FPIs continue to pay higher tax on dividends despite Budget relief

NSDL readying a platform to make it easier for companies to deduct appropriate tax

Companies continue to withhold tax at domestic tax rates of 20 per cent, plus surcharge and cess in FY22 even though this year's Budget amendment has allowed foreign portfolio investors (FPIs) to avail of lower treaty rates of 5-15 per cent on dividends paid from April 1, said two people familiar with the matter.  

Indian companies paying dividends do not have the resources at their disposal to ascertain whether an FPI is eligible for treaty benefits and whether they are the beneficial owner of dividend income, they said. In the past, tax authorities have ruled an entity as not being a beneficial owner of dividend income and have levied interest or penalty on firms for short deduction of tax.

"Right now, registrar and share transfer agents of companies are not able to bring in the level of consistency that we want. They have different formats, different approaches and different expectations from FPIs, and are not consistent in applying a lower or higher rate of tax for the same FPI. The need of the hour is to standardise R&T behaviour," said a custodian familiar with the matter.

To get around this problem, NSDL has begun the groundwork on creating a common platform at the depository account level where FPIs can upload all the relevant details to avail of lower taxes on dividends, and which can be easily accessed by companies.

"We are working with R&T agents, companies, tax consultants and custodians to create this platform," said an NSDL official but declined to give a specific timeframe by which it would be up and running.

Tax consultants and custodians are also putting their heads together to standardise the kind of documents that need to be furnished by FPIs, which can be acceptable to all companies. Other than a tax residency certificate, FPIs will also provide an undertaking with respect to beneficial ownership and a declaration of no permanent establishment to the depositories.

A central repository of information will make it easier for companies to verify the documents and undertaking provided. It will also avoid the need for FPIs to provide the same set of documents to every company paying the dividend every quarter, said experts.

"When we create a common database every document of the FPI cannot be available to the whole market. That's not the intention. There are confidentiality issues that need to be tackled and the company needs to be comfortable in deducting the lower rate of tax, which may not be possible in all cases," said the custodian quoted above.  

A total of 916 companies paid dividends to the tune of Rs 2.6 trillion in 2020-21, shows the data from Capitaline. Of this, the top 20 players contributed Rs 1.49 trillion.

"Companies paying dividend or interest income need to assess the eligibility of the FPI to get the tax treaty benefits. Treaties also have a number of other conditions that the FPI needs to fulfill that includes a tax test and beneficial ownership test. Companies deducting tax at source are unable to verify all the facts and therefore seek an undertaking, Form 10F and other documents from the FPI,” said Suresh Swamy, partner, Price Waterhouse & Co LLP.

He added that FPIs should also be permitted to obtain a withholding tax certificate from the tax office to give more certainty to the payer on the applicable rate of tax. The current provisions do not envisage FPIs approaching the tax office for a lower withholding tax certificate.

Last year, the Supreme Court of India in the Pilcom versus CIT West Bengal - VII case had held that the obligation to deduct tax at source is not affected by the provisions of the tax treaty. The payer cannot apply the provisions of the tax treaty and absolve itself from the liability to withhold tax as per the IT Act. It was upon the taxpayer to file a return, plead the benefit of treaty and claim refund of excess taxes withheld, if any.  

The ruling sparked a concern among the FPI community as taxes were withheld under section 196D without considering the benefit of tax treaty. To address this, the provisions were amended in the Finance Act 2021, allowing income tax to be deducted at 20 per cent or at lower treaty rates provided the FPI furnished a tax residency certificate.