Dividends are generally paid by companies out of their post tax profits. Thus, the dividend-paying company first pays income tax on its profits and then pays dividend out of the balance profits.
Thus, the dividend received by a shareholder is out of the profits which have already suffered tax. Therefore, if the person receiving dividend is again liable to pay income tax, it virtually amounts to double taxation of the same income.
Therefore, in many countries either there is no tax on dividend income or such income is taxed at concessional rates. In India, section 10(34) of the Income-tax Act exempts any income in the hands of the recipient (including foreign company) by way of dividends on which Dividend Distribution Tax (DDT) has been paid under section 115-O. Section 115-O prescribes tax at 16.995 per cent of the amount of dividend declared, distributed or paid.
It may be clarified here that, in India, the dividends declared by a domestic company is treated as tax-free. But where the dividend is received from a company located outside India, such dividend is liable to be taxed in India because the exemption from tax is not available in a case where the dividend paying company is situated outside India.
In such a case, the dividend income in India in case of resident will be taxed at normal rates of tax, and in case of non-residents or in case of a foreign company the rate of tax will be 20 per cent.
However, if the dividend paying company is resident of a country with which India has signed Agreement for Avoidance of Double Taxation (AADT), the taxability of dividend income will be determined by the provisions of the AADT.
For example, in a case where the dividend paying company is in Mauritius, the rate of tax applicable on the person receiving dividend in India is 5 per cent or 15 per cent depending on the conditions prescribed in the tax treaty.
An analyses of various treaties will show that in several cases, there is no tax on dividends income at all. For example, there is no tax in India on dividend received from companies located in Greece, Libya, United Arab Republic.
Likewise, in case of Finland, Mauritius, Qatar, Slovenia, Zambia there is a concessional rate of tax.
It is an established legal position that a tax treaty over-rides the provisions of Income-tax Act wherever the treaty provisions are more beneficial to a tax payer. This issue came up for consideration in a recent case of Torqouise Investment & Finance Ltd where the Supreme Court, vide its judgment dated 20/02/2008, held that if the dividend income is exempt from tax under any AADT, then no tax can be levied on such income by invoking the provisions of the Indian Income-tax Act. The Apex Court observed:-
Revenue thereafter filed appeal before the Income Tax Appellate Tribunal (for short the Tribunal). The Tribunal disposed of the appeal with the observation that Double Taxation Avoidance Agreement (for short DTAA) entered into by the Government of India with the Government of Malaysia would override the provisions of the Act if they are at variance from the provisions of the Act. It was held that from a plain reading of Article XI of the DTAA, it was clear that dividend income would be taxed only in the contracting States where such income accrued.
The issue discussed above is assuming greater importance as overseas investments by the Indian enterprises are rapidly increasing.