The Union Budget has rationalised the tax on dividends for foreign portfolio investors (FPIs), bringing it at par with treaty rates, which could be lower than the 20 per cent tax rate applied today. Last year’s Union Budget had created uncertainty regarding the amount of tax that had to be withheld on dividend paid to non-residents. This was because the exact tax rate was not specified under Section 195, which covers tax deducted at source (TDS) or withholding tax for non-residents.
The Finance Act, 2020, had clarified that a withholding tax rate of 20 per cent plus surcharge and cess be applied for dividends paid to non-residents under Section 195. Also, lower rates could be applied for residents coming from jurisdictions with which India has entered into a double tax avoidance agreement (DTAA).
But while FPIs are classified as non-residents, the withholding tax rates for these 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. However, it does not provide for a lower withholding rate even if the FPIs’ tax liability is a reduced one on account of an existing tax treaty.
At present, firms withhold tax at the rate of 20 per cent plus surcharge and cess on the dividend paid to FPIs even if they invest from a jurisdiction that provides for a lower rate based on India’s DTAA with that country. The lower rate could be 5 per cent, 10 per cent, or 15 per cent.
“Rationalising TDS on dividends for FPIs to reduce it to treaty rates ranging from 5 to 15 per cent, depending on the country of residence of FPIs from current rate of 20 per cent will provide a big cash flow relief for FPIs,” said Sunil Gidwani, partner, Nangia Andersen.
This does away with the need for FPIs to claim credit for excess taxes withheld by the Indian companies, adjusting it against their aggregate annual tax on all sources of income or claiming it as refund. The Budget has also provided that advance tax liability on dividend income will arise only after the declaration or payment of dividend. This will ease the burden for investors as it was difficult to estimate the quantum of dividend income correctly.
The Budget has taken initiatives to make GIFT IFSC one of the leading international financial centres at par with London, New York, Hong Kong, Singapore, and Dubai.
It has proposed exempting funds and fund managers from safe harbour rules if they manage offshore funds from the International Financial Services Centre (IFSC).
“Some of the onerous conditions currently required to qualify for the safe harbour rules may not apply if you are managing a fund from IFSC. This will encourage all the local fund managers to set up fund management companies at IFSC,” said Gidwani.
The Budget has provided for a tax-neutral relocation of foreign funds to the IFSC with continuity of original treaty benefits on the lines of merger and demerger provisions, which will encourage foreign funds from jurisdictions such as Mauritius and Singapore to move to IFSC.
“Providing for a tax-neutral transfer of investment from offshore funds to the IFSC AIF, along with corresponding amendments like provision for considering the holding period and cost of previous owner, non-lapsing of losses at the investee entity level, makes this a thought through amendment package to further incentivise the Indian fund management industry and result in a corresponding boost to the fund management activity in the IFSC,” said Tushar Sachade, partner, PwC India.
The Budget has extended the tax holiday to investment division of banking units in IFSC on the lines of Category-III AIFs investing in India. This will enable such banks to invest in the INR market without taxation.
Exemption is given to foreign aircraft lessors from aircraft lease rentals paid by a lease in IFSC.