Bombay HC Clarifies Applicability of (DTAA) Tax Rate to (DDT)

Introduction

In a landmark and path-breaking judgment, the Hon’ble Bombay High Court in M/s Colorcon Asia Pvt. Ltd. v. Joint Commissioner of Income Tax & Ors.^[1] has conclusively addressed the long-standing controversy concerning the applicability of Double Taxation Avoidance Agreements (“DTAA”) toDividend Distribution Tax (“DDT”) under the Income-tax Act, 1961 (“The Act”). The Court examined whether dividends distributed by an Indian company to its foreign parent could be subjected to DDT at domestic rates, notwithstanding the ceiling prescribed under Article 11 of the India–UK DTAA.

The appeal arose from an adverse ruling of the Board for Advance Rulings (“BFAR”), which, relying on theIncome Tax Appellate Tribunal(“ITAT”) Special Bench decision in Total Oil India Pvt. Ltd.,v. DCIT^[2] had denied treaty protection on the ground that DDT constituted a tax on the domestic company and therefore fell outside the scope of the DTAA. Reversing the BFAR’s ruling, the High Court held that DDT is, in substance, a tax on dividend income of the shareholder, and that the identity of the person from whom the tax is collected is irrelevant for the application of treaty provisions. Placing reliance on Section 90(2) of the Act, the legislative history of Section 115-O, and settled principles of treaty interpretation, the Court ruled that dividend income covered under Article 11 of the India–UK DTAA cannot be taxed in India at a rate exceeding 10%.

This judgment marks a decisive departure from the ITAT Special Bench view and reaffirms the supremacy of tax treaties over domestic tax provisions, carrying far-reaching implications for cross-border dividend taxation in the pre-abolition DDT regime.

Facts of the case

• Colorcon Asia Pvt. Ltd. (“the Assessee”) is an Indian company and a wholly owned subsidiary of Colorcon Inc., United Kingdom, its foreign parent company.
• During the relevant assessment years, the Assessee declared and distributed dividends to its UK parent company.
• Under the provisions of the Act then in force, the Assessee was liable to pay DDT under section 115-O on such dividend distributions.
• Accordingly, the Assessee discharged DDT at the effective domestic rate of approximately 20%, including applicable surcharge and cess.
• The Assessee contended that since the dividends were paid to a non-resident shareholder resident in the United Kingdom, the provisions of Article 11 (Dividends) of the India–UK DTAA were applicable.
• Under the India–UK DTAA, India’s taxing rights on dividends are restricted to 10%, and therefore, according to the Assessee, tax on such dividends could not exceed the treaty-prescribed rate, notwithstanding that the levy was collected in the form of DDT.
• To obtain certainty on this issue, the Assessee approached the Authority for Advance Rulings (AAR) seeking a ruling on whether DTAA benefits could be claimed in respect of DDT paid on dividends distributed to its UK parent.
• AAR rejected the Assessee’s contention, holding that DDT is a tax on the distributing company and not on the shareholder, and therefore falls outside the scope of DTAA protection.
• In reaching this conclusion, the AAR placed reliance on the ITAT Special Bench decision in Total Oil India Pvt. Ltd. v. DCIT, which had adopted a similar view.
• Aggrieved by the ruling of the AAR, the Assessee filed a writ petition before the Bombay High Court, challenging the denial of DTAA benefits on DDT.
• The matter thus came before the Division Bench of the Bombay High Court at Goa, raising a fundamental issue regarding the true nature of DDT and the applicability of DTAA provisions, notwithstanding that the tax was collected from the company under domestic law.

Assessee’s Contention

• The assessee contended that DDT is, in substance, a tax on dividend income, which constitutes income in the hands of the shareholder; the company merely functions as a collection mechanism. Section 115-O of the Act only shifts the incidence of tax for administrative convenience and does not alter the nature or character of dividend income.
• The legislative history of DDT clearly establishes that dividend income has always remained the income of the shareholder, irrespective of the person liable to discharge the tax.
• The Hon’ble Supreme Court in UOI v. Tata Tea Ltd³. held that DDT is a tax on dividends themselves and not an independent or separate levy
• DDT is an “additional tax” and falls within the definition of “tax” under section 2(43) of the Act, thereby bringing it within the scope of the charging provision under section 4. Section 4 operates subject to other provisions of the Act, including section 90.
• Section 90(2) mandates that where the provisions of a tax treaty are more beneficial to the assessee, such provisions shall prevail over domestic law, a principle consistently upheld by judicial precedents.⁴
• The assessee further submitted that all conditions prescribed under Article 11 of the India–UK DTAA are duly satisfied, as the dividend is paid by an Indian resident to a UK tax resident who is the beneficial owner of the dividend.
• It was also submitted that unilateral amendments to domestic tax law cannot override or curtail treaty benefits, as reaffirmed by the Hon’ble Supreme Court in Engineering Analysis Centre of Excellence Pvt. Ltd.⁵
• The assessee also relied upon the decision of Delhi ITAT in Giesecke & Devrient (India) (P.) Ltd. v. ACIT⁶ in support of its contention that the DDT rate is subject to tax rate provided under the DTAA.
• Accordingly, the assessee concluded that DDT on dividends distributed to its UK parent company ought to be restricted to 10% in accordance with Article 11 of the India–UK DTAA.

Revenue Authorities Contention

• The Revenue Authorities submitted that the assessee’s contention that the tax rate prescribed under Article 11(2)(b) of the India–UK DTAA overrides section 115-O of the Income-tax Act, 1961, is misconceived. DDT is a tax levied on the domestic company under section 115-O and not a tax on dividend income in the hands of the shareholder.
• The statutory charge and incidence of DDT rest exclusively on the company declaring the dividend. Consequently, DTAA provisions governing the taxation of shareholders are not attracted.
• Article 11 of the India–UK DTAA applies only in cases where dividends are taxed in the hands of the shareholder, which is not the position under the DDT regime.
• It was further contended that Article 2 of the DTAA does not encompass DDT, as DDT is an “additional income tax” imposed on the company and not a tax on the income of the non-resident shareholder.
• The DTAA can be invoked only where the treaty expressly contemplates the levy in question. The India–UK DTAA does not deem DDT to be a tax on shareholders, unlike certain other tax treaties which contain specific deeming provisions.
• Reliance was placed on the judgment of the Hon’ble Supreme Court in Godrej & Boyce Manufacturing Co. Ltd.⁷ ,wherein it was categorically held that DDT is not a tax paid on behalf of shareholders but an independent levy on the company.
• The absence of any tax credit mechanism under tax treaties for DDT further reinforces the position that DDT was never intended to be treated as shareholder-level taxation.
• It was submitted that tax treaties must be interpreted strictly in accordance with their express terms, and concepts cannot be imported from other treaties or inferred by implication.
• In the absence of any mutual agreement under Article 11(2) regarding the mode of application of the treaty rate to DDT, the provisions of the DTAA cannot override section 115-O of the Act.
• The Revenue concluded that applying DTAA rates to DDT would distort the treaty framework by granting unintended relief to domestic companies, rather than achieving the object of avoiding double taxation of shareholders.

Issues raised before the Bombay High Court and the Court’s Rulings

1. Whether the DDT paid by assessee is governed by the India–UK DTAA or solely by Section 115-O of the Income-tax Act, 1961?
2. The High Court held that DDT is, in substance, a tax on dividend income, which is the income of the shareholder, notwithstanding that the levy is collected from the company. Further, Section 90(2) of the Act permits the assessee to apply the provisions of the DTAA where they are more beneficial. Accordingly, the Court concluded that DDT is governed by the India–UK DTAA to the extent the treaty provides a lower tax rate.

• Whether BFAR erred in not restricting the tax rate on dividends to 10% under Article 11(2) of the India–UK DTAA?
• The Court ruled that Article 11(2) of the India–UK DTAA caps India’s taxing rights on dividend income at 10%. Any collection of DDT beyond this treaty limit was held to be erroneous and contrary to law, including being violative of Article 265 of the Constitution of India. Consequently, the BFAR’s refusal to apply the treaty rate was found to be incorrect.

• Whether the levy of DDT on the company, instead of the shareholder, affects the applicability of DTAA benefits?
• The High Court clarified that the identity of the person on whom tax is statutorily levied is irrelevant for the application of Article 11. What is determinative is the nature of the income, i.e., dividend income. Since DDT is effectively a tax on dividend income of the shareholder, collection of tax from the company does not negate DTAA benefits.

• Whether the 10% tax rate under Article 11(2) requires grossing up to determine liability?
• The Court held that no grossing-up is required. The 10% rate prescribed under Article 11(2) applies directly to the dividend income, and no further adjustment or enhancement of the tax base is warranted.

• Whether unilateral changes in domestic law on DDT incidence can override the beneficial provisions of the DTAA?
• The High Court observed that administrative or legislative changes shifting the point of collection of DDT do not alter the substantive character of the tax. Such unilateral changes under domestic law cannot override or dilute the benefits available under the DTAA.

• Whether denial of DTAA benefits results in double taxation, contrary to the purpose of the treaty and DDT provisions?
• The Court noted that taxing dividends beyond the treaty-mandated rate of 10% would result in double taxation, defeating the object of both the DTAA and the DDT regime. Accordingly, the assessee was held to be entitled to the concessional treaty rate.

Conclusion

The Hon’ble Bombay High Court held that dividends cannot be taxed in India at a rate higher than what is allowed under the applicable tax treaty, even if the tax is collected from the company under the DDT mechanism. DDT is essentially a tax on dividend income, and when a DTAA provides a lower rate, that rate must prevail over domestic law. Shifting the tax collection to the company does not deny treaty benefits, and any tax collected above the treaty limit is unlawful.

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[1] TS-1623-HC-2025(BOM)

[2] TS-197-ITAT 2023(Mum)

[3] [2017] 398 ITR 260 (SC)

[4] UOI v. Azadi Bachao Andolan [263 ITR 706 (SC); Sanofi Pasteur Holding SA v. Dept. of revenue [2013] 354 UTR 316 (AP)

[5] [2021] 432 ITR 471 (SC)

[6] TS-522-ITAT-2020(DEL)

[7] TS-176-SC-2017