Rs 11,000 Crore Retroactive Tax Demand May Hit MNCs After SC Ruling; The Myriad Complexity of Retroactive Taxation

After a recent Supreme Court ruling, numerous multinational corporations based in the Netherlands, Switzerland, and France may confront a retroactive tax demand totalling approximately ₹11,000 crore related to dividend income repatriated from India.

The Supreme Court’s decision, announced last Thursday, clarified that the lower 5% withholding tax rate on dividend income would not apply to all countries within the Organisation for Economic Co-operation and Development (OECD) based solely on the most favored nation (MFN) principle.

Instead, the court ruled that the 5% rate would only be available to companies from countries with which India had established a double taxation avoidance agreement (DTAA) permitting it; in the absence of such an agreement, companies would be required to pay a 10% tax on dividend income.

A senior official explained that many companies had been misusing the OECD Most Favored Nation (MFN) clause, which might result in tax notices for underpaid taxes in previous years.

The official added, “We were awaiting the Supreme Court order, so there will be a review of tax positions in many cases.” According to conservative estimates, India was losing approximately ₹3,000 crore in taxes annually due to this issue.

Tax experts noted that the Supreme Court’s ruling might also affect withholding tax on royalties and fees for technical services.

Riaz Thingna, a partner at Grant Thornton Bharat, stated that the ruling would have a retroactive application and could impact all past and existing transactions where treaty benefits claimed under the MFN clause did not comply with the principles established by the Supreme Court.

The Supreme Court’s decision overturned a 2021 Delhi High Court ruling that had granted companies like Nestle SA, Concentrix Services, Steria, and others a 5% withholding tax rate on dividend income from their Indian subsidiaries.

It was pointed out that India signed a tax treaty with the Netherlands in 1998, allowing for a 10% withholding tax. Thereafter, treaties were formed with Slovenia, Lithuania, and Colombia, permitting a lower 5% rate if the recipient held 10% or more of the share capital in the Indian company. Slovenia, Lithuania, and Colombia later became OECD members.

These companies argued that, under the OECD’s MFN clause, if a tax benefit was available to one of the 38 member countries, it should also be accessible to others. However, the Supreme Court clarified that preferential treatment under a double taxation avoidance agreement (DTAA) was not automatically extended to other member countries unless the prior treaty with them was amended.

According to Divakar Vijayasarathy, the founder and CEO of DVS Advisors, the ruling may have broader implications, extending not only to favorable tax rates but also to the scope of various types of income, such as dividends, royalties, fees for technical services (FTS), and income from asset leasing.

Shruti KP, a partner at Induslaw, suggested that the consequences of the ruling could go beyond the specific issue at hand. She noted that even in scenarios where no ongoing tax proceedings currently exist, tax authorities may scrutinize and potentially initiate new proceedings in light of this ruling.

What is Retrospective Taxation?

Retrospective taxation allows a country to pass a rule on taxing certain products, items, or services and deals and charge companies from a time behind the date on which the law is passed.

Apart from India, many countries including the USA, the UK, the Netherlands, Canada, Belgium, Australia, and Italy have retrospective taxed companies.

The Last Bit,
Retroactive taxation has emerged as a multifaceted issue, shedding light on the intricate nature of tax laws and their interpretations.

The Supreme Court ruling and the subsequent retrospective tax demands faced by multinational corporations accentuate the challenges in creating transparent and equitable tax legislation.