Non-resident investors are staring at higher tax rates on dividends

Those not availing treaty benefits may have to shell out as much as 40% tax

Non-resident investors coming through the foreign direct investment (FDI) route and not availing treaty benefits are a worried lot as they stare at a higher tax outgo, with the withholding tax on dividends considerably higher than the applicable tax rates.

Post amendment, Section 115A of the Income Tax Act provides that non-residents would be taxed on the dividend at 20 per cent, plus surcharge and cess. The TDS or withholding tax is governed by Section 195, for which rates are specified each year in Part II of the first schedule of the Finance Act as “rates in force”. Usually, both TDS and final tax rate are the same.

But, the First Schedule is yet to be amended. And for a non-resident, who is not eligible for relief under an Double Taxation Avoidance Agree-ment, the rate of withholding tax may be 30 per cent or 40 per cent, plus surcharge and cess, depending on whether the shareholder is a non-corporate or corporate entity.

On the other hand, income in the hands of such foreign shareholders under the domestic tax law is taxable at 20 per cent, plus surcharge and cess. The anomaly is because of the way the current tax laws are structured and they need to be corrected, said experts.

“If the treaty benefit is not available to such dividends, it will be subject to withholding tax at higher rates since tax shall be required to be withheld in the residual category, which is 30 per cent for non-companies and 40 per cent for companies,” said Sunil Gidwani, partner at Nangia Andersen.

“Indian companies usually adopt the most conservative position while withholding taxes to avoid disallowance in their assessments. They will, therefore, end up deducting tax at a higher rate even though the non-resident’s ultimate tax liability is lower, hurting the latter’s cash flows,” said Suresh Swamy, partner-financial services, PwC India.

The anomaly will compel foreign shareholders other than FPIs to file a return of income in India and claim a refund of the excess tax deducted or forego it, said experts. This will depend on the amount of dividend receivable as against the time and cost of tax compliance. This would not have been the case if TDS were to be deducted at the rate of 20 per cent.

“The foreign shareholder may need to file an income-tax return in India to reclaim the excess tax withheld. The alignment of the withholding tax provision with the final tax liability of the income in the hands of the foreign shareholder would be desirable,” said Subramaniam Krishnan, partner, EY India.

According to Gidwani, non-residents may apply for a lower-deduction certificate but a large number of shareholders applying for such a certificate will put an unnecessary burden on the government machinery. “Before 1997, when the taxability of dividends was in the hands of recipients, Part II of the First Schedule contained a specific entry for withholding of tax at 20 per cent in case of non-resident non-Indians, as well as foreign companies,” he observed.

Experts say many FDI investors will be eligible for benefits under the respective treaty for the country where such FDI investors are a resident. “Barring investment funds, most FDI investors are companies which have treaty access and in such cases, the withholding rate should be a lower treaty rate of 5, 10 or 15 per cent,” Gidwani said.

Increased burden

• Withholding tax of 30-40 per cent may be applied if a non-resident is not eligible for DTAA benefits 

• Section 115A of the I-T Act taxes dividends at 20 per cent for non-residents

• Section 195, which specifies withholding tax rates, is yet to be amended 

• Indian companies usually adopt the most conservative position while withholding taxes

• The anomaly will compel foreign shareholders other than FPIs to file income tax returns