1. Introduction: The Finance Act, 2021 has proposed that foreign company shall not be liable to pay MAT on its dividend income if the same is chargeable to tax at a rate lower than MAT rate. After the amendment, the dividend income is chargeable to tax in the hands of the shareholders.

  2. At present the taxation of dividend has been shifted from a domestic company to a shareholder. A foreign company shall be liable to pay tax in India on the dividend income, both under normal provisions as well as under the provisions of MAT. Sub-section (7) of Section 115JB, if the company is located in the International Financial Services Center (IFSC) and deriving income solely in convertible foreign exchange, MAT is levied at the rate of 9%.

    Explanation – defines International Finance Services Centre

    1. It shall have the same meaning as assigned to it in Section 2(9) of the Special Economic Zones Act, 2005.

    2. “Unit” means a unit established in an International Financial Centre.

    3. “Convertible foreign exchange” – It means a foreign exchange which is for the time being treated by Reserve Bank of India as convertible foreign exchange for the purposes of Foreign Exchange Management Act, 1999 and the rules made thereunder.

      However, where the dividend is received in respect of GDRs (Global Depository Receipts) of an Indian Company or PSU (Public Sector Undertaking) referred to in Section 115AC or in respect of units of mutual funds purchased in foreign currency referred to in Section 115AB, (it shall have the meaning as in the Foreign Exchange Management Act, 1999). The same shall be chargeable to tax at the rate of 10% as per Section 115AC(1)(ii). However, if the foreign company is a resident of a country with which India has DTAA, the provisions of DTAA shall come into play. However, DTAA provide a beneficial tax rate on dividend income ranging from 5% to 15%. The dividend income of a foreign company may be chargeable to tax in India at a rate lower than the MAT rate applicable as it is unreasonable for a foreign company to pay MAT on such income.

  3. Amendment in clauses (iid) and clause and clause (fb) of Explanation 1 to Section 115JB, certain income and expenses claimed in respect thereof shall be reduced or added back while computing the book profit of a foreign company if the same is debited or credited in the statement of profit and loss respectively. This adjustment is required to be made if the relevant income is taxable at a rate lower than the rate of MAT. The existing provisions included capital gains arising on transactions in securities and the interest, dividend, royalty or fees for technical services (FTS) chargeable to tax at the rate or rates specified in Chapter XII.

The Dividend Distribution Tax (DDT) has been abolished and the dividend income is now taxable in the hands of the shareholder with effect from assessment year 2021-2022.

Minimum Alternate Tax (MAT)

Minimum Alternate Tax (MAT) was introduced by the Finance (No. 2) Act, 1996 with effect from assessment year 1996-1997 to facilitate the taxation of zero tax companies. These companies were paying no tax or marginal tax by undue advantage of various tax concessions or incentives inspite of having high profits. Thus, to avoid the malpractices, the concept of MAT was introduced so that the companies were required to pay a certain percentage of their book profit as minimum alternate tax even if they were not required to pay or liable to pay lower tax as per the normal provisions. At present, the MAT is levied under Section 115JB at the rate of 15%, with effect from 1st April, 2020 of book profit. The “Book Profit” is computed certain adjustments to the profits as show in the profit and loss of the company. They are prescribed under explanation I to Section 115JB. For the purpose of MAT, the profit and loss shall be required to be prepared by the company in accordance with the provisions of Schedule III to the Companies Act, 2013. This is not applicable to companies engaged in the business of insurance, banking and generation or supply of electricity.

Section 115JB does not differentiate between domestic company and a foreign company for payment of MAT. However, the foreign companies not governed by the Companies Act, 2013 unless it has a place of business in India. Various counts have held that MAT provisions can apply in case of a foreign company only when it has a place of business in India. Explanation 4 of Section 115JB inserted by Finance Act, 2016 was made applicable retrospectively form assessment year 2001-02. The Explanation provides that the provisions of MAT shall not apply to a foreign company, if

  1. It is a resident of the country with which India has DTAA and does not have a Permanent establishment in India; or

  2. It is a resident of those countries with which India does not have DTAA and not required to get registered in India under any law relating to companies.

However, the foreign companies are not required to take registration in India under the Companies Act, 2013 unless they have place business in India. As per DTAA, a PE is constituted when an enterprises carries on business in a country through a fixed place of business in India.

A PE is constituted when an enterprise carries on business in a country, through a fixed place of business constituted therein. This is as per DTAA requirement.

Thus, when a foreign company is required to take registration under the Companies Act, 2013 only when it has a place of business in India. Once a foreign company has a place of business in India or PE, it may be required to prepare a financial statement of its Indian business operations in accordance with Schedule III as per Section 381 of the Companies Act, 2013 read with rule 4 of the Companies (Registration of foreign companies) Rules, 2014. Thus, such companies in order to compute book profit, the profit shown in the profit and loss account statement prepared for Indian Business Operations shall be taken into consideration as prescribed under Explanation 1 to Section 115JB.

MAT on Dividend Income of the Foreign Company:

As per Finance Act, 2021, dividend income of a foreign company shall not form part of the book profit. Consequently, MAT will not be levied provided the following conditions are satisfied.

  1. Dividend income is chargeable to tax at the rate specified under Chapter XII, and

  2. The tax rate on such income as per the provisions of the Act is less than the rate of MAT.

It is therefore, necessary to first determination when the dividend of a foreign company is chargeable to tax at the rates specified in Chapter XII. Once, this is determined, the next step is to determine the tax rate on such income as per the provisions of the Income-tax Act or provisions of DTAA, whichever is most beneficial.

Taxability of certain income under Chapter XII of the Income-tax Act

Chapter XII of the Income-tax Act provides for the special tax rates in respect of certain income. Tax rates for dividend income of a foreign company are specified in Section 115A, Section 115AB, Section 115AC and Section 115AD of Chapter XII of the Cat.

They are as follows:

Section

Income covered

Tax rate

115AB

Dividend income from units of Mutual Funds purchased in foreign covered by the overseas financial organization

10%

115AC

Dividend on GDR of an Indian Company or Public Sector company (PSU) purchased in foreign company

10%

115AD

Dividend income from Securities

20%

115A

Dividend income in any other case

20%

Thus dividend income of a foreign company shall, in any case, be chargeable at the special rates provided under Chapter XII.

Tax on dividend income as per DTAA’s

Where the dividend income is chargeable to tax under Section 115AB or Section 115AC, the benefit of amendment shall be available as the tax rate is lower than the rate of MAT. If the dividend is taxable under Section 115AD or Section 115A, if shall be excluded from the book profits only if the rate as per DTAA on such dividend income is upto 15%. As per most of the DTAA’s that India has signed with the foreign countries, the dividend income is taxable in the source country in the hands of the beneficial owner at the rate ranging from 5% to 15% of the gross amount of income of dividends. Thus, the dividend income may be excluded from the computation of book profit in almost all situations.

Tax on Dividend if foreign company has PE in India

  1. If a foreign company does not have a PE in India, it is not chargeable to MAT;

  2. Where a foreign company has a PE in India, the DTAA empowers the taxing country to the source country and accordingly, income is taxable as per domestic law of that country;

  3. As per Section 9, income arising from business connection in India, which is deemed to accrue or arise in India, which may be taxable under the head business or profession.

The dividend income attributable to PE shall be taxable under other sources at the rate specified in Chapter XII. In such a situation, the benefit of Article of the DTAA pertaining to taxability of dividend shall not be available as it excludes a dividend income. In short, the concessional rate of 5% to 15% as specified in DTAA shall not be available and such dividend shall be taxable under Section 115AD or Section 115A, it will not be excluded from the book profit because ultimate rate of tax would be 20%.

The question arises when dividend income is attributable to PE

A shareholding will be deemed to be connected with PE, if the economic ownership of the holding is allocated to that PE under the principles of attribution of profits permanent establishments. This is based on the principle that PE is treated as a private enterprise. The attribution of economic ownership of assets will have consequences for both attribution of capital and interest bearing debt and the attribution of profit to the PE.

For example – If company has a branch in India and such branch is treated as PE. The said branch invests out of profits earned in the shares of another Indian Joint Stock Company. Further, the employees of the branch evaluate from time to time investments made by the branch. In such a case, the holding of investment may effectively considered as connected to that PE and result of the same, the dividend income may be attributable to PE in India.

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