India takes strong stance on tax treaties with MFN countries
Transmitted last week by the apex tax body Central Board of Direct Taxes (CBDT), the view goes against a High Court ruling, sends a strong message from India on tax treaties and could spark a slew of litigation in the coming days.
Several foreign investors had chosen the Netherlands, France and Switzerland to buy stakes in Indian companies because of their MFN status with India and the resulting tax advantages, as well as to overcome tax obstacles such as the general anti-evasion rule. Investors in these countries only pay 10-15% tax on dividends and none on capital gains in some cases. MFN status under tax treaties with India allows additional relief from tax (on dividends and charges) if India accepts a lower rate under a subsequent treaty with another country as long as the latter is also a member of the Economic Cooperation Organization. and development (OECD). The rule aims for India to maintain tax parity between the OECD countries with which it signs tax treaties.
Thus, after India set a dividend tax of less than 5% in tax treaties with Slovenia (in 2006), Lithuania (in 2013) and Colombia (in 2015), many investors from France, of the Netherlands, Switzerland as well as those of Sweden and Spain have started to assess and pay a reduced tax (5% from 10-15%) on dividends from Indian companies after the change in the tax regime. taxation of dividends since April 2020.
Many local companies withheld a lower tax of 5% while returning the dividend to these foreign shareholders. The practice, challenged by the income tax department, was upheld by the Delhi High Court.
However, according to the CBDT directive issued to the tax offices, investors from the Netherlands, France and other countries will still have to pay a higher tax on dividends. The CBDT believes that a lower tax applicable to Slovenia, Lithuania and Colombia cannot be extended to others as these countries were not members of the OECD when India signed the respective treaties with them. For example, Slovenia became a member of the OECD in 2010 — six years after signing the treaty with India; Lithuania joined the OECD in 2018 while the tax treaty with India was closed in 2013; the respective years for Columbia are 2020 and 2015.
“This is a significant development for residents of France, the Netherlands, Sweden, Spain, Hungary and Switzerland with holdings in Indian entities…. The CBDT goes further by stating that ‘unless a separate notification is issued, benefits from another treaty cannot be imported into a tax treaty with the MFN clause.This is a departure from how the judiciary viewed the requirement for a separate notification, in which it had been held that if the text of the MFN clause makes it operational and does not require a separate notification, no further notification should be issued. position, but given the nature of the interpretative issues and nuances involved, this may not yet settle the debate,” said Ritu Shaktawat, a partner at law firm Khaitan & Co who, with other tax experts, follows the development from close.
From a legal point of view, unlike a notification, the circulars do not bind the taxpayer. Taxpayers, Shaktawat said, could still take a different position (relying on the Delhi High Court’s favorable rulings on the issue) which, given the circular’s clarifications, will certainly lead to a dispute with the bureau. taxes.
According to Parul Jain, who heads the fund formation practice at law firm Nishith Desai Associates, the issue is expected to be ultimately resolved by the Supreme Court of India. “While there appears to be fair debate regarding the applicability of such low tax rates, it seems unjustifiable to require the issuance of a separate notification by the government specifically importing treaty benefits into another treaty where a particular tax treaty provides for such automatic substitution.Further, although the government has clarified that the circular will not apply to taxpayers where there is a favorable court ruling (the Delhi High Court in this case), the question of the applicability of the circular in the case of taxpayers having jurisdiction in Delhi is expected to be contentious.Apart from multinationals, this circular will also have an impact on REITs based in the Netherlands and France.
The issue gains prominence in the absence of a uniform dividend distribution tax (levied on companies paying dividends) which was abolished in 2020. With the tax now levied on investors and companies making the payment required to withhold tax before transferring the balance to investors, the actual rates become crucial. Those wishing to avoid legal wrangling would accept the opinions expressed by the CBDT, but many cannot. All non-resident investors would, however, consider whether the Indian tax credit would be available against taxes payable in the source jurisdiction. As the question involves several foreign investors and local companies, the withholding tax rate to be applied would be the subject of discussions between non-resident shareholders and Indian beneficiary entities.