Steep TDS rates on dividend payouts concerns FPIs

Mumbai: India’s foreign portfolio investors (FPIs) are concerned about steep Tax Deduction at Source (TDS) rates on dividend pay-outs. The central government while reintroducing dividend distribution tax (DDT), has not provided any mechanism to allow companies to deduct tax based on rates specified for FPIs in their respective tax treaties. Hence, most of the companies are choosing to levy a TDS of 20-28% on dividends payable to FPIs even as the rate applicable via tax treaties is as low as 5-10%.

Several leading FPIs have shot out mails to global custodians expressing their concerns about this higher tax rate. This has prompted custodians to hold a conference call with their FPI clients later this week to gather inputs and then present a representation to the Finance Ministry.

The development assumes significance since dividend payment season of listed companies will start in next couple of weeks and majority of the companies are expected to make the payments to investors by mid-June.

“In the current market scenario, cash is king, and the higher TDS will unnecessarily hold up the cash of FPIs,” said a global custodian. “Companies don’t want to take the risk of collecting lower TDS since they fear that they could be held liable by tax authorities subsequently,”
All the tax slabs applicable for FPIs are based on the double tax avoidance agreements (DTAAs) their home country has with India. The Indian government too prescribes separate slabs for foreign investors and the funds are at liberty to choose either the DTAA rate or the domestic rate based on their own considerations.

“Under tax law, Indian companies will need to deduct tax at the rate of 20% on dividends paid to FPIs and the law does not allow companies to consider lower rates under tax treaties for TDS purposes,” said Rajesh Gandhi, partner, Deloitte India. “The Government should ideally amend the law and allow treaty rates to be used for TDS purposes,”

To be sure, FPIs will be able to claim treaty benefits on taxes paid on the dividends. However, they will have to wait until the end of the financial year and claim refunds from the tax authorities for any excess taxes paid.

“For FPIs, the TDS is at 20 per cent under section 196D, and this section does not allow for treaty rates even if they are lower as it does not mention 'rates in force',” said Amit Maheshwari, partner, Ashok Maheshwary and Associates, a chartered accountancy firm. “The excess TDS can be claimed as adjusted or claimed as refund while filing return of taxes,”

Also, the TDS in some cases could go even higher than 20% due to applicability of additional surcharge. Any FPI structured as trust or non-corporate will have to cough up this surcharge taking the effective TDS rate to upto 28%.

According to tax experts, the government is keen on retaining the higher TDS rate since existence of a tax treaty between the country of FPI’s origin and India doesn’t essentially mean that the FPI becomes eligible for the concessional tax rate specified in the treaty. The tax authority scrutinises the application of FPIs for treaty benefits though the lens of General Anti-Avoidance Rules (GAAR), a law aimed at cubing tax avoidance by FPIs.

In the Union Budget for FY21, the government overhauled the DDT system. Earlier, companies use to deduct a flat 20% DDT on total dividend amount and then pay rest of the amount to the investors. This system put FPIs at a disadvantageous position since they were being subject to higher tax rates. Also, they were unable to claim tax credits in their home countries for DDT paid, since it was being charged at the company level. Now, government has made dividends taxable in the hands of investors. While FPIs may be subject to TDS, other classes of investors such as retail and high net worth individuals aren’t subject to TDS. Instead, they will have to pay the dividend tax based on their income levels during the year-end tax filings.