Modify tax on dividend by domestic firms

The Budget for 2006-07, to be presented amidst an unprecedented robust economy, is naturally generating large expectations --from lower rates of taxes to substantial incentives for benefits of both urban and rural masses.

In this stride, the interest of foreign enterprises whose contribution to the economy can not be undermined should not be ignored. Particular attention is invited on the following issues.

Tax on dividend declared by domestic companies: The dividend income is entirely free of tax in the hands of recipient. But, an "additional income tax" is levied on the dividend distributing company at the flat rate of 12.5 per cent on the amount declared, distributed or paid by such company by way of dividends. The said additional income tax is payable in addition to the normal income-tax chargeable on the income of the company.

The levy of "additional income tax", which effectively reduces the quantum of dividend to be declared by a domestic company directly, hits a foreign investor because the said additional income-tax does not qualify for the underlying tax credit in the investor's home country. The reason is simple: additional income tax is paid by the Indian domestic company (and not by the shareholder). The credit for tax will be available only of the taxes paid in India by the shareholder himself.

It is, therefore, advisable that the suitable amendment be made in the Income Tax Act to ensure that non-resident shareholders become entitled to avail tax credit for the additional income tax paid by the Indian domestic company. Needless to mention that such an amendment will directly benefit foreign investors without any impact on Indian tax revenues. Filing of tax returns by foreign companies: The income tax rates in India are among the lowest in developing countries. The advantage is, however, inundated by complexity of tax laws multiplied by bureaucratic hurdles.

Foreign companies are required to file return of income in India. Even if the maximum amount of tax has been deducted at source, a foreign company is still obliged to file its return of income in India and undergo the tedious process of assessment. Where, however, the income of foreign company consists of dividend and interest only, no return needs to be filed. Why should filing of return be necessary when no remittance can be made out of India without deduction of tax at source?

Settlement of assessment: Assuming that disputes will arise in interpretation of tax laws, there should be an effective machinery to settle them fast. While an assessment is to be made within two years, the appellate proceedings can take 10 to 15 years up to the high court level and 15 to 20 years up to the Supreme Court level. This time lag is not only a big irritant but also a strong disincentive for foreign investment in India. Formation of separate tax courts for foreign companies is long overdue, and must be implemented as expeditiously as possible.

Updation of tax treaties: A large number of tax treaties were made by India prior to the policy of economic reforms and global liberalisation. The income tax law has, however, substantially changed since then. It is therefore, necessary that the government should update all the tax treaties so as to synchronise them with the current tax provisions.

Treaties should also be modified in respect of collection of disputed tax as has already been done in case of the UK vide instruction No 3/2004, dated March 19, 2004. In the case of the UK, a disputed demand will be kept in abeyance against furnishing of a bank guarantee.

agar@bol.net.in