Dividend tax on foreign payouts to be capped at treaty rate: Bombay HC

Bombay High Court says dividend tax paid by Indian firms to foreign parents must be capped at treaty rates, a ruling that could open large refund claims for multinationals

The Goa Bench of the Bombay High Court has ruled that tax on dividends paid by Indian companies to their foreign parents must be capped at the rate prescribed under tax treaties instead of the one under domestic law. 

The late November ruling, accessed this week, came in a case involving Colorcon Asia, the Indian subsidiary of United Kingdom-based pharma ingredients company Colorcon. The subsidiary had paid over ₹82 crore as dividend distribution tax (DDT) on dividends sent to its British parent between FY16 and FY19. 

According to industry experts, the ruling is likely to trigger refund claims by multinationals, reopening several settled matters relating to past dividend payouts. 

Before April 1, 2020, companies paid tax before distributing dividends to shareholders. This tax was called DDT, charged under Section 115-O of the Income-Tax Act, 1961, which required companies here to pay an additional tax on dividends declared or distributed. 

Though the tax was paid by the company, dividends were exempt in the hands of shareholders. 

Colorcon paid DDT at an effective rate of over 20 per cent as prescribed. It later approached tax authorities seeking the benefit of the India-UK Double Taxation Avoidance Agreement (DTAA). Under Article 11 of the treaty, tax on dividends paid from India to a UK resident cannot exceed 10 per cent. 

However, the Income Tax Department rejected the claim, arguing that DDT was a tax on the Indian company and not on the foreign shareholder. Since tax treaties apply only to income earned by the recipient, the department said treaty protection could not be claimed on DDT. Relying on this view, the Board for Advance Rulings (BFAR) had ruled against Colorcon in June last year. 

The Bombay High Court disagreed with this interpretation. After analysing the history of dividend taxation in India, repeated changes to Section 115-O, and the structure of the India-UK treaty, the court held that DDT was, in substance, on the dividend income of shareholders even though it was collected from the company for administrative convenience. The court said merely shifting the burden of payment from shareholder to company did not change the basic nature of the tax. Since the income retains its character as dividend income, treaty protection under Article 11 must apply, and India cannot tax such dividends beyond 10 per cent. 

Although the DDT regime was scrapped in April 2020 and dividends are now taxed directly in the hands of shareholders, several disputes relating to the earlier period are pending. Tax experts say the ruling could lead to a significant revenue impact for the government. 

“This decision vindicates the proposition canvassed by taxpayers that the rate of DDT applicable to dividend paid by an Indian company to an overseas shareholder is circumscribed by the rate prescribed in the tax treaty. The high court has clarified that for the applicability of the treaty, what is relevant is the nature of income (ie dividends) which is covered by the treaty provisions and not in whose hands it is taxed,” said Himanshu Parekh, partner, KPMG. 

Even if the tax liability is on the Indian company, the rate given in the treaty would be applicable in such cases. This is a landmark decision that will provide relief to taxpayers, according to Parekh.