Netherlands Treaty: Tax Cheer For Dividend Income
Interpretation of tax treaties must be liberated from technical rules, says Delhi High Court.
Netherlands-based shareholders of Indian companies have a reason to cheer. Their dividend income will be taxed at a lower rate of 5% even though the country’s double tax avoidance treaty with India prescribes a 10% rate, the Delhi High Court has held.
Tax treaties are negotiated by diplomats and must not be interpreted using technical rules, the high court noted.
Netherlands is a holding-company structure destination—so, this is a welcome ruling for all shareholders there who receive dividends from their Indian investments, Ajay Rotti, partner at Dhruva Advisors, told BloombergQuint.
This is a first of its kind ruling and an important one since the court has emphasized that while interpreting treaties, commercial relationship and not technical interpretation needs to be given priority.Ajay Rotti, Partner, Dhruva Advisors
Concentrix, Optum vs Tax Department
The case relates to two Netherlands-based companies—Concentrix Services and Optum Global Solutions. Both hold 99.99% share in their Indian counterparts, Concentrix India and Optum India, respectively.
Last year, the two Netherlands-based holding companies approached the revenue department seeking a tax certificate specifying that the dividends received by them from their Indian subsidiaries are taxable at the rate of 5%.
Section 197 of the income tax law allows taxpayers to approach the department for a certificate for nil or lower deduction of TDS. Effective April 1, 2020, dividends are taxable in the hands of the shareholders.
The tax department responded with a certificate specifying the tax rate to be 10% as per the India-Netherlands treaty.
5% vs 10% Argument
The companies approached the Delhi High Court against the tax department’s decision.
Concentrix and Optum argued that even though the India-Netherlands tax treaty prescribes a 10% withholding tax rate, they should get the benefit of a lower rate by applying the “most-favoured nation” clause. The clause ensures if there’s a beneficial tax rate in any other treaty that India has signed, that rate can be imported to the Netherlands treaty.
Basis this clause, the companies pointed to India’s tax treaties with Slovenia, Lithuania and Columbia which prescribe a 5% withholding tax rate.
But the tax department argued against the import of the lower rate to the Netherlands treaty which was signed in 1969. The department took a technical view of the language of the treaty, which says:
“If after the signature of this convention [Netherlands], under any convention or agreement between India and a third state which is a member of the OECD, India should limit its taxation at source on dividends, interests, royalties…..the same rate shall also apply under this convention [Netherlands].”
The revenue department hinged its argument on— is a member of the OECD. For the beneficial rate to be applicable, the three countries should’ve been OECD members when the Netherlands treaty was signed. Since Slovenia, Lithuania and Columbia became OECD members much later, the benefit of the lower rate cannot apply to the Netherlands treaty, it said.
Also, it argued, that even though the Netherlands treaty has been amended several times, no change has made to the withholding tax rate of 10%.
Interpret Treaties Liberally, Says High Court
Tax treaties are meant to aid commercial relations and equitable distribution of tax revenues for income which falls for taxation in both countries, the high court pointed out.
Their interpretation is liberated from the technical rules which govern the interpretation of domestic law, it said. And so the revenue department’s insistence to read the Netherlands treaty in a way that denies it the same benefit as the other three countries is misconceived, the court held.
The principle of parity between the Netherlands treaty and those executed after that kicks in as long as the other country is an OECD member and its treaty provides for a lower withholding rate, the high court said in its order.
The court has come to the correct conclusion that the treaty protocol requires all OECD member countries to be treated alike with respect to withholding taxes, Parul Jain, direct tax leader at Nishith Desai Associates, said.
But the benefit of a lower rate, as per the treaty, will only be available if the recipient of the dividend income is also the beneficial owner of the same, she pointed out.
If this is not the case, the lower rate under the treaty will not be applicable. And given that the high court has now allowed an even reduced rate of 5%, one can expect the tax department to litigate on the aspect of beneficial ownership.Parul Jain, Leader - Direct Tax, Nishith Desai Associates
Since beneficial ownership was not contested by the tax department, the high court approved the 5% withholding rate for Concentrix and Optum.