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

last updated on 27 October 2020 | Reading time approx. 3 minutes

In a landmark judgement in the case of Giesecke & Devrient (India) Pvt. Ltd. [ITA No. 7075/DEL/2017 [Assessment Year 2013-14], Delhi Tribunal ruled that the beneficial rate of tax on dividends prescribed under ‘Article 10 – Dividend’ of the Double Taxation Avoidance Agreement (‘DTAA’) between India and Germany (‘DTAA Ind-GER’) shall prevail over Dividend Distribution Tax (‘DDT’) under the domestic law.

The Tribunal ruling on one hand will permit foreign invested companies in India to raise an additional ground regarding the issue of DTAA impact on DDT as involving a legal issue during the ongoing proceedings and will also allow to raise refund claim in respect of DDT liability discharged in the past without considering DTAA entitlement of its shareholders.

Introduction

Dividends declared, distributed or paid by the domestic companies are subject to DDT under section 115O of the Indian Income Tax Act (‘ITA’). The rate of DDT has varied over the years and has been in excess of 15 per cent for more than a decade. DDT was applied irrespective of the residency of the shareholders. The applicability of lower tax rates on dividend as per DTAA (5/10/15 per cent) to dividend paid to a non-resident shareholder was generally not considered and DDT liability used to be discharged as per the rate specified under the ITA. The debate as to whether tax liability in respect of dividends should be restricted to the rate of dividend prescribed under DTAA has gained momentum in recent years. The aforesaid ruling is first conclusive ruling pronounced directly on the issue.

In past, Delhi Tribunal had allowed additional ground on similar lines in the case of Maruti Suzuki India Ltd [ITA No. 961/DEL/2015]. Tax authorities challenged the same before Delhi High Court. Delhi High Court dismissed petition filed by tax authorities and without deciding on merits and allowed admission of such additional ground.

Key Highlights of the Delhi Tribunal Ruling

Giesecke & Devrient (India) Pvt. Ltd. (‘Indian Company’), a private limited company and a 100 per cent subsidiary of G+D GmbH, a German company, was engaged in the trade of currency verification and processing systems.

During the financial year 2012-13, Indian company declared dividend and discharged DDT liability as per domestic tax laws in India. During the appeal proceedings on other matters before the Tribunal, the Indian Company raised an additional ground of appeal and contended that tax authorities should have granted refund of DDT paid in excess of tax liability computed in respect of dividend income applying beneficial provisions of DTAA Ind-GER.

The Delhi Tribunal allowed the additional ground as indicated above. Further, the Delhi Tribunal took into consideration following arguments to conclude that tax rates specified under DTAA Ind-GER in respect of dividend must prevail over rate of DDT under domestic tax laws:

While DDT is a liability on the company paying dividend, the term ‘tax’ is defined to include income-tax chargeable under the ITA and the same is to be charged in respect of total income of a person. The term ‘income’ is defined to include dividend. Hence, it is observed that DDT is a tax on income and income includes dividend.
In the year 1997, a concept of DDT was introduced in the domestic tax law to facilitate administrative convenience of collection of tax and better monitoring. DDT is a tax on dividend though collected from the company paying dividends for administrative convenience. Finance Act, 2020 abolished DDT to substitute it with the classical system of taxation of dividends in the hands of the shareholders. It was observed that levy of DDT was merely for administrative convenience.
DDT is a levy on the dividend distributed by the payer company. It is covered by the definition of ‘Tax’ as defined under domestic tax law, which, in turn, is subject to the other provisions, including section 90, which provides for adopting beneficial provisions between domestic tax law and DTAA.
Accordingly, the generally accepted principles relating to interpretation of DTAA, in light of object of eliminating double taxation, do not bar the application of DTAA to DDT.
The DTAA between India and Germany is pre dated to the introduction of DDT in the domestic tax laws.
Delhi HC ruling in the case of New Skies Satellite [382 ITR 114] did not permit retrospective amendment made under the domestic tax law to influence provisions of the DTAA.

While deciding the matter in favour of Indian company, the Delhi Tribunal restored the matter to the Tax Authority for limited purpose of verifying factual parameters viz. whether the beneficial owner of dividend income has a Permanent Establishment in India and income is effectively connected therewith, in which case the reduced rate under the DTAA Ind-GER shall not be applicable.

This is a favourable ruling, based on which, many foreign invested companies in India would be able to initiate refund process in respect of DDT liability discharged in past to the extent of excess DDT over tax rate prescribed under DTAA applicable to non resident shareholder in respect of dividend income. However, one would need to note that the matter can be litigated further in the upper Courts viz High Court and Supreme Court.

Foreign Invested companies in India will have an option to raise additional ground to claim refund of excess DDT, where litigation/assessment proceedings are ongoing.

In absence of such ongoing litigation, other options can be explored and foreign invested companies would need to strategies as to how the refund can be initiated for past years.