FPIs will have to furnish residency certificate to avail treaty tax benefit

Foreign portfolio investors (FPIs) will have to submit their tax-residency certificate (TRC) to companies in which they have invested, to avail lower treaty rates on dividends, said a senior government official.

He said the Central Board of Direct Taxes (CBDT) will soon come out with a detailed circular to allay concerns and help companies and FPIs to transition to the new system smoothly. 

At present, the withholding tax provisions do not allow Indian companies to apply lower treaty rates while deducting tax at source (TDS) on dividends paid to FPIs.

On February 1, the government in the Union Budget proposed to apply TDS according to the treaty rate for FPIs.

According to the proposal, advanced tax liability on dividend income would arise only after the declaration or payment of dividend. The move was to further rationalise TDS on dividends for FPIs, bringing it on a par with treaty rates, which could be 5-15 per cent — lower than the 20-per cent tax rate (plus surcharge and cess) applied by companies, so far.

However, companies had expressed reluctance to pass on the benefit citing operational difficulties.

“They (FPIs) do not have to submit any additional undertaking or supplementary documentation, other than TRC, to avail lower rates,” said the official. He also said the Finance Bill, 2021, would entail amendments to Section 196 D of the Income Tax Act which deals with FPIs.

While FPIs are also classified as non-residents, withholding tax rates for them are provided under a separate section 196D of the Income Tax Act. This section specifies a rate of 20 per cent (plus surcharge and cess) on dividends paid. Currently, it does not provide for a lower withholding rate, even if an FPI’s tax liability is lower on account of an existing tax treaty.

There is no such flexibility to deduct tax at a lower rate, even if an FPI invests from a treaty country that provides for a lower rate based on India’s double tax avoidance agreement (DTAA) with that country, official explained.

Experts said in the absence of clarity, some companies may want to ask for various supporting documentation and information to ensure that an FPI is eligible for treaty benefits, especially from the perspective of the general anti-avoidance rules. This could be a subjective determination and would put a lot of onus on Indian companies, given the limited time frame between the date of declaring dividends and payment.

“If the tax authorities notify the list of documents which can be relied on by companies for the purpose of granting treaty benefits, I think it will ease the concerns and make the withholding process smooth from the perspective of Indian companies, as well as FPIs. Indian companies won’t be exposed to the risk of tax and penalties if they rely on the notified documents and FPIs can keep such documentation ready in advance of the dividend declaration date,” said Rajesh H Gandhi, partner, Deloitte India. 

Earlier, tax deducted for non-residents (other than FPIs) was as high as 30-40 per cent if they did not have a treaty arrangement. However, the previous budget had addressed the issue. But for FPIs, the TDS remained at 20 per cent under Section 196D; this section did not allow for treaty rates even if they are lower.

FPIs structured as trusts, for instance, will have to pay TDS of 28.5 per cent, which includes 20 per cent tax on dividends, 37 per cent surcharge and 4 per cent educational cess.