Clarify 'Tax' in tax treaties

In the tax treaties signed by India with other countries, the term “tax” is generally defined to mean the income tax, including any surcharge thereon. Certain tax treaties also cover in the definition of tax, any identical or substantially similar taxes.

The significance of the definition of “tax” lies in that the treaty partners agree that a tax payer should not be required to pay “tax” on the same income in both the treaty signing States. If tax is charged in one country, that income will not be subjected to tax in the other country. But if tax is charged in the other country also, that other country will give a credit for the tax paid in the first mentioned country against the tax payable in that other country.

 

In Indian context, the definition of “tax” has created a confusion. Two glaring examples of such confusion are illustrated below:

Additional Tax (Tax on distributed profits)

The additional tax is payable by a company in India which declares dividend.

Dividends are generally paid by companies out of their post tax profits. Thus, the dividend–paying company first pays income tax on its profits and then pays dividend out of the balance profits.

Thus, the dividend recei-ved by a shareholder is out of the profits which have already suffered tax . Therefore, if the person receiving divid-end is again liable to pay income tax, it virtually amounts to double taxation of the same income.

However, with a view to encourage investment in the corporate sector, the tax on dividends paid by a domestic company has been totally abolished in India. But while abolishing the tax on dividend income, the government inserted a new provision of ‘additional tax’ on the distributed profits. The rate of the said additional tax is currently 15%.

The provisions relating to additional income tax have inflicted an unintended hardship on foreign investors. Prior to imposition of additi-onal income tax, the income tax withheld on dividends was allowed as a credit aga-inst the tax payable on that income by the foreign investor in his country of residence.

However, after the amendment, the additional income tax paid by an Indian company is unlikely to be allowed as a credit in the home country of the foreign investors. This anomalous situation arises because the additional income tax is paid by the Indian company and not by or on behalf of the recipient of the dividend. Furthermore, the term ‘additional income-tax’ is foreign to all the tax treaties made by India. Thus, the incentive provided in Indian law by exempting dividends from tax in fact does not benefit a foreign investor.

Therefore, the tax treaties require a review, so that the tax incentive of exempting dividend income in India is duly passed on to the foreign investors.

Fringe Benefit Tax (FBT)
The Fringe Benefit Tax is charged as additional income tax in respect of the fringe benefits provided by an employer to his employees. Tax is calculated @30% on the value of fringe benefits.

Thus, a company having any employees in India is liable to pay FBT. However, the term FBT is not covered under any of the tax treaties. With the result, the foreign enterprises which are subjected to FBT in India, will not be entitled to get a credit for the same in their country of residence.

In conclusion, therefore it is necessary to clarify that the term “tax” includes “additional income tax” as well as “fringe benefit tax”. It may be emphasised that the modification of tax treaties will benefit the foreign enterprises without any adverse financial impact on Indian exchequer.

Infact the tax benefit which is intended for foreign investors but is denied due to inappropriate definition of the term “tax”, will become available to them. This will certainly help in encouraging foreign investment in India.

H.P. Agrawal 
The author is a Partner in 
SS Kothari Mehta & Co.) 
hp.agrawal@sskmin.com