ITAT: Tax rates specified in DTAA must prevail over DDT

Recent ruling of ITAT wherein it held that the preferential rates of tax which are applicable under the DTAA shall still prevail over the DDT despite its removal.

The government sought to abolish the Dividend Distribution Tax (DDT) through the Finance Act 2020. The Finance Act, 2020, brought in a much more classical regime of taxation through this move since before the abolishment of the DDT regimen, all Indian Companies were required to pay DDT at the applicable rates specified under section 115(O) of the Income-tax Act, 1961 (IT Act) concerning the dividend so declared, distributed or paid by them. However, since most of the taxation treaties provided for a concessional rate of 5%, 10%, and 15% of the gross amount of dividend provided, all such Indian Companies had been requesting the tax officer to cap the rate of the DDT, concerning the dividends paid to their overseas investors, at the Tax Treaty rate (i.e. 5%, 10% or 15% as the case may be).
The Delhi Income-tax Appellate Tribunal (also known as the Delhi Tax Tribunal), in the case of Maruti Suzuki Limited, had passed an interim which thereby admitted the additional ground over the applicability of any treaty rate to the DDT rate as mentioned above.
Moreover, recently, another such opportunity had been presented to the Delhi Tax Tribunal to delve over the admissibility of additional grounds over on similar facts (such as the applicability of treaty rate to the DDT rate). Hence, the Delhi Tax Tribunal did not just admit this additional ground but also ruled in the favour of the taxpayer which implies that the benefit of the tax treaty is available qua the DDT rate.
Facts of the case involved and the decision of the Tribunal
The taxpayer is a wholly-owned subsidiary company of German Company which primarily dealt with the trading of Currency Verification and Processing Systems. This subsidiary company imported these machines from their Associated Enterprises (AE) for their subsequent resale in India and as part of further related services, the taxpayer also indulged in the business of buying and reselling the annual maintenance contracts to their customers in India.
During the year 2012-13, the tax officer made Transfer Pricing adjustments such as the disallowance under section 40(a)(i) of the IT Act wherein they disallowed all the advances written off which were partially upheld by the Dispute Resolution Panel (DRP). Due to this the taxpayer found himself aggrieved due to just the partial relief granted by the DRP, and thus filed an appeal before the Delhi Tax Tribunal. However, the taxpayer also raised an additional ground before the Delhi Tax Tribunal as to whether the benefit of the Double Tax Avoidance Agreement between India and Germany (also known as the Germany Tax Treaty) qua the rate over the payment of dividend to the shareholders must be extended or not due to the above-made changes.
Hence, while admitting the additional ground, the Delhi Tax Tribunal made the observation that a similar grievance had been raised through the means of an additional ground of appeal in the case of Maruti Suzuki India Ltd (supra) wherein the Tribunal had sought to admit the additional ground for the adjudication of the same. Thus, all such additional grounds raised by the taxpayer under the current case were admitted therein.
Upon the merits of the above-mentioned case, the Delhi Tax Tribunal decided that the tax rates specified under the Germany Tax Treaty concerning the rate of dividend should prevail over the DDT rate. Thus the Delhi Tax Tribunal made the following observations while upholding the said judgment:
  1. The burden of DDT falls upon the shareholders instead of the Company since the amount of the distributed profits available for the shareholders always stands reduced to the extent of DDT levied therein. Moreover, the Memorandum to Finance Bills 1997 and 2003 specify and establish that any levy of tax on the Company had been driven by administrative considerations instead of actual legal necessity and there was a further emphasis on the fact that this levy is for all intents and purposes, a charge on dividends only.
  1. Furthermore, the Finance Bill, 2020 has removed section 115-O of the IT Act. Under the Memorandum of the Finance Bill 2020, it has been mentioned that the incidence of tax is upon the payer company and not on any recipient where it should normally be since the dividend is the income within the hands of the shareholders and not in the hands of the Company.
  1. Further reliance had been placed on the Delhi High Court’s decision in the case of New Skies Satellites wherein it was held that any amendment within the domestic tax law cannot be permitted to have the same retrospective effect on an international instrument affected between two sovereign states before such amendment being made. According to the Germany Tax Treaty, the same had been notified before the introduction of section 115-O of the IT Act and thus the tax rates specified within the Germany Tax Treaty concerning dividends must prevail over the DDT. It has to be noted that under the German Tax Treaty, Article 10.4 specifies that clause 1 and 2, which provide for the tax rates of dividend, shall not be applicable in case the beneficial owner of dividends has a Permanent Establishment in India. Since the supporting documents filed by the taxpayer before the Delhi Tax Tribunal needed further verification, the Delhi Tax Tribunal restored this issue for the limited purpose of verification to the Tax Officer therein.

It has already been observed that the DDT is an additional tax that is levied and comes within the ambit of the term ‘income-tax’. The current decision also augments the arguments of taxpayers, who have raised similar contentions before Tax Officers and the Appellate Authorities and Courts or those who have sought a similar ruling on the subject from the Authority for Advance Ruling. Therefore, It is important to evaluate the current ruling whether the same decision shall apply over all other tax treaties.