DTAA vs. DDT: Resolving the Taxation Dilemma

[Shubhanshi Suman]

Introduction:

The discussion with regard to what should be the rate at which the domestic company should be taxed while paying dividends to a foreign shareholder was opened in the case of GIESECKE AND DEVRIENT [INDIA] PVT LTD VERSUS THE ADDL. C.I.T SPECIAL RANGE -04 NEW DELHI - 2020 (10) TMI 750 - ITAT DELHI, where the Delhi tribunal of ITAT passed an order that the provisions stipulated in the Double Tax Avoidance Agreement (hereinafter, “DTAA”) should prevail over the provisions of the Income Tax Act, of 1961 (hereinafter, “the Act”). Further, the Kolkata Bench in its decision of DCIT, CIRCLE-10 (1) , KOLKATA VERSUS M/S. INDIAN OIL PETRONAS PVT. LTD AND (VICE-VERSA) - 2021 (5) TMI 152 - ITAT KOLKATA., took a similar view. This discussion was recently raised again in the case of DEPUTY COMMISSIONER OF INCOME TAX CIRCLE 11 (3) (1) , MUMBAI VERSUS TOTAL OIL INDIA PVT. LTD. AND (VICE-VERSA) AND MARUTI SUZUKI INDIA LIMITED. VERSUS DEPUTY COMMISSIONER OF INCOME TAX CIRCLE 16 (1) , DELHI AND (VICE-VERSA) AND GUJARAT GAS CO. LTD. VERSUS JOINT COMMISSIONER OF INCOME TAX/DCIT, CIRCLE-4, AHMADABAD AND THE ACIT, CIRCLE-4, AHMADABAD VERSUS GUJARAT GAS CO. LTD. AHMADABAD AND GUJARAT GAS CO. LTD. AHMADABAD VERSUS JOINT COMMISSIONER OF INCOME TAX/DCIT, CIRCLE -4, AHMADABAD - 2023 (4) TMI 988 - ITAT MUMBAI (SB), where the Special Bench of Mumbai Tribunal took a different view and adjudged that the tax should be levied as per the rate specified under the Act and not under the provisions stipulated in the DTAA. An analysis of the literal and statutory meaning of Section 115-O of the Act and the necessary provisions of the DTAA read with the provisions of the Act could resolve the Dividend Distribution Tax (hereinafter, “DDT”) taxation dilemma.

Interpreting the DTAAs and the Most Favoured Nation (MFN) Clause.

Chapter IX of the Act is on Double Taxation Relief. The Central Government by means of Section 90 of the Act could enter into an agreement with any country outside India or with any specified territory as the condition may be for granting relief in tax with respect to; (a) Income on which has been paid both income-tax under this Act and income-tax in that country or specified territory; (b) income-tax chargeable under this Act and under the corresponding law in force in that country or specified territory. There are four model forms of DTAA that exist. First, The OECD Model Convention which is based on the residence principle; Second, the UN Model Double Taxation Convention which is based on a combination of the Residence and Source principles. Third, the US Model Income Tax Convention is followed for entering into DTAAs with the US. Fourth, the Andean Community Income and Capital Tax Convention is adopted by the member states, namely, Bolivia, Chile, Ecuador, Columbia, Peru, and Venezuela. India has DTAAs with various countries as per the OECD Model Convention.

Section 90(1) of the Act states that “the Central Government may by means of a notification in the Official Gazette make such provisions as may be necessary to promote mutual economic relations, trade, and investment; or for the avoidance of double taxation of income under this Act and under the corresponding law in force in that country or specified territory, as the case may be; or for exchange of information for the prevention of evasion or avoidance of income-tax chargeable under this Act or under the corresponding law in force in that country or specified territory, as the case may be, or investigation of cases of such evasion or avoidance; or for recovery of income-tax under this Act and under the corresponding law in force in that country or specified territory, as the case may be for implementing the agreement.” This provision includes the provisions of the MFN clause, that is present in the DTAA agreement of various countries. The MFN clause in an international tax agreement encapsulates provisions for favoring the nations with respect to trade and liberal taxation. The MFN Clause is included in the Protocol to India’s Double Taxation Avoidance Agreements (DTAAs) with a number of nations, particularly the European States and OECD members (the Netherlands, France, the Swiss Confederation, Sweden, Spain, and Hungary). In most of the treaties with which India has the MFN clause, are charged DDT at the most concessional rate of 5% to 10% like the DTAA between India and Slovenia.

In the recent judgment of ASSESSING OFFICER CIRCLE (INTERNATIONAL TAXATION) 2 (2) (2) NEW DELHI VERSUS M/S NESTLE SA - 2023 (10) TMI 981 - SUPREME COURT, the Apex Court ruled that the benefits under the MFN clause under the DTAAs can only be availed if the same has been separately notified by the Government. It is to be noted that India has not issued any notification importing the benefit of treaties with Slovenia, Lithuania, and Colombia to treaties with The Netherlands, France, or the Swiss Confederation. However, despite the absence of such a clause, the law is to be read with respect to Section 90 which contains the provisions for creating a DTAA, and then stipulations regarding beneficiary provisions are to be read.

Beneficiary Provisions:

The provisions stipulated in Section 90(2) of the Act make it clear that where a treaty for the avoidance of double taxation has been entered into, then in relation to the taxpayer to whom such treaty applies, the provisions of the Act, to the extent that they are more beneficial as compared to the provisions of the DTAA, would have to be applied and vice versa. India has entered into the DTAA agreements by means of Section 90. It is clearly understood by the wording of Section 90(2) that the provision that is more beneficial to the assessee is to be applied in the case of conflict between the provisions of the Act and the DTAA.

Section 115-O of the Income Tax Act, of 1961 deals with the provisions for DDT charged on domestic companies with respect to paying dividends to its shareholders. As per this provision, the domestic company is to be charged at the rate of 15% plus surcharge and allowances when it distributes dividends to its shareholders. The provision starts with a non-obstante clause, which states that this provision is not subject to the other provisions of the Act. However, the DDT code of Chapter XII D cannot be read in isolation from the other provisions of the Act. It falls under the definition of “Tax” as per Section 2(43) of the Act. It cannot be read in isolation with the interpretation clauses. It is noted that every tax is chargeable under Section 4 of the Act which is the charging section. Section 4 of the Act is further subject to the beneficial provisions of Section 90 of the Act as has been upheld in the case of UNION OF INDIA AND ANOTHER VERSUS AZADI BACHAO ANDOLAN AND ANOTHER- 2003 (10) TMI 5 - SUPREME COURT. Hence, it could be rightfully concluded that Section 115-O of the Act is also subject to the beneficial provisions of Section 90. In the case of DDT, Section 115-O of the Act provides a rate of tax of 15% plus surcharge and cess, while Article 10 of the treaties based on the OECD Convention sets the rate of 10% to be charged as DDT. Many of the agreements that contain the MFN Clauses set the rate of 5% to be taxed as DDT. Since the rates specified in these treaties are more beneficial for the assessee, the assessee should be charged for DDT under the rates stipulated in the DTAAs.

Interpreting Section 115-O of the Act.

It was observed by the Hon’ble Supreme Court in the case of KESHAVJI RAVJI AND CO. VERSUS COMMISSIONER OF INCOME-TAX - 1990 (2) TMI 1 - SUPREME COURT that even in taxing statute, it is aimed to give effect to the intention of the legislature, when strict literal construction leads to a result not intended by Parliament, another construction permissible in the context should be adopted. Section 115-O of the Act was introduced for the purpose of administrative convenience. The intent of the legislature behind introducing such a provision was only because the tax collection by way of Tax Deducted at Source (TDS) was cumbersome and involved a lot of paperwork.

The levy under Section 115-O is on the company charged for and on behalf of the shareholders. With the introduction of Section 115-O, the provision of Section 10(34) was also introduced. This provision exempted tax chargeable on the hands of the shareholders by way of income (dividend) received under Section 115-O of the Act. This provision suggests that the tax charged under the said provision is to be charged for and on behalf of the shareholder, although the incidence of paying tax is on the company paying the dividends. The rule of contextual interpretation could be applied to interpret the legislative intent behind the introduction of such a provision. The provisions of Section 115-O and Section 10(34) were introduced together by the Finance Act of 1997, withdrawn in 2002, reintroduced in 2003, and again has been withdrawn in 2020. The legislative intent behind the withdrawal of such a provision is to charge the shareholders for the dividends they receive. The CBDT Circular No.763 dated 18/02/1998 also clarifies that the levy of DDT is on the shareholders and not on the company. Section 115-O can also be interpreted with its analogous provision of Section 115R, which is the tax on distributed income to unit holders. This provision also has a supplementary provision of Section 10(23D) that exempts tax liability from income from mutual funds. It would be absurd to assert that mutual fund income is taxable under Section 115R and not taxable under Section 10(23D). The absurdity is removed when the two clauses are read together. Only the dividend income of the unit holder must be taxed by mutual funds; their own income is exempt. Hence, the income of the unit holder that the Mutual Fund is required to pay tax on constitutes the subject matter of tax under the provision of Section 115R (2) of the Act.

In the case of Union of India v. Tata Tea Company Ltd., the apex court concluded that DDT is a levy on the shareholder and not the company after considering the Finance Act of 1997, Article 246 of the Indian Constitution, the concurrent list, the state list, and various decisions. It was stated that the provisions have been introduced for ease of collection of tax, and the charge has consequently been transferred to the company, by exempting it in the hands of the shareholders.

Analysis of the decision in the Total Oil case.

While the interpretation of the law strictly suggests that the tax rate more beneficial to the assessee should be applied, the Special Bench of the Mumbai Tribunal has taken a completely different view in the context of Section 115-O. The tribunal has read the provision as a separate charging provision and taken the view of reading the provision in total isolation from the Act. The Tribunal has not considered the beneficiary provisions stipulated in Section 90(2). It has pondered the issue of who has the liability to pay the tax. On a bare perusal of the wording of the provision, it has been interpreted that the charge under Section 115-O is levied on the company. The decision is based on the hypothesis that DDT is a tax charge levied on the company and the company should pay the DDT as per the provision of the Act. The fact that the company distributes dividends to a non-resident shareholder that has DTAA with India has not been taken into consideration by the Special Bench of the Mumbai Tribunal.

Conclusion:

The judgment of the Special Bench of the Mumbai Tribunal has set a precedent that could adversely affect the assessee who distributes dividends to a non-resident shareholder. This judgment is binding to the MNCs and entities that distribute dividends to non-resident shareholders, especially those based in Mumbai. The tribunal has interpreted the entire domain of the DTAAs under the OECD convention in a completely different manner. The Apex Court in the case of RAM JETHMALANI VERSUS UNION OF INDIA - 2011 (9) TMI 69 - SUPREME COURT, observed that a treaty does not need hyper-technical or hair-splitting interpretation. Instead, it needs to be interpreted as a commercial document between two private parties. Hence, the discussion on this matter should open again at the High Court of Bombay where the law should be interpreted as per the intent of the legislature and not just by interpretation through literal construction of the law.