Till 31st March 2020, the dividend income was exempt in the hands of shareholders because the company used to pay tax in the form of Dividend Distribution Tax (DDT). Thus, the shareholders received dividends net of taxes, providing them the tax exemption. This was also applicable on dividends received by the non-resident shareholders. However, from 1st April 2020, the government eliminated the dividend distribution tax. Thus, dividend income became taxable in the hands of the shareholders from 1st April 2020. But what changed for the domestic resident companies, especially when it comes to paying dividends to non-resident shareholders? Well, a lot of things. Let’s understand the impact of DTAA on DDT before and after the abolishment of DDT in India.
The Income Tax Appellate Tribunal (ITAT) in Mumbai made a ruling on 20th April 2023 that domestic resident companies in India are not allowed to use the Double Taxation Avoidance Agreements (DTAA) to offset their DDT liabilities. This ruling was made in the case of Total Oil India Private Limited. It is a resident company having non-resident shareholders in France whereby, dividends were paid to these shareholders in AY 2015-16.
The case discussed the issue as to whether the domestic companies shall pay additional income tax as per the rates specified in Section 115-O or as per the rates applicable to the non-resident shareholders as per the DTAA on receipt of dividend. In simple terms, DDT is eligible for DTAA benefits? The company contended that as per the India-France DTAA, DDT paid by them cannot be higher than the rate at which such dividends are taxed in the hands of non-resident shareholders as per the DTAA.
As per the ITAT, the tax treaties cannot be used to reduce the tax liabilities on dividends that are paid by Indian companies as DDT is levied on Indian companies and not on the recipient of dividends. Thus, the rates under section 115-O shall be applicable and not the rates applicable to the non-resident shareholders as per DTAA. The tribunal also emphasized that the countries shall explicitly agree in the double taxation avoidance agreements to extend protection under DTAA to the domestic companies paying the DDT in order for such companies to claim the benefits of DTAA for DDT liability.
After the DDT and Section 10(34) of the Income Tax Act, of 1961 were abolished by the Indian Government, the dividend income became taxable at the hands of the shareholders instead of the companies. Further, the companies are required to deduct TDS @10% before paying dividends to the resident shareholders if the dividend payment exceeds Rs. 5000 during the financial year. Also, Section 194K requires a deduction of TDS @10% before paying income to a resident investor in specified companies or mutual funds. However, the TDS should not be deducted if the income being paid or likely to be paid does not exceed Rs. 5000 during the financial year or it is in the form of capital gains.
In relation to the non-resident shareholders, the companies must withhold TDS @20% before remitting the dividends as per Section 195. However, the non-resident shareholders can opt for the beneficial rate of TDS either under the Income Tax Act or the DTAA.
Thus, the question of DTAA benefits for dividend distribution tax for domestic companies became irrelevant after the DDT was abolished. In respect of TDS, the non-resident shareholders are allowed to benefit from the beneficial rate under income tax law or the domestic tax law. But in relation to the earlier cases for the period when the DDT was applicable, the above ruling will still hold validity. In case you need any assistance in relation to taxation matters, feel free to contact the ASC Group.
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