How 1996 World Cup is back to haunt foreign portfolio investors

The Budget earlier this year announced a 20% withholding tax on dividends paid to FPIs

A recent Supreme Court ruling on the 1996 Cricket World Cup could have implications for foreign portfolio investors.

The ruling held that provisions for deducting tax at source will apply even to those covered by tax avoidance treaties. The Budget earlier this year announced a 20 per cent withholding tax on dividends paid to FPIs. Taken together, it may mean FPIs cannot seek treaty protection against the new withholding tax that companies are required to deduct at source, according to experts. The apex court order pertains to when the cricketing bodies of Pakistan, India, and Sri Lanka formed a joint committee to conduct the 1996 Cricket World Cup. The panel had made certain payments overseas as part of the tournament.

“India, Pakistan, and Sri Lanka were selected, on the basis of competitive bids, to have the privilege of jointly hosting the 1996 World Cup. These three host countries were required to pay varying amounts… in connection with conducting the preliminary phases of the tournament and also for promoting the game in their respective countries,” noted the order.

The tax department later said it should have deducted taxes for the same. The final Supreme Court order on the matter came on April 29, where it ruled in favour of the tax authorities while also noting that a Double Taxation Avoidance Agreement (DTAA) cannot shield investors from a withholding tax.

“The obligation to deduct tax at source under Section 194E (of the Income-tax Act) is not affected by the DTAA and in case the exigibility to tax is disputed by the assessee on whose account the deduction is made, the benefit of the DTAA can be pleaded and if the case is made out, the amount in question will always be refunded with interest. But, that by itself, cannot absolve the liability under Section 194E,” it said.

 

A senior tax consultant said Indian firms will now have to withhold taxes at 20 per cent (plus surcharge and cess) even if an FPI is eligible for a lower rate under the tax treaty. An FPI can either adjust the excess taxes withheld against their tax on capital gains or claim a refund of excess taxes in their tax return. Not all funds are making a gain because of the state of the capital market. Seeking a refund would mean waiting for a year or more.

“Foreign investors also effectively paid a slightly lower amount under the old dividend distribution tax regime. While FPIs may be net gainers in the new scheme of things, waiting a year or more for a tax refund can be cumbersome. It could be a huge cash flow issue,” said the person.

There was some hope earlier of some relaxations for FPIs coming from treaty jurisdictions. Some of them, such as those from Hong Kong, had only a 5 per cent tax rate. Firms that have recently declared dividends have been deducting taxes at 20 per cent, according to a source.

The exchange data shows that major firms that have declared dividends include information technology companies Infosys and TCS as well as biscuit maker Britannia Industries. Infosys declined to comment, while the other two companies did not respond to an email query about how they were dealing with the issue.

Rajesh H Gandhi, Partner at Deloitte Haskins & Sells, agreed refund may take time to come. “Ideally Indian companies should have been allowed to withhold tax at treaty rates based on prima facie evidence and the onus should have been put on the investor to prove treaty eligibility, if needed,” he said.