Taxability of Indian Depository Receipts1 (IDRs) and income derived therefrom has always been an area of ambiguity. The Income-tax Act, 1961 (IT Act) provides for a separate framework for taxation of Global Depository Receipts2 (GDRs). However, it is silent on the taxation of IDRs, which leads to adoption of different positions for offering to tax the income from IDRs, including income upon their sale.
Recently, the Mumbai Tax Tribunal (Tribunal) had an occasion to examine the taxability of income derived from IDRs to a company based out of Mauritius, including any protection available under the India-Mauritius Double Tax Avoidance Agreement (DTAA).
We, at BDO in India, have summarised the ruling of Mumbai Tribunal and provided our comments on the impact of this decision.
Facts of the case
The taxpayer is a company incorporated and fiscally domiciled in Mauritius and is a Mauritian tax resident. The taxpayer invests in IDRs issued by Indian Branch of a UK based bank, having the shares of the UK bank as underlying assets. The custodian for this investment is a USA based bank and the Indian branch acts as a depository. The shares of the UK based bank are listed on London stock exchange whereas the IDRs are listed on the Indian Stock Exchange.
During the year under consideration, Fiscal Year (FY) 2014-15, the taxpayer had received INR 9.74 crores from the Indian branch of the UK based bank in respect of dividend from the underlying shares relatable to the investments in IDRs. The proceeds were received outside India and subsequently remitted to the Indian bank account of the IDR holder i.e. the taxpayer.
The taxpayer contended that the aforesaid proceeds were not subject to tax in India as they were received from the USA based bank, in respect of shares of the UK based company and were merely remitted in the Indian bank account. In other words, the dividend being received outside and then remitted to India does not attract any tax in India. It was further contended that dividend received does not fall within the ambit of the definition as laid down by the Article 10 of Indo-Mauritius DTAA and hence was required to be considered under the residuary Article 22 –Other Income.
However, the Tax Officer (TO) concluded that India was the first point of receipt of dividend when deposited in banks. The TO inter alia referred to the Red Herring Prospectus (RHP) of the IDR issue, which mentioned that dividends paid to a Non-Resident IDR holder shall be taxed in India if received or deemed to be received in India and exemption under section 10(34) of the Act shall not be available and based on the RHP proposed that the dividends be subject to tax at 20% plus applicable surcharges and cess. Objections raised by the taxpayer before Dispute Resolution Panel (DRP) were rejected on the grounds that dividend is covered by Article 10 of the India-Mauritius DTAA since the company distributing dividend is a resident in India as it is assessed to tax in India on account of place of management and hence taxable as per Indian Tax laws as well as under the DTAA.
Aggrieved, the taxpayer filed an appeal before the Tribunal.
The Tribunal, after hearing the contentions of taxpayer and TO, made the following observations:
- IDR holders are not shareholders and thereby do not have a direct right to receive dividends. IDR holders are only entitled to the benefits of the shareholding net of fees, taxes, duties, charges expenses and cost;
- IDR holders receive the income on account of dividend in below mentioned two scenarios:
- At the time of receipt by custodian on behalf of the depository; or
- At the time of receipt by IDR holders from the depository
- In the given case, the ownership of these shares belongs to the Indian branch of the UK bank and the same has been received by the custodian on behalf of the taxpayer.
- Accordingly, there is significant business connection between the said income and India as:
- The Indian branch of the UK bank is an Indian depository of the underlying shares and they constitute property of the Indian depository;
- The IDRs in respect of which these monies are received are issued in India by the Indian branch;
- The IDRs are listed on Indian stock exchange; and
- The entire management and operations of the depository are in India.
- In light of the above, it was observed that the conditions laid down in section 9(1)(i) of the Act are clearly fulfilled.
- As per section 9(1)(iv) of the IT Act, dividend paid by an Indian company outside India is deemed to accrue or arise in India. In the given case the dividend is not paid by an India company. But the Tribunal accepted the contention of Revenue who pointed out that the section 9(1)(iv) of the IT Act does not start with a non-obstante clause or restricts the scope of section 9(1)(i) of the IT Act. Accordingly, dividend income other than that from an Indian company which cannot be taxed under section 9(1)(iv) of the IT Act, can be taxed under section 9(1)(i)3 of the IT Act.
- Consequently, the receipt of dividend by the taxpayer was considered as income deemed to be accruing in or arising in India and prima facie taxable in India.
- Article 10 of the DTAA on Dividend income comes into play only when a resident of Mauritius or India pays dividend to the resident of other country. However, in the given case, the dividend was paid by the Indian branch of the UK bank, which is a Permanent Establishment (PE) of a UK resident and thereby not a resident of India. Hence, the requirements of Article 10 are not met since the payment of dividend is made by a UK resident to a Mauritius resident. Accordingly, the dividend under consideration cannot be brought to tax under Article 10 of the India-Mauritius DTAA.
- Consequently, incomes not coming under the ambit of any specific section of India-Mauritius DTAA shall be covered by Article 22 (Other Income). Under the erstwhile Article 22 i.e. prior to 1 April 20174, the residuary income which was not specifically covered by any of the specific DTAA articles/provisions and not covered by the exclusion5 clause Article 22(2), could only be taxed in the residence jurisdiction and not in the source jurisdiction i.e. Mauritius in the given case.
Based on the facts and circumstances and the above observations, the ITAT upheld that the dividend received by the taxpayer cannot be taxed in India i.e. the source jurisdiction on account of the specific provisions under Article 22 of the India-Mauritius DTAA.
This ruling brings clarity on taxation of income received on IDRs held by overseas investors and is of relevance to offshore funds / Foreign Portfolio Investors (FPIs) which make substantial investments in such instruments. The Tribunal has extensively discussed the taxability under the Act as well as under the DTAA (India-Mauritius) and has derived a logical conclusion to its judgement that the dividend income is not taxable in India under the India-Mauritius DTAA.
However, it is imperative to note that Clause (3) was inserted under Article 22 of the India-Mauritius DTAA w.e.f. 1 April 2017, which gives permits source-based taxation rights for residual incomes. Accordingly, dividend income from IDRs pertaining to periods prior to fiscal year 2017-18 are taxable in the country of residence of the taxpayer under the India-Mauritius DTAA. However, dividends on IDRs earned post 1 April 2017 can be brought to tax in India under clause (3) to Article 22 of the India-Mauritius DTAA.
1An IDR is an instrument denominated in Indian rupees in the form of a depository receipt created by a Domestic Depository (custodian of securities registered with the Securities and Exchange Board of India) against the underlying equity shares of issuing company to enable foreign companies to raise funds from the Indian securities market.
2GDR means any instrument in the form of a depository receipt or certificate (by whatever name called) created by the Overseas Depository Bank outside India or in IFSC and issued to investors against the issue of –
- Ordinary shares of issuing company, being a company listed on a recognized stock exchange in India; or
- Foreign currency convertible bonds of issuing company;
- Ordinary shares of issuing company, being a company incorporated outside India, if such depository receipt or certificate is listed and traded on any IFSC [the aforesaid clause shall be effective from 1 April 2022]
3All income accruing or arising, whether directly or indirectly, through or from any business connection in India, or through or from any property in India, or through or from any asset or source of income in India, or through the transfer of a capital asset situate in India.
4Clause 3 was inserted to Article 22 of the India-Mauritius DTAA by Notification No. SO 2680(E) (No. 68/2016 (F.No.500/3/2012-FTD-II) dated August 10, 2016 w.e.f. April 1, 2017 whereby income of a resident of a contracting state not dealt with in the foregoing articles and arising in the other contracting state may also be taxed in that other state.
5Income from immovable property, business through PE or independent personal services from a fixed base connected with such PE of fixed base.