India Tax Tribunal Rules on Dividend Distribution Tax and its Interplay with Tax Treaties

Until March 31, 2020, dividends declared, distributed or paid by an Indian company were subject to an additional income tax (referred to as dividend distribution tax or DDT) at the rate of 15% (exclusive of applicable surcharge and cess) in the hands of such Indian company under Section 115-O (Tax on distributed profits of domestic companies) of the Income-tax Act, 1961 (the Act).

The DDT was discharged by the dividend paying (Indian) company at the above rate, irrespective of whether the shareholder was a resident or a nonresident for India tax purposes. Such dividends were tax exempt in the hands of the shareholders under Section 10(34) of the Act, to avoid economic double taxation, since the amount distributed to them was already net of tax in the form of DDT.

Whether DDT is a tax leviable on the dividend paying company or is a tax leviable on the shareholder, and DDT is merely a mechanism of collecting the same through the company for administrative convenience, has been a matter of debate for over two decades.

This ruling pronounced by the New Delhi bench of the tax tribunal, in the case of Giesecke & Devrient [India] Pvt Ltd v. The Addl. Commissioner of Income Tax, has reignited the doused fire by upholding that DDT is nothing but a tax on shareholders which was collected through the dividend paying companies, in order to avoid the administrative inconvenience of requiring the company to identify each shareholder and deduct tax at source (TDS). Accordingly, it was held that since ultimately DDT is a tax on shareholders and not on the company, the shareholders are entitled to apply the provisions of the double tax avoidance agreement (DTAA) or the Act, whichever is more beneficial to them.

Facts

Giesecke & Devrient [India] Pvt Ltd (the Appellant) is a wholly-owned subsidiary of Giesecke & Devrient GmbH, a German company.

During FY 2012–13, the appellant declared dividends to its German parent and discharged DDT at the rate specified in Section 115-O of the Act (i.e. without reference to the rate mentioned in the India–Germany DTAA). However, the appellant, inter alia, raised the issue of applicability of the DTAA on DDT, through an additional ground which was acknowledged by the tax tribunal.

Issues in Relation to DDT

The following issues were considered by the tax tribunal:

• Is the DDT a tax on the company or the shareholders?
• Is the lower rate of tax on dividend under the India–Germany DTAA available on DDT?

Ruling

DDT is a Tax on Dividends in the Hands of the Shareholder

The tax tribunal, on perusal of the charging section and definition of the terms “tax” and “income” under the Act, observed that:

• income tax chargeable on total income of a person includes additional income tax (Section 4 of the Act);
• the term “tax” would include DDT (being additional income tax) within its ambit (Section 2(43) of the Act); and
• the term “income” includes dividends within its fold (Section 2(24) of the Act).

In light of the above, the tax tribunal observed that while the liability to pay DDT is on the Indian company, DDT is a tax on the income and income includes dividends.

The tax tribunal acknowledged that it was mindful of the fact that the Bombay High Court, in the case of Godrej & Boyce Manufacturing Company Limited v. DCIT & Anr., had unequivocally held that DDT was a tax on the company and not on the shareholders. Even though the Bombay High Court ruling was in a different context the fundamental question—whether DDT is a tax on the company or a shareholder—was ruled in favor of the revenue authorities. The Bombay High Court ruling was even upheld by the Supreme Court of India.

Legislative History of DDT

See below how dividends paid by Indian companies have been taxed over the last two decades:

DDT Regime—June 1, 1997–March 31, 2002

Traditional Regime—April 1, 2002–March 31, 2003

DDT Regime—April 1, 2003–March 31, 2020

Traditional Regime—April 1, 2020 to date

The tax tribunal also referred to the Memorandum to Finance Bill, 1997 and the Memorandum to Finance Bill, 2003 and concluded that the rationale behind introduction of DDT was merely administrative convenience (i.e. collection of tax at a single point) rather than a legal necessity.

The tax tribunal further referred to the Memorandum to Finance Bill, 2020 which removed the DDT and moved back to the traditional system of dividend taxation. The tax tribunal pointed out that the Memorandum acknowledges that dividend is the income of the shareholder, and not that of the Indian company.

On a combined reading of the Memorandums to the Finance Bills, the tax tribunal concluded that the introduction of DDT was always with the intent of easing administrative convenience and it was never intended for adding an extra levy on the company.

Interplay Between DTAA and DDT

The tax tribunal observed that the income of a nonresident is to be determined by the provisions of the Act or the DTAA; whichever is more beneficial to the taxpayer.

It further observed that the liability to pay the DDT is on the Indian company and is not relevant considering the applicability of rates of dividend tax set out in the DTAA.

Another pertinent observation made by the tax tribunal is that the India–Germany DTAA was notified in November 1996 (i.e. prior to introduction of DDT in FY 1997–98).

The tax tribunal, relying on the Delhi High Court’s ruling in the case of Director of Income Tax v. New Skies Satellite BV (which had concluded that amendments made in domestic law subsequent to entering into a DTAA cannot override the provisions of the DTAA), concluded that the tax rates mentioned in the DTAA will prevail over the tax rates mentioned in the Act. Thus, the tax tribunal held that DDT levied by the appellant should not exceed 10% (i.e. the rate specified under Article 10 of the India–Germany DTAA) subject to fulfillment of the following conditions prescribed in the DTAA:

• the recipient (parent company, in this case) is the beneficial owner (Paragraph 2 of Article 10); or
• no permanent establishment (PE) of the parent company exists in India (Paragraph 4 of Article 10).

In verifying the above facts, the tax tribunal referred the matter to the concerned assessing officer.

Conclusion

This ruling is the first of its kind in Indian judicial history and is certainly of great significance.

It is important to note that the DTAA with Germany was signed prior to the introduction of the DDT and, therefore, played a significant role in the conclusion reached by the tax tribunal. Numerous DTAAs entered into by India (i.e. with the U.S., the U.K., Mauritius, Singapore, the Netherlands) have been entered into prior to the original introduction of DDT and Indian companies with shareholders being tax residents of such countries are likely to benefit from this decision.

With all due respect, once the tax tribunal decided that DDT is a tax liability of the shareholder, though discharged through the dividend paying company for administrative convenience, the fact of when a DTAA entered into force should not be a deciding factor.

Even though this ruling is a bold statement by the tax tribunal, there is only a slim chance that it will hold its ground when it reaches the Delhi High Court (assuming that the revenue authorities will appeal against the same) as it simply brushed aside the existing law of the land as on the date, set out by the Supreme Court of India (i.e. DDT is a tax on companies and not on shareholders) in the Godrej & Boyce case.

Whether the findings of the Supreme Court of India in the Godrej & Boyce case are correct or not does not matter—the lower appellate authorities are bound to follow them. The Godrej & Boyce case was different but the fundamental question remained whether DDT is a tax on companies or on shareholders—which the Supreme Court answered in favor of the revenue authorities.

Furthermore, hypothetically assuming this ruling will hold its ground even before the higher appellate forums, the ruling leaves a plethora of unanswered questions including:

• What happens to the shareholders who are tax residents of countries with which India entered into a DTAA post introduction of DDT (i.e. DTAAs entered between June 1, 1997–March 31, 2002 and April 1, 2003–March 31, 2020)? Interestingly, the India–Hungary treaty, which was re-entered (signed on November 3, 2003; effective from April 1, 2006) post re-introduction of DDT in 2003, clearly spells out through a protocol that when the company paying the dividends is a resident of India, the DDT shall be deemed to be taxed in the hands of the shareholders and it shall not exceed 10% of the gross amount of dividend. Does it make it clear that India has specifically agreed to such definition in selected cases and the same cannot be generalized?
• Who is eligible to claim the refund—the payer company who deposited the DDT or the respective shareholders? How will the government issue refunds to shareholders who technically have paid no tax against dividend income as it was exempt in their hands?
• Impact on claim of foreign tax credit by a nonresident (in its home country) of the reduced tax rate assuming the taxpayer gets refund of excess tax (DDT rate minus DTAA rate on dividend): does Section 115-O(4) continue to operate to restrict the same? Will that not be tantamount to a treaty override by unilateral domestic law amendments as discussed at length by the tax tribunal?
• Will this ruling also apply to nonresidents earning dividends from mutual funds in India (Section 115R—Tax on distributed income to unit holders)?
• Though it may be an academic question now, given that DDT has been removed from the Act, it is important to consider if at all DDT comes back. How would the dividend paying company, at the time of paying DDT, determine which rate to apply—the Act rate (15% plus surcharge and cess, assuming it does not change when it is reintroduced) or the DTAA rate for each and every shareholder? How feasible will that be?

Given the ramifications of this ruling, it is highly likely to be challenged before the higher forums.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Karnik Gulati is a Tax and Regulatory Consultant at Coinmen Consultants LLP in India. He is also a member of the International Taxation Committee of the Bombay Chartered Accountants’ Society. The author may be contacted at: cakarnikgulati@yahoo.com or karnik.gulati@coinmen.com

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