Currently, Section 115BBD of the Income Tax Act, 1961 provides a concessional tax rate on foreign dividends where the recipient Indian company holds a minimum of 26 per cent equity shares of a foreign company. The tax rate prescribed on the foreign dividend is 15 per cent plus applicable surcharge and cess.

The concessional tax regime regarding foreign dividends was introduced in 2012 to attract repatriation of income earned by Indian corporates from their overseas investments.

The Finance Bill 2022 proposes taking away the concessional tax rate regime on foreign dividends from April 1, 2022. Accordingly, foreign dividends received by an Indian company would be taxable at the rate of 25.17 per cent (for companies opting for the new tax regime) or at the rate of 34.94 per cent (for companies continuing under the old tax regime). Effectively removing the concessional tax rate would result in higher tax outflow to the extent of 8-18 per cent depending upon the tax regime.

The intention of the proposed amendment (as explained in the memorandum) is to eliminate disparity in the differential tax treatment for dividends received from domestic and foreign companies.

This proposed amendment has far-reaching consequences. The increased dividend tax rate is a sheer discouragement to Indian companies with a global presence. They would be deterred to plough back their foreign earnings to India, which would ultimately impact the flow of foreign currency into India.

In the future, companies would have to seek alternate restructuring options through mergers, demerger, capital restructuring, etc., to repatriate surplus funds to India from their overseas subsidiaries. Needless to add, this could also involve a certain degree of tax uncertainty and tax litigation and would be time-consuming. Clearly, this was not what Corporate India was expecting in this pandemic-hit economy.

By way of comparison, several countries such as the United States, the United Kingdom, and Singapore exempt foreign-sourced dividends from domestic tax. Countries such as the Netherlands, Switzerland, France, etc., provide participation exemption to their corporates investing in overseas companies, intending to encourage global expansion.

It is also interesting to note that the tax on dividends distributed by an Indian company to its foreign parent is subject to a beneficial tax rate prescribed in the double tax avoidance agreement, which is 5 per cent compared to 36 per cent tax payable by resident individuals. The crux of providing tax concessions is to attract more foreign investment. India Inc. expected the same treatment to be given while taxing foreign dividends in India to encourage forex inflow into the country. It is, however, discouraging and ironic that the proposal in Budget 2022 disincentivises the repatriation of income earned and parked overseas.

Further, removal of the concessional tax rate is not warranted as Section 80M of the Act provides shelter from taxability of such foreign dividend income in cases where the recipient Indian company distributes the same to its shareholder on or before the filing of its return of income.

With this proposal, many corporates with cash-rich foreign subsidiaries may try to repatriate surplus profits before this provision comes into effect to save an 8-18 per cent tax cost.

Budget 2022 has brought cheer to many fronts. Unfortunately, the issue of tax concession on foreign source dividends is not one of them.

 

 

Created & Posted by Pooja

Income Tax Expert at TAXAJ

 

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