Budget Issues: Foreign dividends

One of the banes of outbound investments is the country's policy of taxing foreign dividends ""- dividends received by an Indian company from a foreign subsidiary. Say, an Indian multinational has a subsidiary in the UK, which makes a profit of Rs 100 in that country.

The subsidiary will pay corporate income tax of 30 per cent, which works out to Rs 30 in the UK and thereafter, it remits the balance profit of Rs 70 to its Indian parent. The entire dividend of Rs 70 is taxed in India in the hands of the Indian multinational at a full corporate tax rate of 33.66 per cent. This results in a tax outgo of Rs 23.56 in India.

The total tax cost in the UK and India, therefore, works out to Rs 53.56, approximately 54 per cent of the total earnings from the outbound investment. Clearly, the effective tax cost is too high to encourage Indian multinationals to venture into outbound investments and bring in foreign dividends to service their Indian shareholders.

Option: Generally, countries provide fiscal incentives for outbound investments, vis-à-vis taxing of foreign dividends, through either of the two methods -- the exemption method -- where foreign dividends are fully exempt from tax in the country of the parent company, or the method of providing underlying tax credit.

Under the first method, the total tax cost on foreign dividends is capped at the level of the foreign country's corporate tax rate, whereas, in the second method, the total tax cost on foreign dividends is capped at the level of the home country's corporate tax rate.

In other words, if the Indian government adopts the exemption method to provide fiscal incentives for foreign dividends, then the entire Rs 70 will be exempt from tax in India in the hands of the Indian multinational, with the result that the total tax cost for the group will be Rs 30 -- 30 per cent being the corporate tax rate of the country (UK), where the subsidiary company is situated.

On the other hand, if the Indian government prefers to adopt the method of providing underlying tax credit as a measure to provide fiscal incentives for foreign dividends, then the entire profit of the UK subsidiary "" after grossing up of the corporate tax paid in the UK, which, in the present case, works out to Rs 100 "" becomes taxable dividends in the hands of the Indian parent, on which it is liable to pay a 33.66 per cent tax in India. This works out to Rs 33.66. However, it receives credit for corporate taxes paid by the UK subsidiary on its profits out of which dividends are distributed ""Rs 30. Thus, the Indian parent pays the balance amount of Rs 3.66 as corporate tax in India, with the result that the total corporate tax liability for the group gets pegged at Rs 33.66, which is 33.66 per cent "" the tax rate of the country of residence.

It will not be out of place to mention that only a few tax treaties entered into by India provide for relief on account of underlying taxes, such as with Mauritius and Singapore. But most tax treaties do not provide for such relief to Indian multinationals.

Instead of amending each and every treaty for introducing such fiscal measures, the government will be better off introducing such benefits in domestic tax laws, so as to provide incentives to Indian multinationals to invest in any and every jurisdiction without having to cherry-pick for availing treaty protection for foreign dividends

Rahul Krishna Mitra,
executive Director,
PricewaterhouseCoopers (Kolkata)