Understanding Dividend Income Taxation: A Guide to Section 9(1)(iv) and Model Tax Conventions

Dividend income taxation can be complex, especially when cross-border elements are involved. In India, the taxation of dividends paid by Indian companies, including those paid to non-residents, is primarily governed by Section 9(1)(iv) of the Income Tax Act, 1961, and relevant provisions in the Double Taxation Avoidance Agreements (DTAAs). This blog delves into the nuances of dividend income taxation in India, particularly in relation to foreign dividend payments, and how they align with global tax standards like the OECD and UN Model Tax Conventions.

What is Section 9(1)(iv) of the Income Tax Act, 1961?

Under Section 9(1)(iv) of the Income Tax Act, 1961, dividends paid by an Indian company, even when paid outside India, are deemed to accrue in India. This provision ensures that dividends received by both resident and non-resident assessees are subject to Indian taxation, even if the payment is made outside the country. This is critical for cross-border taxation, as it helps India maintain tax jurisdiction over income originating from its companies, irrespective of where the recipient is located.

Section 9(1)(iv) extends the scope of Section 5(2)(b) of the Income Tax Act, which outlines that income may either accrue in India or be deemed to accrue in India, including for non-residents. Prior to this extension, dividends paid outside India to non-residents would not fall under the scope of Section 5(2)(b). However, thanks to Section 9(1)(iv), these dividends are now deemed to be income that arises in India, even if paid abroad.

Key Case Study: Pfizer Corporation v. CIT (2003)

A landmark case in understanding this taxation rule is Pfizer Corporation v. CIT (2003) 259 ITR 391. In this case, the Bombay High Court ruled that the right to receive dividends for a non-resident taxpayer only crystallizes once approval is granted by the Reserve Bank of India (RBI), under the Foreign Exchange Regulation Act (FERA), now replaced by the Foreign Exchange Management Act (FEMA).

The case made it clear that dividend income is taxable in the year the RBI grants approval for the payment, not when the dividend is declared. Therefore, for cross-border dividends, the actual tax liability arises only when the necessary approvals are received, and not earlier.

Dividend Taxation Under the OECD and UN Model Tax Conventions

The taxation of dividends across different countries is also governed by international agreements like the OECD Model Tax Convention (2017) and the UN Model Tax Convention (2021). Both models aim to prevent double taxation and clarify the taxing rights of each country involved in a dividend transaction.

OECD Model Tax Convention (2017)

According to Article 10 of the OECD MTC, the taxation of dividends is as follows:

• Article 10(1): Dividends paid by a company resident in one contracting state may be taxed in the other contracting state where the recipient resides.
• Article 10(2): However, the state where the company paying the dividends resides can also tax the dividends, subject to a limitation if the beneficial owner of the dividends is a resident of the other state. The maximum tax rate is capped at:
  • 5% of the gross dividend if the beneficial owner holds at least 25% of the company’s capital.
  • 15% in all other cases.

UN Model Tax Convention (2021)

The UN MTC closely mirrors the OECD provisions but has some slight differences, particularly regarding the taxation of foreign dividends and their exemptions. Under Article 10(2), the tax rate on dividends is similarly limited to 5% for significant ownership (25% of shares), with a general tax rate of 15% in other cases.

Both models emphasize that dividends should not be taxed excessively by both countries involved. The taxation is usually limited to the country where the company is based, and if the recipient is a resident of the other state, tax rates are capped through bilateral agreements.

How India’s Tax Treaties Affect Dividend Taxation

India has signed several DTAAs with countries around the world, including with key trading partners like the United States, Canada, Mauritius, and Singapore. These agreements help reduce the tax burden on cross-border dividends by clarifying which country has the taxing rights and limiting double taxation.

For example, the India-Portugal DTAA contains provisions under Article 10(2) that outline tax limitations on dividends. This allows for a reduced tax rate on dividends depending on the beneficial ownership and ensures fair treatment for taxpayers under the agreement.

India has also incorporated provisions under Article 8(4) of the Multilateral Convention, which affects several India DTAAs, such as those with Canada, Serbia, and Slovenia. These provisions allow for negotiated tax rates under Article 10(2) or 11(2) of the respective treaties, ensuring that taxpayers do not face excessive tax burdens.

FAQs on Dividend Income Taxation under Section 9(1)(iv) and Model Tax Conventions

1. What is Section 9(1)(iv) of the Income Tax Act, 1961?

Section 9(1)(iv) of the Income Tax Act, 1961, deems dividends paid by Indian companies, even when paid outside India, to accrue in India. This means that such dividends are taxable in India, regardless of where the recipient is located (resident or non-resident). It extends the scope of Section 5(2)(b), which governs income arising or deemed to arise in India, to include dividends paid outside India.

2. How does the Pfizer Corporation case impact dividend taxation?

In the Pfizer Corporation v. CIT (2003) case, the Bombay High Court ruled that the right to receive dividends for non-resident taxpayers only crystallizes when regulatory approval (e.g., from the RBI) is granted. This means that dividend income becomes taxable only in the year approval is received, not in the year the dividend is declared. The case is significant in understanding when non-resident dividend income becomes taxable under Indian law.

3. What are the key differences between the OECD and UN Model Tax Conventions on dividend taxation?

While both the OECD Model (2017) and the UN Model (2021) follow similar principles regarding dividend taxation, the key difference lies in the tax exemptions for specific types of income and the treatment of foreign dividends:

• OECD Model provides clear caps on tax rates at 5% for significant ownership (25% or more) and 15% for others.
• The UN Model has similar provisions but offers slightly more flexibility in certain cases and provides room for negotiation of tax rates under bilateral agreements.

4. Are there any tax treaties between India and other countries that affect dividend taxation?

Yes, India has signed several Double Taxation Avoidance Agreements (DTAAs) with countries worldwide, which impact the taxation of dividends. For example:

• The India-Portugal DTAA offers reduced tax rates on dividends under Article 10(2).
• Other agreements, such as with Canada, Serbia, and Slovenia, follow similar provisions to prevent double taxation and ensure fair tax treatment on cross-border dividends.

5. How does India’s taxation of dividends compare to other countries?

India follows a deemed accrual principle for dividends, meaning dividends paid abroad by Indian companies are taxable in India under Section 9(1)(iv), even for non-residents. In contrast, many countries primarily tax dividends based on the residency of the company paying the dividends and may apply reduced tax rates based on tax treaties. The OECD and UN models ensure a harmonized approach to cross-border dividend taxation, promoting fairness and preventing double taxation.

6. What are the tax rates for dividends under the OECD and UN Model Tax Conventions?

Under Article 10(2) of both the OECD and UN Model:

• 5% tax rate applies if the beneficial owner holds at least 25% of the company’s capital.
• 15% is the general tax rate for other cases. These rates can be further negotiated bilaterally, which may result in lower rates depending on the tax treaty provisions between countries.

7. What happens if the dividend-paying company has a permanent establishment in another country?

If the beneficial owner of the dividends has a permanent establishment or a fixed base in the country where the company is a resident, the dividends may be taxed differently. Under both the OECD and UN Models, the provisions of Article 7 (which deals with business profits) or Article 14 (dealing with independent personal services) may apply, and the dividends may be taxed as part of the business profits rather than as separate dividend income.

8. How can I reduce the tax burden on cross-border dividends?

To reduce the tax burden on dividends, you should:

• Take advantage of the tax exemptions and reduced tax rates provided by DTAAs between India and the country where you reside.
• Ensure that you meet the ownership requirements (such as holding at least 25% of the company’s capital) to qualify for the reduced 5% tax rate.
• Consult a tax professional to understand the specific provisions of the relevant DTAA and any applicable tax credits or exemptions.

9. How is dividend income taxed in India for residents and non-residents?

• For residents, dividends paid by Indian companies are subject to tax in India. Residents are eligible for certain exemptions under Section 10(34) for dividends up to a certain limit.
• For non-residents, dividend income is taxed in India under Section 9(1)(iv), which deems the income to accrue in India, regardless of where it is paid. However, the tax rates are often reduced based on the provisions of the relevant DTAA.

10. Are there any special considerations for dividend taxation in India?

Yes, RBI approval may be required for the payment of dividends to non-residents under Foreign Exchange Management Act (FEMA) regulations. Additionally, the tax rate applicable to dividends can vary based on the specific provisions of any DTAA India has signed with the foreign country.

Conclusion

Understanding the taxation of dividend income under Section 9(1)(iv) of the Income Tax Act, 1961, and the provisions outlined in international Model Tax Conventions is crucial for both residents and non-residents receiving dividends from Indian companies. The deemed accrual principle under Section 9(1)(iv) ensures that even dividends paid outside India are taxable in India, which is an extension of the provisions under Section 5(2)(b).

However, the taxation of dividends can vary depending on the specific Double Taxation Avoidance Agreements (DTAAs) between India and other countries. Taxpayers can benefit from reduced tax rates and exemptions on dividend income by leveraging these agreements. For instance, the OECD and UN Model Tax Conventions provide clear frameworks for taxing dividends, with provisions to reduce double taxation for cross-border investors.

In practice, non-residents may face a more complex tax situation, especially when RBI approval is required, or if the dividends are connected to a permanent establishment in another country. It’s essential to stay informed about the rules that apply in your particular case and take advantage of tax treaties and tax credits to minimize tax burdens.

To ensure compliance with tax laws and to optimize tax liabilities, it’s always advisable to consult with a tax professional. They can help navigate the complexities of dividend taxation, offering tailored advice to meet the specific needs of your investment strategy or business operations.

By being well-versed in these provisions, individuals and corporations can ensure they meet their tax obligations while making the most of the tax benefits available under Indian tax law and international agreements.