued that the DDT paid by the company cannot be higher than the rate at which such dividends can be taxed in the hands of non-resident shareholders under the India-France DTAA.

What was the ruling of the income tax tribunal in the case of Total Oil India?

The ITAT ruled that in cases where domestic companies pay DDT, they are liable to pay tax at the rate mentioned in Section 115-O and not at the rate applicable to the non-resident shareholder specified in the relevant DTAA.

The tribunal also stated that countries must explicitly agree in the DTAA to extend treaty protection to the domestic company paying DDT before such companies can claim benefits of the DTAA. 

For example, in the Indo-Hungarian Tax Treaty, the Contracting States have extended treaty protection to the dividend distribution tax. The protocol to the Indo-Hungarian Tax Treaty specifies that when the company paying the dividends is a resident of India, the tax on distributed profits shall be deemed to be taxed in the hands of the shareholders, and it shall not exceed 10 percent of the gross amount of dividend.

Taxation of dividend income in India in FY 2024

The Finance Act 2020 eliminated the DDT and the exemption under Section 10(34) of the Income-tax Act, 1961, shifting the responsibility of taxing dividends from the company to the ultimate shareholders.

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As per Section 194 of the Income-tax Act, companies must deduct tax at a rate of 10 percent before paying dividends to their resident shareholders. However, the company is not required to deduct tax at source if the dividend payment does not exceed INR 5,000 in a financial year and is not made in cash.

Similarly, Section 194K mandates the deduction of TDS at a rate of 10 percent before paying income to a resident investor in mutual funds or specified companies. However, TDS is not required to be deducted if the income paid or likely to be paid in a financial year is below INR 5,000 or is in the form of capital gains.

Individuals who earn dividend income exceeding INR 5,000 in a financial year and whose total income does not surpass the Basic Exemption Limit (BEL) must file an income tax return to claim a refund of TDS on dividends.

Resident individuals with an estimated annual income below the BEL can submit Form 15G to the company or mutual fund to avoid the deduction of TDS. Senior citizens can apply for the same purpose by submitting Form 15H.

Regarding non-resident taxpayers, companies must withhold tax at a rate of 20 percent (plus surcharge and cess) before remitting dividends under Section 195 read with Section 115A of the Income-tax Act. Taxpayers can opt for the beneficial TDS rate under the Income-tax Act or the relevant DTAA under Section 90(2) of the Income-tax Act.

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