The tax court “doubts” the application of advantages from the double taxation agreement to the dividend distribution tax
The Mumbai Bench of the Income Tax Appellate Tribunal (Tribunal) in the case of Deputy CIT v. Total Oil India Private Limited (ITA No. 6997 / Mum / 2019) (taxpayer) has expressed “doubts” about the correctness of certain decisions taken by the coordinating bodies of the Tribunal (see our previous Ergo, published October 21, 2020) on the issue of Applicability of the double taxation agreement to the dividend distribution tax (DDT). In those decisions, it was stated that in relation to dividends paid to non-resident shareholders, the DDT rate payable by an Indian company should not exceed the dividend income tax rate in the applicable tax treaty between India and the country of taxation of the country of residence resident shareholder. As the Court of Justice expressed doubts as to the correctness of these decisions, the Court of Justice asked the President of the Court to set up a “special bank” (with three or more members of the Court of Justice) to rule on this matter.
Dividend income was tax-free until March 31, 2020 amongst other things in the hands of non-resident shareholders and the dividend-paying company had to pay additional corporate income tax in the form of DDT at an effective and flat rate of ~ 21% without taking into account the tax rate applicable to the shareholders. As of April 1, 2020, the DDT regime will be abolished and dividends will be taxable among shareholders. The political goal of the introduction of DDT in 1997 was to ensure ease of administration through a single tax collection agency.
Since DDT was payable by Indian companies rather than by non-resident shareholders (who exempted dividend income), the applicability or relevance of advantageous tax rates in tax treaties was questionable. When this issue came up for review before the Bank of the Tribunal in Delhi last year, it ruled in favor of the taxpayer and decided that the DDT rate should be limited by the rate set for dividend income under the applicable tax treaty (our Ergo analyzes the The decision of the Bank of the Tribunal in Delhi can be viewed here). The judgment of the bench of the tribunal in Delhi was followed by a decision by the bench of the tribunal in Calcutta.
In the most recent case, the year in question was 2015-16 and the taxpayer had distributed dividends to its shareholders, some of whom were French residents. The taxpayer had filed an additional counter-defense during the ongoing appeal proceedings before the tribunal, asserting that the DDT rate should not exceed the rate set in the tax treaty between India and France.
The court of the tribunal in Mumbai admitted the counter-objection filed by the taxpayer and then expressed doubts about the correctness of the above decisions of the coordinated courts of the tribunal. There were the following main reasons / perspectives why it questioned the correctness of these previous decisions:
- DDT should be viewed as a tax on the company rather than a shareholder, so contract protection is not available to resident companies without a specific provision
The tribunal argued that DDT should be considered a tax liability of the dividend-paying company and that it would be paid by that company. In this regard, the Tribunal relied on the Supreme Court ruling in Godrej & Boyce Manufacturing Company Limited v DCIT [(2017) 394 ITR 449 (SC)]where the Supreme Court ruled that DDT cannot be equated with a tax paid on behalf of the beneficiary shareholder. The Tribunal also added that in a situation where taxes are considered to be paid by an India based company in relation to its own liability in India, such taxation in India will not be governed by any provision of the tax treaty (applicable to non- Residents), unless the double taxation agreement contains a special provision.
- Where intended, the provisions of double taxation treaties expressly provide for the treaty to apply to taxes such as DDT
The tribunal found that wherever the contracting states of a double taxation agreement wish to extend the protection of the agreement to DDT, this is expressly provided for in the double taxation agreement itself. As an example, the tax treaty between India and Hungary was cited, in which the protocol to the tax treaty explicitly states that the taxation of distributed profits of an India-based company that pays dividends is deemed to be taxed in the hands of the shareholders and that it is 10% do not exceed the gross amount of the dividend. The court found that in the absence of such a provision in other tax treaties, it cannot be inferred that the DDT rate should be limited by the applicable tax treaty provision.
- No tax credit for shareholders
The tribunal found that tax treaties do not provide for tax credits in the hands of shareholders in relation to DDT paid by the company in which the shares are held. The Tribunal argued that in such a case, DDT cannot be equated with a tax paid by or on behalf of a shareholder.
- Foreign jurisdiction on taxes like DDT
With regard to the foreign jurisdiction on DDT-like taxes, the Tribunal cited the judgment of the South African High Court in Volkswagen of South Africa (Pty) Ltd v Commissioner of South African Revenue Service (Az. 24201/2007). The South African High Court ruling concerned a tax similar to DDT, known as the Secondary Tax on Companies (STC), paid on the distribution of dividends. In this case, STC was found to be a tax on “a company that declares dividends, not dividends”. The Tribunal found that while the views expressed by a foreign judicial authority are not binding on any judicial authority in India, their views deserve a fair and open-minded examination
After giving reasons for doubting the accuracy of previous decisions, the court referred the matter to the Mumbai Tribunal for review to a special bank (composed of three or more members of the tribunal). The specific question that was raised regarding the examination of the special bank was formulated as follows:
“Whether the protection afforded by the double taxation treaties under Section 90 of the Income Tax Act 1961 with regard to the taxation of dividends in the source state can be extended to the dividend without a corresponding specific treaty provision”. Section 115-O dividend tax in the hands of a domestic company ? “
The above reference and the composition of the special bank are subject to approval and any changes by the President of the Tribunal.
A special bench of the tribunal is generally formed when opposing views are held on the same issue from different seats of the tribunal. The decision of a special bank is binding on all chambers of the tribunal in the matter decided by the special bank.
In this latest judgment, while the Tribunal did not deliver a final judgment contrary to that of the previous seats of the Tribunal, the Tribunal relied on the Supreme Court’s judgment in Union of India v Paras Laminates Private Limited [(1990) 186 ITR 722 (SC)] to justify the reference of the case to a special bank. In the above judgment, the Supreme Court ruled that it was appropriate and effective to refer the case to a major instance if a judicial authority found the decision in a previous case to be flawed.
Given the nature of the problem, with multiple principles of law relevant, with some assisting the taxpayer while others assisting the revenue, timely referral to a special bank (rather than delivering a conflicting judgment or waiting for the High Court / Supreme Court the decision is made by debate) is certainly a constructive step. Unless the order of a special bank is overturned by the High Court / Supreme Court or the law is changed, this is a binding precedent.
Given the divergence in opinion among jurisdictional authorities, taxpayers who have requested or intend to request a refund for DDT paid in the past (i.e. DDT in excess of the tax rate on dividends in the applicable tax treaty) may move their position forward.
The next step that needs to be watched closely is whether a special bank will be formed to rule on the matter, and if so, how the special bank will decide on it. Still, as noted earlier, readers should be aware that the problem is per se is only relevant for the tax liability of the years before 2020-21.
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