Mitesh Chauhan and Sumeet Agrawal
Currently, Section 115BBD of the Income Tax Act, 1961 provides concessional tax rate on foreign dividend where the recipient Indian company holds minimum 26 percent equity shares of a foreign company. The tax rate prescribed on foreign dividend is 15 percent plus applicable surcharge and cess.
The concessional tax regime in respect of foreign dividend was introduced in 2012 with an intention to attract repatriation of income earned by Indian corporates from their overseas investments.
The Finance Bill 2022 proposes to take away the concessional tax rate regime on foreign dividend with effect from April 1, 2022. Accordingly, foreign dividend received by an Indian company would be taxable at the rate of 25.17 percent (for companies opting for the new tax regime) or at the rate of 34.94 percent (for companies continuing under the old tax regime). Effectively, removal of concessional tax rate would result in higher tax outflow to the extent of 8-18 percent 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 dividend received from domestic companies and foreign companies.
This proposed amendment has far-reaching consequences. The increased dividend tax rate is a sheer discouragement to Indian companies which have a global presence. They would be deterred to plough back their foreign earnings to India, and this ultimately would impact the flow of foreign currency into India.
Going forward, companies would have to seek alternate restructuring options by way of merger, demerger, capital re-structuring, etc. to repatriate surplus funds to India from their overseas subsidiaries. Needless to add, this could also involve a certain degree of tax uncertainty, tax litigation, and would be time consuming as well. Clearly, this was not something which 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 dividend from domestic tax. There are countries such as the Netherlands, Switzerland, France, etc. which provide participation exemption to its corporates investing in overseas companies, with a view to encourage global expansion.
It is also interesting to note that the tax on dividend 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 percent as compared to 36 percent 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 dividend in India to encourage forex inflow into the country. It is, however, discouraging and ironical, that the proposal in Budget 2022 disincentivises 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 filing of its return of income.
With this proposal, many corporates which have cash-rich foreign subsidiaries may try to repatriate surplus profits before this provision comes into effect to save an 8-18 percent tax cost.
Budget 2022 has brought cheer to many fronts. Unfortunately, the issue of tax concession on foreign source dividend is not one of them.
Mitesh Chauhan is Partner, and Sumeet Agrawal is Principal Associate, Economic Laws Practice. Views are personal, and do not represent the stand of this publication.
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