The Income Tax department had sent queries to these offshore entities asking why their dividend incomes should not be taxed. Foreign funds, which were unable to demonstrate ‘commercial substance’ to it, have been denied the tax treaty benefit. An entity is said to fulfil commercial substance requirements, if it has an office, working staff, cash flows and management there.
Most of these tax assessments pertain to dividends received by the foreign entities in FY21. The tax department sent these queries to these foreign funds between October and December, said people cited above.
In the Union Budget FY20-21, the government made dividends taxable in the hands of investors. In case of FPIs, the effective dividend rate varies from 5% to 20% depending on factors such as country of origin of FPI, how it is structured and how much dividend is being earned.
Several double tax avoidance agreements (DTAAs) allow foreign funds to be taxed in their home jurisdiction instead of India. The tax rates for dividends are much lower in jurisdictions like Mauritius.
However, tax rules also say that a beneficial rate of dividend can be availed only if the dividends are being paid to beneficial owners. Overseas funds set up intermediaries in Mauritius or Singapore that receive the dividend. The Singapore or Mauritius entity then transfers the dividend to the original fund or company. The tax department is taking a view since the dividends were not received by the beneficial owners and instead to pass-through entities, treaty benefit cannot be availed.
“Holding companies which are setup in a different country and not the country of residence of the feeder fund or the fund manager could be exposed to some tax risk if they are not able to substantiate the purpose and beneficial ownership test,” said Rajesh Gandhi, partner, Deloitte.
“In the case of FPIs (Foreign Portfolio Investors), questions were raised on beneficial ownership and substance during the recently concluded tax assessments,”.
Gandhi said tax authorities have analysed the responses of the FPIs. In all genuine cases based on supporting documents provided, the department accepted the residential status after reviewing facts, he said.
An email query to the tax department went unanswered till the time of going to print.
According to Riaz Thingna, partner, Grant Thornton Bharat, most of the tax treaties provide a beneficial tax rate to fund vehicles set up in their jurisdictions.
“But in the last few months, it is seen that the Indian tax authorities have in some instances denied tax treaty benefits to funds set up in Singapore, Mauritius, etc on the premise of lack of beneficial ownership at the Fund level.”
Applicability of anti-avoidance provisions are a key factor in deciding treaty benefits, said tax experts. For instance, if a US-based fund or company wants to invest in India, it cannot choose to route its investment through a jurisdiction like say Singapore just because it would help in saving tax. It needs to show to the tax department that the purpose of going through that intermediary is not just for tax benefits.
“As per the provisions of the General Anti Avoidance Rules (GAAR) and the tax treaties, treaty benefits may be denied to entities which do not have enough substance or is not the beneficial owner of the income streams such as dividends,” said Punit Shah, partner, Dhruva Advisors. “The entity needs to demonstrate that it is not receiving income on behalf of any other entities.”
Tax experts said some of the double-tax avoidance agreements allow beneficial ownership to be recognised if the entity possesses valid documents. Bhavin Shah, partner, PWC India, said a circular of the Income Tax department dated April 13, 2000, clarifies wherever an entity holds a Certificate of Residence issued by Mauritius, authorities will constitute sufficient evidence for accepting beneficial ownership. “This circular is binding on tax assessing officers. Treaty should not be denied except in limited cases of treaty abuse, which involves round tripping etc. as articulated by Supreme Court Vodafone’s case,” said Shah.
