Bombay HC Refers DDT-DTAA Controversy to Larger Bench; Questions Correctness of Colorcon Asia.
 

The decision in Foseco India Ltd¹ marks a significant development in the long-standing controversy surrounding the characterization of Dividend Distribution Tax (DDT) under Section 115-O of the Income-Tax Act, 1961 (the Act) and its interplay with tax treaties.

The Bombay High Court, while expressing prima facie reservations regarding a recent coordinate bench ruling, has referred the issue to a Larger Bench.

Facts of the case

Foseco India Ltd., an Indian company, distributed dividends to its UK-based shareholders and discharged DDT at the rate prescribed under domestic law. Subsequently, the company contended that, under the India-UK Double Taxation Avoidance Agreement (DTAA), the tax should have been limited to the treaty rate of 15%.

On this basis, the company sought a refund of the excess DDT paid.

Issues under Consideration

The central issue for determination is whether DDT levied under Section 115-O is, in substance:

• a tax on the profits of the company, or
• a tax on the dividend income of shareholders, with the incidence merely shifted to the company

This distinction assumes critical importance in cross-border scenarios. If DDT is characterized as a tax on shareholder income, non-resident shareholders may claim the benefit of concessional tax rates under the applicable DTAA. Conversely, if DDT is regarded as a tax on the company, DTAA provisions would not apply, as the tax is imposed on a domestic entity that is not entitled to treaty protection in India.

Divergent Judicial Views

There have been conflicting judicial interpretations on the characterization of DDT and the application of DTAA.

• The Supreme Court, in Godrej & Boyce Manufacturing Co. Ltd. v. DCIT², examined the nature of DDT in the context of disallowance under Section 14A. The court upheld the view that DDT is an additional income tax levied on the company's profits, specifically on the portion distributed as dividends. This decision has clearly stated that DDT is a tax on the company and not a tax on dividend income on behalf of the shareholders
• Despite of the above Supreme Court ruling, several Tribunal decisions took a contrary view, leading to the constitution of a Special Bench in DCIT v. Total Oil India Pvt. Ltd³. which held that DTAA provisions are not applicable to DDT, as the tax is levied on the company and not on the shareholder.
• However, recently in the case of Colorcon Asia Pvt. Ltd. v. JCIT⁴, the Bombay High Court (Goa Bench) reversed the special bench decision and held that DDT is, in substance, a tax on shareholder income, with the liability merely shifted to the company for administrative convenience. The Court reasoned that treaty provisions should apply based on the nature of the income (dividend) rather than the person discharging the tax liability. Accordingly, it concluded that the beneficial DTAA rate should apply to DDT.

The Foseco Ruling and Reference to a Larger Bench

The High Court, after examining the statutory framework of Section 115-O, expressed a prima facie view and held as follows,

• DDT under Section 115-O is a tax on the company's distributed profits, creating an independent liability, with dividends exempt in shareholders' hands and no linkage to DTAA provisions.
• It was observed that the reasoning in Colorcon Asia Pvt. Ltd. (supra) appears inconsistent with the Supreme Court ruling in Godrej & Boyce Manufacturing Co. Ltd. (supra)
• Accordingly, due to this conflict in judicial precedents, the matter has been referred to a Larger Bench.