[Paras Khetan is a 5th year BA.LLB (Hons.) student at the National Law School of India University, Bangalore]
Dividend taxation in India has undergone significant changes over the past few decades. For a substantial duration, India followed a unique system for taxing the dividends declared or paid by a domestic company called the ‘Dividend Distribution Tax’ (“DDT”) under section 115-O of the Income Tax Act, 1961 (“I-T Act”). The DDT regime stipulated a flat 15% rate of tax to be paid by the company declaring the dividend. Due to various reasons, the DDT was repealed by the government, and the taxation of dividends is now governed by ordinary provisions of the I-T Act, treating it as regular income of the taxpayer from 2021 onwards. However, since disputes relating to the applicability of DDT can still arise and continue to find themselves before Income Tax Appellate Tribunals (“ITATs”), clarity around the DDT regime is still necessary.
There existed certain controversy over whether the beneficial provisions of the Double Taxation Avoidance Agreements (“DTAAs”) relating to dividend taxation are applicable to non-residents in case of DDT. This matter was put to rest in the case of Deputy Commissioner of Income-tax v. Total Oil India (P.) Ltd. However, the recent decision in Polycab India Ltd. v. Assistant Commissioner of Income-tax has again stirred up the controversy over this issue. In light of the above background, this article critically analyses the decision in Polycab India, including how the same differs from the earlier settled position of law and how it creates significant uncertainty on the interpretation of DDT.
The Pre-Polycab India Position of Law on DDT
One of the first cases to delve into the controversy surrounding the applicability of DTAAs to DDT was Giesecke & Devrient (India) (P.) Ltd. v. Additional Commissioner of Income-tax. The ITAT held that the rate of taxation of DDT must be restricted by the rate of tax on dividends as provided in the applicable DTAA and thus the taxpayer would enjoy the benefits of the lower taxation rate found in the DTAA. This is possible pursuant to section 90 of the I-T Act which stipulates that the provisions of the DTAAs will prevail over the provisions of the I-T Act to the extent that they are more beneficial to the taxpayer. The ITAT, after relying on the High Court decision in Godrej & Boyce Mfg. Co. Ltd. v. Dy. CIT, recognized that the DDT is a tax on the company and not on the shareholder. However, it nonetheless held that this distinction does not affect the applicability of DTAAs, given their object of eliminating double taxation.
Subsequently, in Deputy Commissioner of Income-tax v. Total Oil India (P.) Ltd, while dealing with the same issue, the ITAT doubted the correctness of the decision in Giesecke & Devrient and referred the matter to a special bench of the ITAT. The special bench decision in Total Oil held that the DDT, under section 115-O of the I-T Act, is a tax on “distributed profits” and not a tax on “dividend distributed”. After a perusal of the relevant Central Board of Direct Taxes (“CBDT”) circulars, Finance Acts and higher court decisions, it held that the DDT is a tax on the company and not the shareholders. Thus, the domain of DTAAs cannot be entered into as there does not exist any double taxation since the non-resident shareholder is not being taxed at all through the DDT. Even though the ITAT does not expressly mention this, it is alluding to the distinction between juridical double taxation and economic double taxation with the latter being relevant only in limited circumstances for the purpose of applicability of DTAAs. This is also discernible from the Commentary to article 10 of the OECD Model Tax Convention on Income and Capital which states that the provision applies only to “the taxation of dividends and not to the taxation of the profits of the company paying the dividends”. It further held that where the parties to the DTAAs intended to extend the treaty protection to DDT, only then can the taxpayers of these countries can claim benefit of the DTAA. For example, the Protocol to the India-Hungary DTAA specifically states that “when the company paying the dividends is a resident of India the tax on distributed profits shall be deemed to be taxed in the hands of the shareholders”.
The ITAT also clarified that the DDT is not paid on behalf of the shareholder, nor does the burden of the DDT fall on the shareholder due to the requirement of “grossing up”. This could be explained through an illustration. Company X declares a dividend of Rs. 85 with DDT applicable at a rate of 15%. Now, for calculating the DDT, it is to be assumed that Rs. 85 is inclusive of the 15% DDT and thus amount for calculating the DDT would be Rs. 100 (i.e., 85/(1-0.15)). Thus, the DDT would be Rs. 15 (i.e. 15% of Rs. 100) and the dividend distributed to the shareholders would be Rs. 85, which is the original dividend declared by the company. Therefore, the burden of the DDT lies completely on the company and is not passed onto the shareholders. Further, the dividend received by the shareholders was exempt from taxation in their hands pursuant to section 10(34) of the I-T Act.
This was followed by subsequent ITAT decisions in Van Oord India (P.) Ltd. v. Deputy Commissioner of Income-tax [2023] 155 taxmann.com 462 (Mumbai – Trib.), Deputy Commissioner of Income-tax, Circle-3(3)(1), Mumbai v. Total Energies Marketing India (P.) Ltd. [2023] 156 taxmann.com 307 (Mumbai – Trib.), Schaeffler India Ltd. v. Assistant Commissioner of Income-tax, Piaggio Vehicles (P.) Ltd. v. Assistant Commissioner of Income-tax, and JC Bamford Excavators Ltd. v. ACIT (International Taxation). All these decisions followed the line of reasoning adopted in the case of Total Oil. Thus, it can be seen that different jurisdictional ITATs have consistently followed the decision in Total Oiland held that DTAAs are not applicable in case of DDT as it is a tax on the company and not the shareholders. However, this consistency and certainty have gone for a toss with the recent decision in Polycab India.
The Decision in Polycab India
In Polycab India, the taxpayer company had declared and paid dividends to its shareholders. One of the shareholders of the taxpayer company was the International Finance Corporation (“IFC”), a member of the World Bank group. A special statute called the International Finance Corporation (Status, Immunities and Privileges) Act, 1958 (“IFC Act”) was enacted by India to give effect to the international agreement establishing IFC. Section 3 and section 9 of article VI of the IFC Act granted immunity from taxation to IFC and stipulated an overriding effect of the IFC Act over all laws in India. The taxpayer company had paid the applicable DDT and had later filed an application for claiming refund of DDT paid in respect of the dividend paid to the IFC since it enjoyed immunity from taxation. The ITAT was called upon to decide this issue.
The ITAT held that the Indian taxpayer company was not liable to pay DDT in respect of the dividend paid to IFC based on a range of reasons. First, it held that the IFC Act has an overriding effect over the I-T Act and thus IFC enjoys immunity from taxation of income. Second, it relied on section 115-O(1A)(ii) of the I-T Act, which stipulates that the amount of DDT payable must be reduced by the amount of dividend paid in respect of the New Pension System Trust. It reasoned that the rationale of this provision is that since any income received by any person under the New Pension System Trust is exempt from taxation, no DDT should be payable in respect of dividends paid to such persons. A similar logic was extended to IFC and other institutions which are exempt from taxation due to certain parliamentary statutes. The ITAT held that this would be in furtherance of the overall scheme of the IFC Act and the legislative intent behind section 115-O(1A)(ii) of the I-T Act. Third, it distinguished the decision in Total Oil by holding that even though DDT is a tax on the company and not on the shareholder, a “nuanced and purposive reading of the statute reveals that this levy of tax is not intended to apply indiscriminatory, particularly in case where recipient IFC enjoys unequivocal statutory immunity from taxation in India”.
Thus, Polycab India has deviated from the settled position of law laid down in Total Oil. In the facts of Polycab India, a direct application of the law laid down in Total Oil would lead to the conclusion that the taxpayer company is liable to pay the DDT on the entire amount of dividends paid as DDT is a tax on the company and not the shareholder. The fact that the shareholder is IFC, which is exempt from income taxation, is not relevant to the levy of the DDT. Further, the reasoning related to section 115-O(1A)(ii) of the I-T Act is absent in the case of Total Oil. This raises a concern that the decision in Total Oil may well be challenged subsequently as the legislative intent behind section 115-O(1A)(ii) of the I-T Act seems to indicate that the legislature is concerned with the income in the hands of the shareholder as well, and not merely the company. This was not argued before the ITAT Special Bench in the case of Total Oil.
However, it is more likely that the decision in Polycab India would be overturned by higher courts due to poor judicial reasoning and that the decision in Total India would continue to govern the field. Considering the binding higher court decisions which have conclusively held that DDT is a tax on the company and not on the shareholders, the decision in Polycab India substantially deviates from this position and is liable to be set aside. Further, the analogy with respect to New Pension System Trust being extended to IFC is not very strong. It can very well be argued that the legislature intended the benefit of no DDT being payable to members of New Pension System Trust only. If the legislature intended a broader scope of section 115-O(1A)(ii) of the I-T Act, it could have included wider language to state that the benefit of this provision would be available to all persons exempt from taxation under the I-T Act. However, the legislature did not make any stipulation to that effect and limited section 115-O(1A)(ii) to the New Pension System Trust only.
Conclusion
Polycab India has departed from the settled position of law laid down in Total Oil and created significant scope of uncertainty and inconsistent approach being adopted by subsequent case laws. It remains to be seen how subsequent case laws would tackle the conflicting positions adopted by these two cases. The nature and applicability of DDT, though no longer applicable, continues to be an important issue, both under domestic taxation and international taxation, with multiple cases coming before ITATs over the past few years.
– Paras Khetan