An overview of tax and transfer pricing compliances for a non-resident entity receiving dividend income from India

A dividend is the distribution of profits by a company to its shareholders as determined by the company’s board of directors. When a corporation earns a profit or surplus, it is able to pay a proportion of the profit as a dividend to shareholders. A dividend is defined under Section 2(22) of the Income-tax Act, 1961 (the Act) as under:

(22) "dividend" includes

  • any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company.
  • any distribution to its shareholders by a company of debentures, debenturestock, or deposit certificates in any form, whether with or without interest, and any distribution to its preference shareholders of shares by way of bonus, to the extent to which the company possesses accumulated profits, whether capitalized or not.
  • any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalized or not.
  • any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits which arose after the end of the previous year ending next before the 1st day of April, 1933, whether such accumulated profits have been capitalized or not.
  • any payment by a company, not being a company in which the public are substantially interested, of any sum (whether as representing a part of the assets of the company or otherwise) made after the 31st day of May, 1987, by way of advance or loan to a shareholder, being a person who is the beneficial owner of shares (not being shares entitled to a fixed rate of dividend whether with or without a right to participate in profits) holding not less than ten per cent of the voting power, or to any concern in which such shareholder is a member or a partner and in which he has a substantial interest (hereafter in this clause referred to as the said concern) or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits.
    Previously, an Indian company was required to pay a Dividend Distribution Tax (DDT) equivalent to 20.555% (including surcharge and cess) on dividends paid to its shareholders on or before 31 March 2020. There was no withholding tax on the dividends distributed by the Indian company and such dividends were exempt in the hands of the recipient.

However, from 1 April 2020, the DDT was abolished, and a withholding tax was introduced on the payment of dividends. Accordingly, an Indian company paying dividends is no longer liable to DDT but should instead withhold tax at source at the time of payment of the dividend since the recipient of the dividend is now subject to tax.

In the context of the above, the following aspects pertaining to dividend income received by a non-resident taxpayer from India are highlighted:

  • Taxability of dividend income received by a non-resident entity from India
  • Requirement to furnish corporate tax return in India u/s 139(1) of the Act
  • Requirement to undertake Transfer Pricing (TP) compliances in India u/s 92 of the Act

Taxability of dividend income

As per Section 115A of the Act, the withholding tax rate on dividends paid to non-resident shareholders is 20% (plus applicable surcharge and cess).

However, preferential withholding tax rates are available under India's Double Taxation Avoidance Agreements (DTAAs) with other countries, provided that the recipient of such dividends fulfills the eligibility criteria. Typically, the concessional withholding tax rate could be as low as 5% - 10%.

Furnishing corporate tax returns under Section 139(1)

In this regard, it may be noted that Section 115A provides an exemption from filing corporate tax returns with respect to Dividend income, provided the withholding tax is deducted as per the rate prescribed under the said Section viz 20% (plus applicable surcharge and cess).

However, the taxpayer who opts to enjoy concessional withholding tax rates as provided under the DTAA, would have to furnish the corporate tax return on or before the due date.

TP compliances under Section 92 of the Act (u/s 92D and 92E)

In an ideal scenario, dividends are considered an appropriation of profits (current or previous years). Such profits are after-tax profits and therefore, while DDT was in force, all taxes were paid on net profits, the applicability of TP on dividends from a practical point of view had no or little relevance.

The implications in relation to transaction pertaining to dividend between two Associated Enterprises (AE) as per Section 92A of the Act has been a much-debated affair under the TP regulations in India.

It is pertinent to note that the provisions of the Act do not provide any specific exemption from the annual TP compliances, regardless of the fact whether the withholding tax is deducted as per Section 115A (higher rate) or as per the DTAA (concessional rate).

While there are certain technical arguments to support the view that where the taxpayer is not required to do a corporate tax return in India (referring to exemption u/s 115A), he would also enjoy the exemption from TP compliances. However, such a position may be litigative, considering that the provisions of the Act do not specifically provide an exemption from TP compliances.

Therefore, non-resident taxpayers deriving dividend income from India would have to undertake belowmentioned TP compliances:

Sr. No. Nature of Compliance
1. Issuance of Accountant’s Report (i.e., Form No. 3CEB)
2. Master File compliance (Form No/ 3CEAA)
3. TP documentation report (Format prescribed under Rule 10D of the Income Tax rules.