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Dividend distribution can be a great deal
Fri, 12 Nov 2010 20:22:25 GMT
The Economic Times

Dividend distribution can be a great deal

Every investor’s objective is to make a good return on investment and, as a result, inbound investments and exit options are structured after thorough deliberations and research. However, when it comes to repatriation of dividends — as one of the modes of reaping returns — the high tax rate of dividend distribution tax (DDT) of 16.995% on the dividend declared, distributed or paid by a domestic Indian company to its shareholders, becomes a major irritant.

This is because DDT impacts the Indian company’s bottomline and reduces the profit pool available to the foreign investor.

Also, it is believed that DDT leads to tax leakage and does not qualify for tax credit or exemption in the shareholder’s home jurisdiction, as DDT is paid by the Indian company and not the shareholder (or on the shareholders’ account). In this article, we assess whether this understanding is correct and whether there is a mechanism to reduce the applicable DDT rate, in addition to claiming tax credit for the DDT paid in India.

The government continues the policy of expanding its network of international tax treaties, and is also renegotiating existing treaties that require changes. In recent tax treaties, the government has been open to allowing a credit for DDT paid by an Indian company in the hands of the foreign shareholder.

Moreover, in many tax treaties that India has entered into with OECD and non-OECD countries — namely, France, Spain, Sweden, the Netherlands, Norway, Belgium, Switzerland, Israel, Kazakhstan and the Philippines — there are most-favoured nation (MFN) clauses that seek to promote equalisation of treaty benefits amongst countries.

In an MFN clause, generally, India agrees to grant the residents of the other contracting state (for example, Norway) the same beneficial tax treatment — relating to rate of tax or scope of tax — as is provided to the resident of any other country by virtue of a subsequent tax treaty or protocol. The idea is to avoid discrimination between nationals of two contracting states.

Most of these MFN clauses relate to items of income such as royalties, fees for technical services (FTS), dividends, interest, etc, as such items are generally taxed on a gross basis, and providing such benefits is easier.

For example, a protocol to the treaty between India and France includes an MFN clause that allows French residents to claim benefits on royalty or FTS taxation provided under subsequent treaties with OECD member countries. This has been tested before courts and French residents have been permitted to take the benefit of the US and the Swiss treaties.

A similar MFN clause can be found in the India-Israel treaty that allows Israeli residents to claim benefits under subsequent treaties with countries, regardless of whether they are OECD members or not. Therefore, Israeli residents can claim the benefit of the lower withholding tax rate on dividends that is prescribed in the treaty with Qatar — the Israel treaty prescribes 10%, whereas the Qatar treaty provides 5%, both are subject to conditions — albeit, there is not much of a benefit to be had in this case as India does not tax dividends in the hands of the shareholder.

The above are examples on subsequent treaties prescribing reduced rates on royalty and dividend taxation, and there are similar advantages on credit for taxes paid on distributed profits, and reduced rates of DDT in some Indian treaties. Such treaties limit the rate of the DDT payable by an Indian company in relation to dividends to be paid to a resident of their jurisdiction, and also treat the DDT as having been paid in the hands of the shareholder.

Such provisions allow foreign investors to plug this leakage of DDT by either using treaty jurisdictions that provide for such benefits on DDT, or other jurisdictions that leverage such benefits through MFN clauses. This can be the key for a foreign investor to stake its claim to avail a tax credit for DDT paid in India, as well as to obtain a reduced rate of DDT in India when the domestic company distributes dividends.

This choice of jurisdiction would also vary with other benefits available under this treaty network, such as reduced rate of interest taxation, EU holding company benefits, capital gains benefits, domestic tax scenarios, etc. Apart from the above, one should not lose sight of the proposed Direct Taxes Code that requires a tax residence certificate from a foreign jurisdiction in order to avail the benefit of a specific treaty. For investors who have already invested in the country, redomiciliation options should be considered subject of course to provisions of treaties between those specific holding jurisdictions and the investors’ jurisdictions.

(Mr Raghavan is principal for tax group and Mr Sah is associate at Majmudar & Co)
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