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Indian domestic tax laws regarding taxation of dividend income were changed by the 2020 Finance Act, which traces the tax liability of dividend income distributed by corporations back to the classic system of taxing such income in the hands of the shareholder. Prior to this change, the dividend distributed by a company was subject to dividend distribution tax for some time (‘DDT’) in the hands of the company and in the hands of the shareholder. The DDT paid by the company probably did not benefit from a lower withholding tax (“WHT”) Rate according to the double taxation agreement (‘DTAA‘) Although the taxpayers had tried in the last few years before the change now made to apply the DTAA rates; a topic that is currently being taught.
The change has brought the relevance of DTAAs back to the fore, as DTAAs in most cases mandate a lower WHT rate than the 20% WHT rate applicable to dividend income in the hands of non-residents under the domestic tax law. In general, the application of a WHT sentence prescribed in the context of a DTAA is simple and straightforward. Application of the WHT rate for DTAAs with a Most Favored Nation (“MFN”) Clause has its nuances which have been examined by Indian courts from time to time.
In this regard, the Delhi High Court has made a recent case of
Concentrix Service Netherlands BV against the deputy commissioner for income tax & claims.1 (‘Concentrix‘) had the opportunity to examine the applicability of the MFN clause under the Indo-Dutch DTAA in connection with the WHT rate applicable to dividend income received by the Dutch parent company from its Indian subsidiary. Pursuant to Article 10 of the DTAA India-Netherlands, the dividend that a resident of one country receives from the payer of the other country of residence is subject to 10% WHT. However, the protocol contains an MFN clause which states that in relation to dividends, interest, royalties and fees for technical services (‘AGV‘) If India, after signing the DTAA, according to an agreement or agreement between India and a third country that is a member of the OECD, limits its withholding tax on such income to a lower or lower level than the rate or the scope of application DTAA provided in India – Netherlands, the same rate or scope as provided in this convention or convention relating to the above-mentioned items of income shall also apply under this convention. Simply put, if the provision of another DTAA later concluded between India and the OECD member country is beneficial for the specified type of payments, it would apply regardless of the provisions of the Indo-Dutch DTAA.
Claim by the taxpayer
In Concentric, the taxpayer had requested a WHT ruling from the tax authorities to apply for a WHT rate of 5% (versus 10% required under the DTAA between India and the Netherlands) on shared income, with the MFN clause was used and the rates applicable to India were applied – Slovenia2, India – Lithuania3 and India – Colombia4 DTAA. It has been alleged that since India has conducted DTAAs with such other countries that were members of the OECD, the lower rate or restricted scope of the DTAA conducted between India and that other country will automatically apply to DTAAs between India and the Netherlands would apply. This relates to the protocol, in which it was stipulated, among other things, that the protocol “should be part of an integral part of the Convention”, ie the subject of DTAA.
In the case of, the judgments were relied on in support of this plea Steria (India) Ltd. against Commissioner of Income-Tax-VI5, Apollo Tires Ltd. v Commissioner of Income Tax, International Taxation6th
Tax authorities dispute
However, the tax authorities denied the claim with the following argument:
- that the protocol attached to the DTAA between India and the Netherlands, which offers the lower WHT rate or a more restricted scope, would only be available if the country with which India enters into a DTAA was a member of the OECD at the time the DECA was carried out the India-Netherlands DTAA and
- The DTAAs with such third countries were registered while these countries were OECD member countries.
India’s DTAA with Slovenia, Lithuania and Colombia was carried out before such countries became OECD member countries. Since none of the countries, ie Slovenia, Lithuania and Colombia, were members of the OECD at the time when these countries carried out DTAAs with India, the protocol attached to the DTAA would not have any applicability.
However, the Court ruled in favor of the taxpayer that:
- The protocol is an integral part of the DTAA and therefore no separate notification is required as far as the applicability of the provisions of the protocol is concerned.
- The factual situation, i.e. the point in time when the third country should become a member of the OECD, should not necessarily exist at the time of the execution of the relevant DTAA (India – Netherlands DTAA), but when an application is made by the taxpayer or the withholding recipient to issue a Withholding tax certificate with a lower tax rate.
The Court also referred to the decree issued by the Kingdom of the Netherlands on February 28, 2012, which stated:
“Slovenia became a member of the OECD on July 21, 2010. Pursuant to the most favored nation clause in the Protocol to the Convention, this event means that, retrospectively from July 21, 2010, a rate of 5 percent will apply to equity dividends paid by a company based in the Netherlands to an entity based in India. “
The Court made an important observation on the principle of “common interpretation” to be adopted by the courts of the contracting states. This would ensure that Conventions / DTAAs are applied efficiently and fairly so that the interpretation of the provisions by the tax authority and the courts of the relevant State Party is consistent. The Court of Justice accordingly accepted the application of the DTAA WHT rate of 5% with Slovenia using the MFN clause.
Insight for taxpayers
The court ruling confirms the importance of MFN clauses in DTAAs, which, when used sensibly, offer considerable opportunities for tax savings. The ruling confirms the application of the MFN clause in the context of DTAAs in countries such as the Netherlands, France, Sweden, the hungry and Switzerland and enables the application of a lower WHT rate of 5% to the dividend payment compared to the one prescribed in the respective DTAAs 10%. The MFN clause also helps to read down the scope of certain income categories, especially FTS in DTAA, such as in France, Sweden, Hungry, Belgium and Spain, which restricts tax liability in the country of residence only in the case of a permanent establishment in the country of origin.
Appropriate application of the MFN clause is also important when you consider that the country of residence can only allow a tax credit in the country to the extent that the appropriate tax applicable under the DTAA is levied. For example, as in the Netherlands and France, Indian DTAAs prescribe a period of three years within which an application for reimbursement of the tax excess charged at source should be submitted. In addition, requests for a refund of the tax surplus must be submitted to the authority of the state that levied the tax. It is therefore important to assess the impact of the MFN clause in accordance with the applicable DTAA.
It’s also important to note that the 2020 Finance Act made significant changes to the provisions governing the filing of income tax returns by non-residents. According to the applicable regulations, a non-resident taxpayer is required to file an Indian tax return in which lower WHT rates according to DTAA are applied for income in the form of license fees / FTS (taxable on a gross basis) and interest or dividends. Exemption from the tax return is only possible if WHT has been deducted at the rate prescribed in national tax law. Failure to comply will result in criminal penalties.
Given the importance of the MFN clause in DTAAs and the opportunity this clause offers to reduce tax costs, taxpayers are well advised to evaluate the MFN clause in the context of the relevant DTAA while ensuring timely compliance the tax regulation remains on the right side of the law.
1 WP (C) 9051/2020, judgment of April 22, 2021
2 DTAA carried out between India and Slovenia; which came into effect on 02/17/2005 and was notified on 05/31/20
3 DTAA carried out between India and Lithuania; which came into effect on 07/10/2012 and was notified on 07/25/2012
4 DTAA carried out between India and Colombia; which came into effect on 07/07/2014 and was notified on 23/09/2014
5  386 ITR 390 (Delhi)
6th  92 taxmann.com 166 (Karnataka)
7th [No. IFZ 2012/54M, Tax Treaties, India], published on March 13, 2012
The content of this article is intended to provide general guidance on the subject. A professional should be obtained about your particular circumstances.