Tax Ruling Says Dividend Tax in India to be Based on Beneficial Treaty Rate

A recent judgement by the Delhi Income Tax Appellate Tribunal has held that the beneficial tax rate under the relevant tax treaty will apply to the withholding tax on dividend income, even if the shareholder is a non-resident foreign investor, instead of the domestic tax rate.

Confusion over which tax rate must apply on dividend income was addressed in the case of Giesecke & Devrient India Pvt Ltd, a 100 percent subsidiary of G&D GmbH, a company incorporated in Germany. G&D India imports Currency Verification and Processing Systems from its associated enterprise (AE) and resells the same to its customers in India.

This year, effective April 1, 2020, the dividend tax liability in India was shifted to shareholders/unit holders and the dividend distribution tax (DDT) on companies was scrapped.

Previously, limited liability partnerships (LLPs) were often favored in India over setting up companies because of the higher tax incidence. Reduction of corporate tax rates and abolishing DDT on companies should make investing in India a more attractive proposition for foreign investors.

What are the implications?

Taxpayers should pay attention to if the country’s tax authorities appeal this decision by the Delhi appellate tribunal.

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Further, there are other considerations that must be assessed, such as the exemption under Indian tax laws for foreign shareholders when the dividend tax is paid by the Indian company, or if the taxpayer benefits from a tax credit in their home country with respect to the income tax paid in India by or on behalf of the distributing company who has paid dividends out of their profits.

The language of the relevant tax treaty is also crucial and may not offer a lower withholding tax rate in the case of dividend payouts.

India’s steps to reduce dividend tax burden on shareholders

• In the case of dividend income (and interest on securities – any reasonable sum paid through remuneration or commission for the purpose of realizing dividend or interest) – deduction is allowed up to a maximum of 20 percent of such income (amended Section 57 of the Income Tax Act, 1961).
• Section 80M of the Income Tax Act removes the cascading effect of tax on dividend income for corporate shareholders. The introduction of this provision means that domestic holding companies that receive dividend income from their subsidiaries can set off such amounts from their total taxable income. This set off, however, cannot exceed the amount of dividend further distributed by it – up to one month before the due date of filing their return.

Tax liability of resident shareholders

Dividend income for individual shareholders is taxed as per applicable slab rates. There is no additional tax of 10 percent on dividend income that exceeds INR 1 million – for the resident individual taxpayer (Section 115BBDA of the Income Tax Act).

Corporate shareholders shall see their dividend income taxed as per effective tax rates, ranging from 25.17 percent to 34.94 percent (including surcharge and cess).

Tax liability of non-resident shareholders

Non-resident shareholders are liable to pay withholding tax at the rate of 20 percent on the dividend income.

Non-corporate non-resident shareholders can claim benefit under the lower tax rate of the relevant tax treaty, such as a double tax avoidance agreement (DTAA) – but they need to be ‘beneficial owners’ of the dividend income. DTAAs provide for a lower tax rate that ranges from five to 15 percent. Confusion may arise because the term – beneficial owner – is not clearly defined and often comes down to a factual assessment, helped by judicial precedents.

Thus, to be a beneficial owner of the dividend income, the taxpayer must have unrestricted access to the income and be able to use it independently – that is, they must not be legally obliged to pass on the dividend payment to another person.

Further, according to Article 8 of the Multilateral Instrument to Implement Tax Treaty Related Measures to Prevent BEPS (the MLI) – the concessional tax rate on dividend in case of beneficial owners is applicable only if the shares are held by the shareholder for at least 365 days. India announced it had ratified the MLI on June 12, 2019, which came into effect October 1, 2019.

It is important to note that if the non-resident accesses the lower tax rate under applicable tax treaty – they must file return of income in India.

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