Rahul Charkha, Economic Laws Practice

15 Jul 2021

The DDT Rate Conundrum: Tax on Income of Shareholder or Company?

The dividend distribution tax (‘DDT’) regime in India, over the past few years, has led to a critical tax feud between the domestic companies and the revenue authorities regarding the applicability of beneficial treaty-rate [i.e., tax rate prescribed under the Double Taxation Avoidance Agreements (‘DTAA’)] over such rate as prescribed under the Income-tax Act, 1961 (‘IT Act’).


DDT was an additional income tax levied on the dividends distributed by domestic companies before 1st April 2020. In accordance with Section 115-O of the IT Act, DDT is payable by the company i.e., a domestic company is liable to deduct and pay DDT at the prescribed rate.


Legislative History of DDT

Prior to 1st June 1997, domestic companies were required to deduct tax at source at the specified rate on payment of dividend to shareholders (‘TDS mechanism’). However, since the procedure for tax collection through TDS mechanism was cumbersome and involved a lot of paperwork, DDT was introduced w.e.f. 1st June 1997[1]. Another reason for introduction of DDT was to avoid double taxation, i.e., taxation of profits of the company once in the hands of the company and again in the hands of the shareholders. Resultantly, dividend income was also made tax exempt in the hands of the shareholders. Later, w.e.f. 1st April 2002, DDT was abolished, and the taxation of dividends again shifted back to TDS mechanism with the tax exemption withdrawn. As per Memorandum to Finance Act, 2002, the objective for shifting back to the TDS mechanism was primarily that, since dividend is an income in the hands of the shareholders and not in the hands of the company, the incidence of the tax should also be on the shareholder. Moreover, the DDT provisions levy tax at a flat rate on the distributed profits, irrespective of the marginal rate at which the recipient was otherwise taxed and hence, the provisions were considered iniquitous also. However, from 1st April 2003 onwards, again the DDT regime was introduced along with the tax exemption to shareholders stating[2] that it is easier to collect tax at a single point i.e., from the company rather than compel the company to compute the tax deductible in the hands of the shareholders. After much back and forth, DDT has been finally abolished w.e.f. 1st April 2020 and taxation of dividend has again shifted back to the TDS regime. Resultantly, dividend income is no longer tax-exempt in the hands of the shareholders as well. The Memorandum to Finance Act, 2020 explained that earlier, the TDS mechanism was cumbersome as well as highly iniquitous. However, with the advent of technology and easy tracking system available, the justification for DDT regime had outlived itself.


Issue of applicability of beneficial treaty-rate over the rate prescribed under the IT Act

In furtherance of our endeavor to decipher the DDT enigma, it is indispensable to understand the legal scheme laid down under the IT Act that enables a taxpayer to avail the beneficial provisions of DTAA. The charging section 4 of the IT Act is expressly made "subject to the provisions of this Act" which would include section 90 of the IT Act. Section 90(2) of the IT Act provides that, wherever the Government of India has entered into a DTAA with the government of any country outside India, then, in case of an assessee where DTAA applies, provisions of the IT Act or DTAA whichever are more beneficial shall apply. Government of India has entered into DTAAs with many jurisdictions wherein it is provided that, subject to fulfilment of beneficial ownership conditions (wherever applicable) tax charged on dividend income shall not exceed 5% (ex. India-Mauritius DTAA) or 10% (ex. India-Germany DTAA), etc. of the gross amount of dividend. Thus, taxpayers may claim the applicability of lower rate of tax on dividend income as against the higher rate of DDT charged at an effective rate of 20.56% under the IT Act.


However, DTAA would be applicable to the issue at hand only if DDT is considered as a tax on the income of shareholder and not company. As argued by the Revenue Authorities, since the domestic companies are Indian tax residents, question of applicability of DTAA on the income of the companies does not arise in the first place if DDT is considered as a tax on the income (i.e., distributed profits) of the company. Thus, the moot question at the heart of this tax feud is to decide whether DDT is a tax on the income of shareholder or company?


Evaluation of relevant legal precedents

In order to deliberate the issue further, it is imperative to evaluate the case of Tata Tea Co. Ltd.[3] wherein, the taxpayer was a tea company, claiming that Section 115-O of the IT Act was indirectly imposing tax on the agricultural income of the taxpayer, being ultra vires of the legislative competence[4] of the Parliament. While deciding upon the constitutionality of Section 115-O of the IT Act, Supreme Court highlighted that dividend distributed by a company is not impressed with the character of its own income and thus, the dividend is still taxable as income, though the incidence of tax has shifted from the shareholder to the company paying the dividend. Thus, the legal principle that follows the Apex Court’s conclusion is that dividend income should be chargeable to tax in the hands of the person earning such income i.e., the shareholders.


The emphasis placed on the case of Tata Tea Co. Ltd. can be argued to be far-fetched, since the case deals with the constitutionality and not the interpretation of Section 115-O of the IT Act. However, only the ratio decidendi[5] of the case (i.e., the principle upon which the case is decided) can set a binding precedent. In the case of Tata Tea Co. Ltd., the ratio decidendi i.e., the core reasoning for concluding Section 115-O of the IT Act to be constitutional is the understanding that dividend income is not same as the profits earned by the company. Hence, the reliance placed is definitely tenable.


Furthermore, the inference drawn from the case of Tata Tea Co. Ltd. ultimately corroborates the objective stated in the executive documentation pertaining to legislative history of DDT regime. In my view as well, dividend is the income of shareholder; whereas DDT was only a mechanism to collect tax for administrative convenience as stated in the Memorandum to relevant Finance Acts.


Interestingly, the Finance-Minister in the 1997 budget speech specified that the intention behind introduction of Section 115-O of the IT Act was to reward companies that re-invest profits and discourage the distribution of exorbitant dividends. However, no such objective was specified at the time of re-introduction of DDT under the Finance Act, 2003. Thus, with respect to the DDT re-introduced under the Finance Act, 2003, one-time inconsistency between the 1997 budget speech and the Memorandum to the Finance Act, 1997 can be ignored. Instead, another view which may be considered is that the Memorandum to the Finance Act, being an executive document of the Parliament, would hold precedence over the speech considering the fair amount of human element as well as the parliamentary debates/viewpoints involved therein. Further, it is an accepted legal practice[6] to rely upon the Notes to clauses or the budget speech or the memorandum to the Finance Act presented by the Finance-Minister in the Parliament while introducing the Finance Act for the purpose of ascertaining the reason for introducing a specific clause. However, it is highlighted that external documentation such as Budget Speech or Memorandum should not be imported for legal interpretation of a provision where the language is clear and unequivocal[7].


Proceeding further, one cannot ignore the fact that, even in economic and commercial parlance, the burden of DDT ultimately falls on the shareholders rather than on the company, as the amount of distributed profits available for shareholders stands reduced to the extent of DDT[8].


At this juncture, it would be interesting to evaluate the Supreme Court ruling in the case of Godrej & Boyce Manufacturing Company Ltd.[9] wherein the taxpayer claimed that no expenses should be disallowed under Section 14A[10] of the IT Act since the companies distributing dividend had already paid tax (i.e., DDT) on such dividend income. Thus, the taxpayer purported that even though no tax is paid by the shareholders on the dividend income[11], it cannot be considered as tax-exempt income, since DDT is paid by the dividend distributing companies on behalf of shareholders. The Apex Court categorically held that DDT cannot be understood to be paid on behalf of the shareholder, because, had that been the case, the provisions of Section 57[12] of the IT Act would have enabled the shareholder to claim deduction of expenditure incurred to earn the dividend income. Thus, it can be concluded that the Apex Court promulgated the view that, whatever be the conceptual foundation of DDT, it is not a tax paid on behalf of the shareholder, instead, it is a liability of the company and discharged by the company. Thus, it can be inferred that the legal interpretation derived from the Supreme Court Rulings in the case of Godrej & Boyce Manufacturing Company Ltd. and Tata Tea Co. Ltd. seem to be ostensibly contrary.


Another interesting aspect that merits consideration is the fact that the taxability of any income has to be considered from the perspective of the recipient. In all practicalities, the term 'income' can only have a logical relevance qua the recipient of the money or any other asset and not the payer thereof[13]. Although, an alternate view may be possible on detailed perusal of Section 115-O of the IT Act as the provision clearly purports DDT to be a tax on the ‘distribution of profits’ and not on ‘income earned’.


Foreign Jurisprudence

In the process of legal evaluation of debates concerning international conventions, it is desirable[14] to consider the decisions enunciated under different jurisdictions so as to be aligned with the global practices. That being said, it is particularly important to reflect upon the foreign judicial precedent in the case of Volkswagen of South Africa (Pty) Ltd Vs Commissioner of South African Revenue Service[15], wherein it was observed that a tax similar to DDT, known as Secondary Tax on Companies (‘STC’) paid on the distribution of dividends, is a tax on “a company declaring the dividends and not on dividends”. The said case distinguished the nature of STC and withholding taxes stating that STC is a tax levied with reference to the net amount of a company’s total dividends during a particular period, and on the other hand, non-resident withholding tax could be levied on the amount of the dividend declared to the affected shareholder. Also, the case evaluated that the provisions of DTAA refer to the recipient of dividends and not the company declaring the dividend. Resultantly, the provisions of DTAA cannot be applied to the company paying the dividend.


Protocol under India-Hungary DTAA

Further, wherever the Contracting States to a DTAA intended to extend the treaty protection to the dividend distribution tax, it has been specifically provided in the DTAA itself i.e., in case of India-Hungary DTAA[16]. In the absence of a specific provision in other DTAAs, it would be inappropriate to draw such inference because the treaties are to be interpreted as they exist and not on the basis of what ideally should have been.


Ongoing tussle between the taxpayers and the revenue authorities

The DDT issue first arose in the case of SGS India (P.) Ltd.[17] and thereafter, fresh claims for refund of excess tax paid on dividend income based on the beneficial provisions of applicable DTAAs were made in the case of Reckitt Benckiser (I) Pvt. Ltd[18] and Van Oord India (P.) Ltd.[19] The issue therein was remanded back by the jurisdictional Income Tax Appellate Tribunal (‘ITAT’) Benches to the Assessing Officers for re-adjudication. However, in the case of Giesecke & Devrient (India) (P.) Ltd.[20], theDelhi bench of ITAT decided the issue in favor of taxpayers mainly based on the rationale that the introduction and levy of DDT was merely for administrative conveniences.


Doubting the appropriateness of the co-ordinate bench ruling in the case of Giesecke & Devrient India Pvt. Ltd, ITAT (Mumbai bench) has referred the question of ‘applicability of beneficial treaty-rate over DDT’ for the consideration of ITAT (Special Bench) in the case of Total Oil India Pvt. Ltd.[21]


A decision in favor of the taxpayers may lead to further practical questions, such as, who would be eligible to claim the refund – the shareholder or the company. Further, domestic companies may draw an analogy to extend the interpretation of law provided by ITAT (Special Bench) regarding the DDT issue to ‘Buyback Tax’[22] as well.


To conclude, it will be interesting to evaluate how the ITAT (Special Bench) adjudicates the issue considering such conflicting rationales. The Bench will have to make sure that the decision taken by them is consistent with India’s obligations under the DTAA as the International treaties have to be abided by as per Art.253 of the Indian Constitution.

Bibliography

[1] Memorandum to the Finance Act, 1997 

[2] Memorandum to the Finance Act, 2003 

[3] UOI vs Tata Steel, [2017] 85 taxmann.com 346 (SC) 

[4] As per Entry 82 of List I of and Entry 46 of List II of the Seventh Schedule of the Constitution of India, the agricultural income is within the legislative competence of the State and not in the legislative competence of the Parliament 

[5] B. Shama Rao (1967) 2 SCR 650; Sudhanshu Sekhar Misra and Ors. (1968) 2 SCR 154; Dalbir Singh (1979) 3 SCR 1059 

[6] K.P Varghese vs ITO, [1981] 131 ITR 597 (SC); [1985] 156 ITR 525 (SC); [2003] 259 ITR 51 (SC); [2008] 301 ITR 309 (SC) 

[7]Loka Shikshana Trust vs. CIT, [1975] 101 ITR 234 (SC) 

[8] Giesecke & Devrient [India] Pvt Ltd Vs. The Addl. C.I.T, ITA No. 7075/DEL/2017  

[9] Godrej & Boyce Manufacturing Company Ltd vs DY Commissioner of IT Mumbai, [2017] 394 ITR 449 (SC) 

[10]As per Section 14A of the IT Act, expenditure incurred in relation to exempt income is disallowed [11] Dividend income was exempted in the hands of the shareholders before 31st March 2020 (except the income specified under Section 115BBDA of the Act)  

[12] Section 57 of the IT Act provides for the deductions allowed in respect on income chargeable under the head ‘income from other sources’ (in this case, dividend income)  

[13] Kolkata vs Indian Oil Petronas [2021] 127 taxmann.com 389 (Kolkata - Trib.) 

[14] T. v. Secretary of State for the Home Department [2 All ER 865], p. 891: (1996) AC 742: (1996) 2 WLR 766 (HL) 

[15] Volkswagen of South Africa (Pty) Ltd Vs Commissioner of South African Revenue Service, Case no. 24201/2007 

[16] The protocol to the Indo Hungarian tax treaty specifically provides that “When the company paying the dividends is a resident of India the tax on distributed profits shall be deemed to be taxed in the hands of the shareholders and it shall not exceed 10 per cent of the gross amount of dividend”. [17] SGS India (P.) Ltd vs Additional Commissioner of Income tax, [2017] 83 taxmann.com 163 (Mumbai – Trib.) 

[18] Reckitt Benckiser (I) Pvt. Ltd vs DCIT, [2020] 117 taxmann.com 519 (Kolkata – Trib.) 

[19] Van Oord India (P.) Ltd vs DCIT Rg 5(3), [2019] 111 taxmann.com 480 (Mumbai - Trib.) 

[20] Giesecke & Devrient (India) (P.) Ltd vs Addl. CIT, [2020] 120 taxmann.com 338 (Delhi - Trib.) 

[21] CIT vs Total Oil (India) Pvt Ltd TS-473-ITAT-2021(Mum) 

[22] As per Section 115-QA of the IT Act, additional income tax is chargeable on the distributed income via buy-back of shares by a domestic company

Cite this Article - Charkha Rahul, ‘The DDT Rate Conundrum: Tax on income of shareholder or company?’ (The Tax Terminal, 15th July 2021) <https://www.taxterminal.in/post/the-ddt-rate-conundrum-tax-on-income-of-shareholder-or-company>


 

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