FPIs may face challenges related to withholding tax on dividend income

Foreign portfolio investors (FPIs) may have to face challenges related to the withholding tax on dividend income, because of changes in the Budget.

The tax applies even to FPIs that might otherwise have been protected from a higher tax rate because of existing treaties. They may require special certificates from the revenue department or have to wait for a refund after filing their returns, say experts. Firms will be required to withhold tax at the rate of 20 per cent (plus applicable surcharge and education cess) on dividend to FPIs once the Budget changes come into effect. 

At present, they do not appear to have the flexibility to deduct tax at a lower rate, even if the FPI invests from a treaty country that provides for a lower rate based on India’s double tax avoidance agreements (DTAA) with that country, noted Suresh Swamy, partner (financial services), PwC. 

This applies even if the FPI satisfies all conditions for availing of treaty benefits, according to him. For example, an FPI from Hong Kong should be entitled to a 5 per cent rate under the India-Hong Kong treaty, but the tax deducted will attract a rate upwards of 20 per cent. “Like other non-resident entities, FPIs should also be given an option to approach the tax department for obtaining a lower withholding tax certificate, in case they satisfy treaty conditions,” he said. 

“At present, FPIs do not have that option. Companies should also be directed to respect such certificates and deduct tax only at the rate specified in the certificate,” he added.

Rajesh H Gandhi, partner at Deloitte Haskins & Sells, said the provision for tax deduction at source existed earlier too, but wasn’t applicable to dividends, given that they were exempt from tax in the hands of shareholders. 

“The introduction of tax on dividends has widened the scope of the provision, since it applies to all income with respect to securities,” he said. The earlier regime had a dividend distribution tax. The Budget has sought to replace it with taxation based in the hands of investors, depending on their tax slab. This change has led to concerns over FPIs’ dividend income.

The law should ideally be amended so that FPIs claiming treaty benefits may avoid the higher withholding tax, said Gandhi.

“The said section, inter alia, provides that where any income in respect of securities…is payable to a Foreign Institutional Investor, the person responsible for making the payment shall, at the time of credit of such income to the account of the payee, or at the time of payment thereof in cash or by the issue of a cheque or draft or by any other mode — whichever is earlier — deduct income tax thereon at the rate of 20 per cent,” according to the Finance Bill 2020.

A change in the law before it is passed is a cleaner way of addressing the situation, according to Pranav Sayta, National Leader, International Tax and Transaction Services, EY India. “A circular would be enough, but it would be better if it is changed in the law itself,” he said.