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The Indian domestic tax laws in relation to taxation of dividend
income were amended by the Finance Act of 2020 restoring taxability
of dividend income distributed by companies to the classical system
of taxation of such income in the hands of the shareholder. Prior
to this amendment, for some time, dividend distributed by a company
was subject to dividend distribution tax
(‘DDT’) in the hands of the company
and exempt in the hands of the shareholder. DDT paid by the
company, arguably, did not enjoy benefit of lower withholding tax
(‘WHT’) rate prescribed under Double
Tax Avoidance Agreements (‘DTAA‘),
though during the last few years prior to the amendment now made,
attempts had been made by taxpayers to claim the DTAA rates; an
issue which is currently sub-judice.
The change has once again brought the relevance of DTAAs to
forefront given that DTAAs in most case prescribe a lower rate of
WHT vis-à-vis the WHT rate of 20% applicable on dividend
income in the hands of non-resident under the domestic tax law.
Generally, application of a WHT rate prescribed under a DTAA is
simple and straight forward. However, applying WHT rate where DTAAs
have a Most Favored Nation (‘MFN’)
clause has its nuances which have from time to time been examined
by Indian courts.
In this respect, the Delhi High Court in a recent case of
Concentrix Service Netherlands B.V. vs Deputy Commissioner
of Income Tax & Anr.1
(‘Concentrix‘) had the
occasion to examine applicability of MFN clause under the
India-Netherlands DTAA in context of WHT rate applicable on
dividend income received by the Dutch parent company from its India
subsidiary. Under Article 10 of the India-Netherland DTAA, dividend
received by a resident of one country from the payer of the other
resident country is subject to 10% WHT. However the protocol
provides a MFN clause stating that in respect of dividend,
interest, royalties and fee for technical services
(‘FTS‘), if after signing of the DTAA,
under any Convention or Agreement between India and a third State
which is a member of the OECD, India limits its taxation at source
on such income to a rate lower or a scope more restricted than the
rate or scope provided for in India – Netherlands DTAA, the
same rate or scope as provided for in that Convention or Agreement
on the said items of income shall also apply under this Convention.
Simply put, if the provision of another DTAA subsequently entered
between India and OECD member country is beneficial to the stated
nature of payments, the same would apply notwithstanding the
provisions of India-Netherlands DTAA.
Taxpayer’s Contention
In Concentric, the taxpayer had applied for a WHT order
before the tax authorities seeking 5% WHT rate (as against 10%
prescribed under India-Netherland DTAA) in relation to divided
income taking the benefit of MFN clause and applying the rates
applicable under India-Slovenia2, India –
Lithuania3 and India – Columbia4 DTAA.
It was contended that since India has executed DTAAs with such
other countries which were members of OECD, the lower rate, or the
restricted scope in the DTAA executed between India and such other
country would automatically apply to India-Netherlands DTAA.
This is considering the protocol which inter alia stated
that the protocol “shall form part an integral part of the
Convention” i.e., the subject DTAA.
In support of this plea, reliance was placed on the judgements
in the case of Steria (India) Ltd. vs. Commissioner of
Income-tax-VI5, Apollo Tyres
Ltd. vs. Commissioner of Income Tax, International
Taxation6.
Tax Authorities Contention
The tax authorities however contested the claim putting forth
the following argument:
- that the protocol appended to the India-Netherlands DTAA
providing benefit of the lower rate of WHT or a scope more
restricted would be available only if the country with which India
enters into a DTAA was a member of the OECD at the time of the
execution of the India-Netherlands DTAA, and - the DTAAs with such third States were entered while such States
were OECD member countries.
India’s DTAA with Slovenia, Lithuania and Columbia were
executed prior to such countries becoming OECD member countries.
Since none of the countries, i.e., Slovenia, Lithuania, and
Columbia were members of the OECD, on the date when such States
executed DTAAs with India, protocol appended to the DTAA would have
no applicability.
The Ruling
The Court however ruled in favour of taxpayer holding that:
- the protocol forms an integral part of the DTAA and therefore
no separate notification is required, insofar as the applicability
of provisions of the protocol is concerned, - the state of affairs i.e. the point of time when the third
State should be a member of OECD, should exist not necessarily at
the time when the subject DTAA (India – Netherlands DTAA) was
executed but when a request is made by the taxpayer or deductee for
issuance of a lower rate withholding tax certificate.
The Court went on to draw reference to the decree issued by the
Kingdom of Netherlands on 28.02.20127 where in it was
thus specified:
“Slovenia became a member of the OECD on 21 July 2010.
Under the most favored nation clause in the Protocol to the
Convention, this event has the effect that, with retroactive effect
to July 21, 2010, a rate of 5 per cent will apply to participation
dividends paid by a company resident in the Netherlands to a body
resident in India.”
The Court made an important observation regarding principle of
“Common Interpretation” to be adopted by courts of the
contracting States. This would ensure that Conventions/DTAAs are
applied efficiently and fairly so that there is consistency in the
interpretation of the provisions by the tax authority and courts of
the concerned contracting State. The Court accordingly accepted
application of WHT rate of 5% prescribed under the DTAA with
Slovenia, applying the MFN clause.
Insight for taxpayers
The court ruling reinforces importance of MFN clauses in DTAAs
which, if applied judiciously, present significant opportunity of
tax saving. The ruling provides credence to the application of MFN
clause under DTAAs with countries such as Netherland, France,
Sweden, Hungry and Switzerland enabling application of lower rate
of WHT of 5% on dividend payment as against the 10% prescribed
under the respective DTAAs. The MFN clause also aids in reading
down the scope of certain categories of income, more specifically
FTS in DTAA such as with France, Sweden, Hungry, Belgium and Spain,
restricting taxability in the state of residence only in case of a
permanent establishment in the country of source.
Appropriate application of MFN clause also becomes important
considering that the resident State may allow credit of tax payable
in the country only to the extent of appropriate tax applicable
under DTAA. For instance, Indian DTAAs such as with Netherland and
France prescribe a period of three years within which application
for refund of excess tax levied at source should be filed. Further,
applications for the refund of the excess amount of tax will have
to be lodged with the authority of the State having levied the tax.
This makes it critical to evaluate impact of MFN clause under the
applicable DTAA.
It is also relevant to take note that the Finance Act of 2020
has materially amended provisions relating to filing of income tax
returns by non-residents. As per the current provisions, a
non-resident taxpayer will mandatorily be required to file an
Indian tax return where lower WHT rates as prescribe under DTAA are
applied in respect of income in the nature of royalty/FTS (taxable
on gross basis), interest or dividend. Dispensation to file the tax
return is available only where WHT has been deducted at the rate
prescribed under the domestic tax law. A non-compliance has penal
implications.
Given the significance of MFN clause under DTAAs and the
opportunity such clause offers to reduce the tax cost, taxpayers
will be well advised to evaluate MFN clause under the relevant DTAA
while at the same time ensuring timely fiscal compliance to remain
on the right side of law.
Footnotes
1 W.P.(C) 9051/2020, judgement dated 22 April
2021
2 DTAA executed between India and Slovenia; which
came into force on 17.02.2005 and was notified on
31.05.20
3 DTAA executed between India and Lithuania; which
came into force on 10.07.2012 and was notified on
25.07.2012
4 DTAA executed between India and Columbia; which
came into force on 07.07.2014 and was notified on
23.09.2014
5 (2016) 386 ITR 390 (Delhi)
6 (2018) 92 taxmann.com 166
(Karnataka)
7 (No. IFZ 2012/54M, Tax Treaties, India), published
on 13.03.2012
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