We are pleased to present the latest edition of Tax Street – our newsletter that covers all the key developments and updates in the realm of taxation in India and across the globe for the month of November 2021.
- The 'Focus Point' covers an overview of the transfer pricing's impact on the Indian dividend tax regime.
- Under the 'From the Judiciary' section, we provide in brief, the key rulings on important cases, and our take on the same.
- Our 'Tax Talk' provides key updates on the important taxrelated news from India and across the globe.
- Under 'Compliance Calendar', we list down the important due dates with regard to direct tax, transfer pricing and indirect tax in the month.
We hope you find our newsletter useful and we look forward to your feedback. You can write to us at email@example.com. We would be happy to hear your thoughts on what more can we include in our newsletter and incorporate your feedback in our future editions.
The Nexdigm (SKP) Team
Transfer Pricing Impact On The New Dividend Tax Regime Of India
The taxation aspect when it comes to dividends has undergone many changes over the years. The Dividend Distribution Tax (DDT) was introduced in 1977 in India, wherein dividend income was not taxed in the shareholders' hands. Instead, the company paying dividends used to pay DDT at a flat rate. The incidence of tax payable on the dividend income was shifted to the shareholders in 2002 and thereafter again in the hands of the company in 2003.
With the aim of making the Indian capital market more attractive and increasing the flow of foreign investments, the Indian government proposed changes to the existing dividend DDT regime through the Union Budget for the fiscal year 2020- 2021, wherein the burden of taxability has once again moved in the hands of the shareholders.
A. Inter-Play With Transfer Pricing (TP) Provisions
In an ideal scenario, dividends are considered as an appropriation of profits (current or previous years). Such profits are after-tax profits, and therefore, while DDT was in force, all taxes were paid on net profits, the applicability of TP on dividends from a practical point of view had no or little relevance.
The implications of the payment of dividends between two Associated Enterprises (AE) as per Section 92A of the Income-tax Act (the Act) have been a much-debated affair under the Indian TP Regulations.
We have encapsulated below the interplay between the payment of dividends and its implication from an Indian TP standpoint:
- To apply the TP provisions in relation to the transaction pertaining to payment of dividends, it must first qualify as an international transaction. There should be a way to compute the Arm's Length Price(ALP) of the said transaction as mandated under the Indian TP Regulations.
- For a transaction to qualify as 'International
transaction' as per Section 92B, it should have the following
- To begin with, there has to be a 'transaction.'
- The transaction has to be with two or more AEs, of which at least one AE has to be a non-resident entity.
- The transaction is in the nature of purchase, sale or lease of tangible/intangible property, provision of services, lending or borrowing of money or any other transaction having a bearing on the profits, income, losses or assets, etc. [read with explanation to Section 92B inserted by the Finance Act 2012].
Read ahead to understand if the payment of dividends qualifies the definition of 'transaction' as given under the Act.
Definition of Transaction as per Section 92F (v) of the Act
(v) "transaction" includes an arrangement, understanding, or action in concert,
(A) whether or not such arrangement, understanding or action is formal or in writing; or
(B) whether or not such arrangement, understanding, or action is intended to be enforceable by legal proceeding.
- For TP provisions to apply, it is imperative to analyze whether the payment of dividends qualifies under the definition of a transaction as per Section 92F (v) of the Act. It is essential to establish whether the payment of dividends can be construed as an arrangement, understanding, or action in concert, say between the company and its shareholders at the time the shareholders invest in the company.
- In relation to whether a particular inter-company arrangement falls under the definition of transaction and consequent international transaction, recourse can be taken to the various judicial precedents, which provide useful guidance on what can constitute a 'transaction.' For example, Maruti Suzuki India Ltd.1 has elaborately discussed various interpretations to the definition of 'transaction' in the context of TP adjustment involving marketing intangible.
- All in all, one may infer that payment of dividends is not a result of any contractual arrangement or obligation (either oral or in writing) with the company's shareholders. " Accordingly, ' a view can be taken that the payment of dividends doesn't fall under the definition of a 'transaction.'
Other important consideration
- Additionally, it is pertinent to note that the declaration of dividends is not mandatory for the company, and there is no law compelling the Board of Directors to declare a dividend. The payment of the dividend is at the sole discretion of the Management of the company.
- Though a dividend is a return on capital invested in the company, its declaration and distribution are discretionary on the Management of the company as per the Companies Act 2013.
- Recently, the Polish authorities issued guidance on whether a dividend payment among associated companies falls within the scope of the definition of a 'controlled transaction' for TP purposes. In lieu of the guidance provided, we understand that payment of dividends should not be considered as a controlled transaction. Dividends are remuneration for capital, and their allocation and payment are the results of economic activity, not an activity of economic nature. Thus, there is no requirement from a TP perspective to document the payment of dividends.
- Since the payment of a dividend is an unilateral act and does not get covered under the definition of transaction and consequently the definition of international transaction, there is no requirement to determine the arm's length price as well as per the Indian TP Regulations.
Should disclosure be made to avoid any penalty exposure?
- With the abolition of the DDT and the taxability now being transferred to the shareholders, the companies are now required to comply with Withholding Tax and Double Taxation Avoidance Agreement (DTAA) provisions. It is certain that the perception regarding dividend treatment from an Indian TP viewpoint will change.
- Although the interpretation of the 'transaction' as discussed above still holds true, however, on a prudent basis and keeping in mind the penal provisions for non-disclosure/ non-reporting of transactions, the payment of dividends may be reported in Form No. 3CEB.
- At the same time, the challenge may arise on selecting the Most Appropriate Method (MAM) to benchmark the payment of dividends. In a scenario, even if we try to obtain and compare third-party comparable data, the data obtained will be volatile in nature as different companies have different criteria while determining the frequency, rate, quantum, etc.
B. Taxation Impact On Companies And Shareholders Post 1 April 2020
Dividend income received from India company
- Taxability in the hands of resident shareholders: The exemption benefit available to the shareholders under Section 10(34) of the Act in respect of dividend income is withdrawn w.e.f. 1 April 2020.
- Taxability in the hands of non-resident shareholders: The dividend income is taxable at the rate of 20% (plus applicable surcharge and cess) with no provisions of claiming any deductions under the Act or at the rate provided under the relevant DTAA (subject to availability of documents for claiming tax treaty benefit).
- Taxability in the hands of the domestic company paying the dividends: No liability to pay DDT, however, the companies will be liable to deduct tax under Section 194.
- Withholding tax: (i) Resident shareholders: The withholding tax rate is 10% on dividend income paid. With regard to individuals, there is a monetary threshold of INR 5000 (ii) Non-resident shareholders: The withholding tax rate is 20%, or the rate as per DTAA, whichever is lower.
- Deduction of expenses from dividend income: If the dividend is assessable to tax as business income, the taxpayer can claim a deduction of all expenses incurred to earn that dividend income.
With the abolition of the DDT regime and the taxability being shifted in the hands of the shareholders, there could be a consequential shift from a TP standpoint wherein the company declaring and paying dividends to its shareholders would need to ensure certain factors, i.e., rate, frequency, necessary approvals pertaining to dividends are documented well.
Additionally, keeping in mind the penal provisions pertaining to non-reporting and non-maintenance of documentation concerning the inter-company transactions, it would be prudent for the taxpayer to disclose the same and maintain adequate documentation while undertaking TP compliance.
1 ITA--710/2015. Case: MARUTI SUZUKI INDIA LTD. Vs. COMMISSIONER OF INCOME TAX. High Court of Delhi (India)
To read the full article click here
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.