Budget 2020 abolished Dividend Distribution Tax (DDT) and dividend taxation was shifted on shareholders. Resident Shareholders were liable to pay tax on dividend as per the tax rates applicable to them. Similarly, for non-resident and Foreign Portfolio Investors (FPI’s), the dividend is taxable as per the provisions of Income Tax Act or rates provided under the relevant Tax Treaty.
However, this was not the case for FPI’s, as under Indian domestic tax law (IDTL), there was a specific provision for withholding tax (Section 196D of Income Tax Act, 1961) pertaining to withholding tax on income of FPI’s, which provided for withholding tax at 20% (plus applicable surcharge and education cess) and did not provide option to apply lower tax rate provided under Tax Treaty. This position of noneligibility of treaty rates for specified sections was also upheld by Supreme Court in case of PILCOM vs. CIT West Bengal (Civil Appeal No. 5749 of 2012). While this decision of Supreme Court was not in context of the said section but was very much applicable.
Accordingly, even though FPI’s were eligible to claim the tax treaty benefit while filing the tax return, the withholding tax on dividend payment received by them was applied under the IDTL at 20% (plus applicable surcharge and cess). This resulted in blockage of funds for FPI’s as many tax treaties provides for tax rates ranging from 5% to 15%.
With an intention to resolve the anomaly, an amendment have been introduced in this budget to extend the benefits of tax treaties to FPI’s shareholders while applying the withholding tax on Dividend. This is a favourable change for FPI’s and would certainly have positive impact on cash flows of FPI’s.
Another issue in relation to dividend income was on interest payment for delay in payment of advance tax. Given that declaration and payment of dividend by Indian Companies is uncertain and dependent on various factors, it was really difficult for a shareholder to estimate the dividend income, which has resulted in excess/short payment of Advance tax liability. Accordingly, the taxpayer was either in a tax refund situation or they were liable to pay additional interest on shortfall of advance tax liability. In either case, there was blockage of fund or payment of interest.
In order to remove the above difficulty, amendments have been made wherein taxpayer would be liable to pay the advance tax on the dividend income in the quarter in which the same is being declared by the company.
While providing of tax treaty benefit to FPI’s at a withholding tax level is a welcome change but it may increase compliance and documentation burden on the Indian companies. In order to grant tax treaty benefit, the Indian payer company would have to collect the relevant declaration/documents like Tax Residency Certificate (i.e. TRC), Form 10F & No PE declaration, etc. Almost all the tax treaties provide that beneficial tax rates for dividend would be available only if the recipient of the income is a beneficial owner of the dividend income. Given that determination of beneficial ownership would be a factual exercise, Indian payer would not be able to verify the same and would have to rely on declarations. Also companies need to be mindful of the Multilateral Instrument (MLI) provisions before granting the tax treaty benefits.
While the above changes are a welcome move, in our view other issues like withholding tax on shares held by Investor Education and Protection Fund (IEPF) – Government fund, compliance requirement for NRI shareholders having Indian bank account ought to be clarified.