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Direct Tax Alert: Benefits of Tax Treaty extended qua the Dividend Distribution Tax rate

15 October 2020


Recently, the Finance Act 2020 abolished the Dividend Distribution Tax (DDT) regime and brought in the classical system of taxation. Prior to the abolishment, under the erstwhile DDT regime, Indian Companies were required to pay DDT at applicable rates under section 115-O of the Income-tax Act, 1961 (IT Act) in respect of dividend declared, distributed or paid by them. Since most of the Tax Treaties provided for concessional rate of 5%/10%/15% of the gross amount of dividend, Indian Companies have been requesting the tax officer to cap the rate of DDT, in respect of dividends paid to their overseas investor(s), at the Tax Treaty rate (i.e. 5%/10%/15% as the case may be). In this regard, Delhi Income-tax Appellate Tribunal (Delhi Tax Tribunal) in the case of Maruti Suzuki Ltd1 had passed an interim order admitting the additional ground on applicability of treaty rate to DDT rate. Please click here  to ready our alert on Maruti Suzuki Ltd’s decision.

Recently, the Delhi Tax Tribunal2 got another occasion to delve on admissibility of additional ground on similar facts (i.e. applicability of treaty rate to DDT rate). The Delhi Tax Tribunal has not only admitted the additional ground but also ruled in the favour of the taxpayer i.e. the benefit of Tax Treaty is available qua the DDT rate. We, at BDO in India, have summarised this ruling and provided our comments on the impact of this decision.

Facts of the case:

Taxpayer, wholly owned subsidiary of German Company, primarily deals in trading of Currency Verification and Processing Systems. The taxpayer imports these machines from its Associated Enterprises (AE) for resale in India and as part of the related services, the taxpayer also buys and resells annual maintenance contracts to its customers in India. Further, it is engaged into distribution and personalisation of smart cards in India; renders software development services to its AE.

During the fiscal year 2012-13, the tax officer made Transfer Pricing adjustments; disallowance under section 40(a)(i) of the IT Act; and disallowed advances written off which were partially upheld by Dispute Resolution Panel (DRP). Aggrieved with partial relief granted by the DRP, the taxpayer filed an appeal before the Delhi Tax Tribunal. Before the Delhi Tax Tribunal, the taxpayer also raised an additional ground as to whether the benefit of the Double Tax Avoidance Agreement between India and Germany (Germany Tax Treaty) qua the rate on payment of dividend to the shareholder should be extended or not.

Tribunal ruling:

While the Delhi Tax Tribunal granted relief to the taxpayer in respect of Transfer Pricing adjustments, with respect to disallowance under section 40(a)(i) of the IT Act and advances written off, it restored the matter to the tax officer for verification.

While admitting the additional ground, the Delhi Tax Tribunal observed that similar grievance was raised by way of additional ground of appeal in the case of Maruti Suzuki India Ltd (supra) wherein the Tribunal had admitted the additional ground for adjudication. Hence, the additional ground raised by the taxpayer in the instant case is admitted.

On merits, the Delhi Tax Tribunal held that the tax rates specified in the Germany Tax Treaty in respect of dividend must prevail over DDT rate. The Delhi Tax Tribunal made the following observations:

  • Hon’ble Bombay High Court in case of Godrej and Boyce Manufacturing Company Limited3 has unequivocally held that DDT is tax ‘on the company’ and not ‘on the shareholder’.
  • The burden of DDT falls on the shareholders rather than on the Company, as the amount of distributed profits available for shareholders stands reduced to the extent of DDT levied.
  • Memorandum to Finance Bills 1997 and 2003 clearly establish that levy of tax on the Company was driven by administrative considerations rather than legal necessity and further emphasis on the fact that levy is for all intents and purposes, a charge on dividends.
  • Finance Bill, 2020 has removed section 115-O of the IT Act. In the Memorandum of Finance Bill 2020, it has been mentioned that incidence of tax is on the payer company and not on the recipient where it should normally be as the dividend is income in the hands of the shareholders and not in the hands of the Company.
  • A conjoint reading of the Memorandum to Finance Bills 1997, 2003 and 2020 would show that levy of DDT was merely for administrative conveniences and withdrawal of DDT is keeping in mind that revenue was across-the-board, irrespective of marginal rate, at which recipient is otherwise taxed.
  • DDT is levy on the dividend distributed by the payer company, being an additional tax is covered by the definition of ‘Tax’ as defined under section 2(43) of the IT Act which is covered by the charging section 4 of the IT Act and charging section itself is subject to the provisions of the Act which would include section 90 of the IT Act.
  • The Germany Tax Treaty was notified on 29 November 1996 whereas section 115-O of the IT Act was inserted in the Act by Finance Bill, 1997 which means that the Germany Tax Treaty is pre-dated to the amendment.
  • Reliance was placed on Delhi High Court’s decision in case of New Skies Satellites4 wherein it was held that amendment in the domestic tax law cannot be allowed to have the same retroactive effect on an international instrument effected between two sovereign states prior to such amendment.
  • As the Germany Tax Treaty was notified before the introduction of section 115-O of the IT Act, the tax rates specified in the Germany Tax Treaty in respect of dividend must prevail over DDT.

Article 10.4 of the Germany Tax Treaty specifies that clause 1 and 2 (which provides for tax rate of dividend) will not be applicable if the beneficial owner of dividend has Permanent Establishment in India. As the supporting documents filed by the taxpayer before the Delhi Tax Tribunal needed verification, the Delhi Tax Tribunal restored this issue for limited purpose of verification to the Tax Officer.

BDO comments:

Apart from observing that DDT is an additional tax which comes within the ambit of the term ‘income-tax’, the Delhi Tax Tribunal has heavily relied on the fact that any amendment made post the execution of the Tax Treaties will not have impact on the Tax Treaties executed before the amendment was made. Hence, it is unclear whether this decision will hold true for Tax Treaties that have been notified post the introduction of section 115-O. In light of the peculiar observation made by the tax officer, the taxpayers should evaluate the said aspect before placing reliance on the ratio laid hereby. At this juncture, it would not be out of place to take cognisance of an important observation made by the Delhi Tax Tribunal – income-tax includes additional tax. DDT being additional tax, it is part of income-tax. This observation could help the taxpayer to contend that DDT is also governed by the Tax Treaties and thereby concessional dividend tax rate should be available to the taxpayer. This decision certainly augments the arguments of taxpayers, who have raised similar contentions before Tax Officer / Appellate Authorities/ Courts or who have sought ruling on the subject from Authority for Advance Ruling.

The Delhi Tax Tribunal has relied on Bombay High Court’s decision in case of Godrej and Boyce Manufacturing Company Limited, which has been upheld by the Supreme Court5. Considering this fact, it will be interesting to see if the tribunal decision is challenged by the tax department and on what grounds. While this ruling may have bearing on tax positions on the subject of dividends declared in the past, with abolition of DDT, this decision will have limited implication for dividends paid on or after 01 April 2020.

1. ITA No. 961/Del/2014 dated 31 October 2019. Writ filed against this order has been dismissed by Delhi High Court in WP(C) 1324/2019, order dated 16 December 2019

2. Giesecke & Devrient (India) Pvt. Ltd. Vs Addl. CIT (ITA No. 7075/Del/2017 dated 13 October 2020)

3. 328 ITR 81 (Bom)

4. 382 ITR 114 (Del.)

5. Civil Appeal No. 7020 of 2011 dated 8 May 2017