Is India–UK DTAA Benefit Available On Dividend Distribution Tax? Bombay High Court Refers Issue To Larger Bench

The Bombay High Court has referred to a larger bench the question of whether companies paying Dividend Distribution Tax (DDT) can claim the benefit of lower tax rates under the India–UK tax treaty.

The court was hearing appeals filed by Foseco India Ltd. challenging the denial of a refund of excess income tax paid.

The issue, though arising in the context of the India–UK tax treaty, could also affect how similar provisions in other tax treaties are applied.

A Division Bench of Justices G.S. Kulkarni and Aarti Sathe was dealing with a batch of income tax appeals arising from orders rejecting the company's claim for a refund of excess DDT paid on dividends distributed to its UK-based shareholders.

The company had contended that such dividends ought to have been taxed at the lower rate under the India–UK Double Taxation Avoidance Agreement (DTAA).

The central issue before the Court was whether DDT is, in substance, a tax on the company's profits or on the dividend income of shareholders. The answer to this question determines whether treaty benefits can be invoked.

The company relied on the Goa bench ruling in Colorcon Asia Pvt. Ltd. v. JCIT to argue that DDT should be treated as a tax on shareholders, thereby allowing the application of treaty rates. The Revenue, however, relied on earlier precedent, including Godrej & Boyce Mfg. Co. Ltd. v. DCIT, which holds that DDT is an additional tax on the company's profits and not on shareholder income.

Examining the statutory framework, the Court prima facie noted that the provision governing DDT imposes an additional tax liability on the company distributing dividends.

“On a plain reading of the provision, it is abundantly clear that the provision provides for a dividend distribution tax payable by a domestic company under a domestic law.”

In this context, the Court prima facie observed that there is nothing in the provision to indicate that tax treaty provisions are intended to apply to such a levy.

“There appears to be nothing in the provision to indicate that the operation of Section 115-O in any manner is either related and/or is controlled by the DTAA. Also the provisions of Section 115-O, when it concerns the rate of tax, we do not find in such provision, that the legislature intended to include the operation of the DTAA, and more particularly as contained in Article 11 of the DTAA in question, which relates to tax on dividend income and not relating to tax on distribution of profits by way of dividend by a company. Thus, insofar as the charging of such tax under Section 115-O is concerned, the DTAA appears to have no application.”

The bench further noted that once DDT is paid by the company, the dividend income is exempt in the hands of shareholders, reinforcing the view that the tax is not on shareholder income.

“Thus, when Section 115-O imposes such tax payable by the company as an additional tax, it is not a tax on the amounts being received by the shareholders on such dividend, hence, there is no question of the DTAA provisions being applicable in the operation of Section 115-O.”

However, the court clarified that these observations are only prima facie and that a contrary interpretation has been taken in Colorcon Asia, which held that DDT is effectively a tax on shareholder income and that treaty benefits may apply.

In light of this conflict, the court held that the issue raises substantial questions of law requiring authoritative determination.

Framing the question for consideration, the court observed,

“Whether the decision of the Division Bench in M/s. Colorcon Asia Private Limited Vs. Joint Commissioner of Income Tax and Ors. lays down the correct position in law when it holds that, Dividend Distribution Tax (DDT) is a tax paid by the Company, on dividend income of the shareholder, entitling the shareholder of the benefit of the provisions of Double Taxation Avoidance Agreement (DTAA) between India and UK?”

Accordingly, the court directed that the matter be placed before a larger bench for an authoritative ruling on the issue.