Application of Sec 2(22)(e) for sums lent to a Domestic concern in which the foreign Parent had substantial shareholding, provides for interesting discussion. While the very application of Sec 2(22)(e) itself could be contested in certain circumstances, we assume for the purposes of this Post that the sums lent do constitute ‘Deemed Dividend’ and go on to discuss TDS implications in the light of the Shareholder being a foreign company.
Application of Domestic Law:
The first issue is the applicability of Sec 195. The question is whether Sec 195 would cover instances where taxability arises due to a deeming fiction. Sec 194 dealing with dividends to a Resident, is quite explicit when it includes S.2(22)(e). Sec 195 is not as explicit, but it brings ‘ any other sum chargeable under the provisions of this Act’ under its fold, leaving nothing to escape. It appears to me that a textual, contextual and purposive interpretation of section 2(22)(e) supports withholding tax. Indian cases including CIT V V.S. Dempo Company Ltd (SC) were also not very helpful in avoiding the above inference.
Meanwhile, I found reading the following link quite instructive and would encourage you to take a look.
Application of DTAA:
Application of DTAA throws interesting challenges. The first is whether ‘deemed dividend’ falls within the meaning of ‘Dividend’ under Article 10. While a plain reading does not give positive results, the OECD Commentary ( 2011) in Para 28 of Art 10 states that “ Payments regarded as dividends may include not only distributions of profits decided by annual general meetings of shareholders, but also other benefits in money or money’s worth, such as bonus shares, bonuses, profits on a liquidation and disguised distributions of profits. The reliefs provided in the Article apply so long as the State of which the paying company is a resident taxes such benefits as dividends. It is immaterial whether any such benefits are paid out of current profits made by the company or are derived, for example, from reserves, i.e. profits of previous financial years. Normally, distributions by a company which have the effect of reducing the membership rights, for instance, payments constituting a reimbursement of capital in any form whatever, are not regarded as dividends.” The UN Commentary does not go beyond the OECD’s.
Thus, the Commentaries provide relief by way of lower tax on dividends subject to shareholding criteria. One could therefore settle for anywhere between 10-15% depending on the country of residence of the foreign Parent Shareholder.
But what are the consequences if such a view is not accepted? In Rajiv Makheja V DDIT ITA 3148/Del/2008, the Delhi Tribunal had to decide the taxability of Deemed Dividend under Article 10. The Tribunal found that Deemed Dividend did not fit into the meaning of ‘Dividend’ under Article 10 and (interestingly enough) did not find any merit in the action of the lower authorities for bringing the amount of loan received by the assessee who is resident of Canada, by treating the same as deemed dividend, within the meaning of Article 10 of DTAA. Interesting because, there is no discussion if the Deemed Dividend can come under the ‘catch all’– ‘Other Income’ – Article 21.
Some thoughts here. In conventions where Article 21 does not contain the 3rd para (granting rights to State of Source to tax ‘Other Income’) and the foreign company has no PE/FB to which the shareholding (giving rise to deemed dividend) is effectively connected, Deemed Dividend will not be taxable in India.
But in a majority of Conventions, including the Indo-Canada treaty which was the subject matter in the case supra, the 3rd para is indeed present. In such cases, the question arises if the sum was ‘not dealt with’ in Article 10. Article 21 captures only incomes that are ‘not dealt with’ in the other Articles. Those that were dealt with - but not taxed under the respective articles- cannot be brought under the ‘catch all’. Popular cases are those concerning DTAAs without Article on FTS - and in such cases, Courts have held that absent a PE, Fee for Technical Services would not be taxable in India. In other words, there was no looking to ‘Other Income’!
Taking a cue from these decisions, a possible line of argument is that ‘deemed dividend’ was indeed ‘dealt with’ in the Article on Dividend, but since the conditions essential to constitute ‘Dividend’ were not satisfied, one needs to look no further. This can possibly render deemed dividend to a foreign company, not taxable in India. This is of course easily said than done, given that different Conventions use different terms such as ‘expressly dealt with’, ‘mentioned’, ‘expressly mentioned’ each of which can be a subject matter of discussion by themselves! We will save that for another day!