Over the past two decades, India is being viewed as one of the premier destinations for the global foreign direct investments. These investments have been the major supplement of the growth story of the country, particularly in the areas of infrastructure, information technology and power.
However, in the fray of competitive environment of attracting the foreign direct investment in India, the Government needs to provide a tax efficient means of repatriation of profits. Currently, the profits can be repatriated in the form of dividend, if the investments are made through the equity route. The incidence of tax on the dividend is the area of concern for the foreign investors.
Under the existing tax framework, a domestic company is required to pay the Dividend Distribution Tax (DDT) at the effective rate of 16.995% on any amount declared, distributed or paid by way of dividends.
This implication becomes more regressive when the credit of DDT is not available in the resident country of the foreign investors in terms of the tax treaties. This is principally on account of the fact that the foreign countries usually tax the dividends as
Effectively, DDT reduces the return on investment of the foreign investors in corporations vis-à-vis partnerships as total tax cost of dividends is more then 50% (33.99% as effective corporate tax rate on the net profit and 16.995% as effective DDT), whilst in case of partnership, the same comes to be 33.99%.
In view of above, it is expected from Budget 2009, that the rate of DDT shall be rationalised to reduce the burden on the investors.
Further, the incongruity in the tax credit of DDT can be simplified through exemption method as provided under several treaties. The exemption method provides that the dividends paid by a company which is a resident of one of the territories to a resident of the other territory may be taxed only in the first-mentioned territory. Accordingly, the dividend received from the company resident in India by a person resident of other State shall be taxable only in India. Considering, the domestic tax law of India provides that the dividend on which DDT has been paid are exempt in the hands of shareholder receipt. Resultantly, the burden of tax on dividend from investments made by foreign investors gets effectively reduced.
Another method of achieving the same would on the lines of the provisions of Section 115WKB of the Income Tax Act, 1961, wherein the Fringe Benefit Tax (FBT) paid by the employer company and recovered from the employee on allotment or transfer of stock options under an employee stock option plan (ESOP) is deemed to be tax paid by such employee. Accordingly, the said FBT can be claimed as tax credit against the levy of income tax on ESOPs in foreign jurisdiction.
If one were to evaluate the two alternatives, it merits consideration to note that the tax treaties are the bi-lateral agreements and require consent of both the states before any amendments are made. Therefore, the former methodology of exemption method would require due consent from the other State. Further, since the latter method envisages credit of tax in foreign jurisdiction by unilateral amendment in the domestic laws of India, the same remains untested.
Aseem Chawla is partner, tax practice group and Amit Singhania is senior consultant, tax practice group at Amarchand & Mangaldas & Suresh A Shroff & Co
