Taxation of dividends in India: the impact on Luxembourg investment funds

in Financial Services, 19.05.2020

This article has been written together with Kadambari Chari.

As market trends consistently show, investments in emerging markets are increasing in importance for the asset management industry, making it even more critical to keep up with the local changes and practices of those countries. At the same time, it incentivizes these markets to align their domestic practices with international standards, without hindering their domestic policy strategies.

In keeping with this trend, the Indian Finance Minister introduced several changes to the existing tax laws in the recent Union Budget session of 1 February 2020. None were more important for the asset management industry than the repeal of the dividend distribution tax (DDT) and the introduction of a 20 percent withholding tax (WHT) on dividends.

Globally, the taxation of dividends is typically imposed at the level of investors/shareholders, usually in the form of a WHT on the gross amount of dividends. On the contrary, until 31 March 2020, the tax in India was imposed, not on the investors/shareholders, but on the company making the distribution. This came in the form of the DDT, an effective tax of 20.56 percent imposed at the time of a distribution of dividends to the shareholders. The DDT was a tax on the distributing company itself, and since it would not have created any double taxation for the taxpayer (in this case, the shareholder), it was not included in the scope of any applicable tax treaties. As a result, it was not possible for foreign investors, including foreign investment funds, to benefit from any provisions under the relevant tax treaties.

The question now is how do these changes impact investors/shareholders?

By bringing dividends distributed by Indian companies within the purview of India’s withholding taxes, it opens the door to more beneficial rates under the applicable tax treaties with India. In the case of Luxembourg, the tax treaty with India provides a maximum tax rate of 10 percent on the gross amount of dividends and would therefore allow a reduction of the overall tax rate from 20 percent (base rate) to 10 percent.

At present, Luxembourgish tax authorities do not issue certificates of tax residence (CoTRs) to Luxembourg funds, so these funds are unable to apply the provisions of the India-Luxembourg tax treaty. As a result, Luxembourg funds would be subject to WHT in India at the rate under Indian domestic law. If one were to apply Indian domestic law to dividend distribution, in effect as of 1 April 2020, the maximum WHT rate on dividends would be 21.84 percent in the case of corporate entities (e.g. SICAVs) or 23.92 percent in the case of non-corporate entities (such as FCPs). The domestic rate of taxation includes two additional elements: a surcharge that varies based on the type of entity and net annual taxable income, and the Health and Education Cess (HEC) of 4 percent applied on the base rate and surcharge. Both of these are not applied when the WHT rate is imposed on the basis of the relevant tax treaty.

An additional consideration for Luxembourg funds is that they cannot claim a credit for the Indian taxes paid, as Luxembourg funds are exempt from taxation on their income in Luxembourg.

It is clear that these changes will greatly impact investments made by Luxembourg funds, particularly when considering that Luxembourg funds do not, at present, have access to the India-Luxembourg tax treaty. Access would certainly reduce the fiscal impact of these changes and we, at KPMG Luxembourg, believe there are sufficient arguments to justify the applicability of the India-Luxembourg tax treaty to Luxembourg SICAVs, particularly considering that they would be treated as resident for Luxembourg tax purposes. However, until the Luxembourgish tax authorities are willing to issue CoTRs for Luxembourg SICAVs, they will continue to bear a WHT on dividends of up to 21.84 percent (23.92 percent in the case of Luxembourg FCPs).

We would be happy to work with you in assessing the impact of these new provisions on your funds’ investments in India and in complying with all related tax obligations in India.

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