Dividend Tax Rate Between India and USA Under DTAA

Dividend Tax Rate Between India and USA

The India-USA Double Taxation Avoidance Agreement (DTAA), signed on September 12, 1989, and effective from December 18, 1990, provides specific withholding tax rates on dividend income under Article 10. These rates are significantly different from India's domestic withholding tax rate of 20% (plus applicable surcharge and 4% health and education cess) under Section 195 of the Income Tax Act, 1961. Understanding the treaty rates and qualifying conditions is essential for cross-border investors and companies operating between India and the USA.

The India-USA DTAA is one of the most important tax treaties India has signed, given the volume of bilateral investment and trade between the two nations. Unlike many other Indian DTAAs, this treaty is not covered by the Multilateral Instrument (MLI) because the United States has not signed the MLI. This means the original treaty provisions remain in force without MLI modifications such as the Principal Purpose Test (PPT).

Treaty Rate vs Domestic Rate: Detailed Comparison

Article 10 of the India-USA DTAA establishes two primary withholding tax rates on dividends, depending on the level of shareholding by the beneficial owner:

15% Rate for Substantial Holdings

Under Article 10(2)(a), dividends paid to a company that directly owns at least 10% of the voting stock of the dividend-paying company are taxed at a maximum rate of 15% of the gross amount. This reduced rate applies when a US parent company receives dividends from its Indian subsidiary (or vice versa), provided it holds the requisite minimum stake.

25% Rate for Portfolio Investors

Under Article 10(2)(b), all other dividends are taxed at a maximum rate of 25% of the gross amount. This applies to individual retail investors, portfolio investors, and any shareholder holding less than 10% of the voting stock. Notably, the 25% treaty rate is higher than India's domestic rate of 20% (before surcharge and cess), which means portfolio investors may find the domestic rate more favourable in certain situations.

Special Rules for RICs and REITs

The treaty contains specific provisions for US Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs). Dividends paid by a US RIC are subject to the 25% rate. For REITs, the reduced 15% rate under Article 10(2)(a) does not apply; the 25% rate applies only if the dividend is beneficially owned by an individual holding less than 10% interest in the REIT.

Who Qualifies for the Reduced Rate

Claiming the reduced 15% DTAA rate on dividends requires satisfying several conditions under the India-USA treaty:

Beneficial Ownership Test

The recipient must be the beneficial owner of the dividends. This means the recipient must have the right to use, enjoy, and dispose of the dividend income without being a mere agent, nominee, or conduit. The OECD commentary advocates a substance over form test to determine beneficial ownership. Direct recipients who are agents, nominees, or conduits with restricted powers over the income are excluded from treaty benefits.

Limitation of Benefits (LOB) under Article 24

The India-USA DTAA contains one of the most robust Limitation of Benefits clauses among India's tax treaties. Under Article 24, a US resident claiming treaty benefits must satisfy at least one of the following tests:

• Active trade or business test: The US resident is engaged in an active trade or business in the USA (other than making or managing investments), and the income from India is derived in connection with or incidental to that business.
• Ownership/base-erosion test: More than 50% of the beneficial interest (or shares) is owned directly or indirectly by US residents or citizens, and the income is not substantially used to meet liabilities to non-US residents.
• Competent authority determination: If neither test is met, the competent authority of India may grant benefits if considered appropriate.

The LOB clause is particularly relevant for holding companies and investment vehicles. A US shell company with no substantive business activities in the USA would likely fail the LOB test and be denied treaty benefits on dividends received from India.

Dividend-Specific Treaty Provisions

Article 10 contains several important provisions specific to dividend taxation:

Source Country Taxation

Under Article 10(1), dividends paid by a company resident in one contracting state to a resident of the other state may be taxed in the state of residence. However, Article 10(2) preserves the source country's right to tax, subject to the rate limitations. This means India retains the right to tax dividends paid by Indian companies to US residents, but the withholding tax rate is capped as specified above.

Definition of Dividends

The term "dividends" under Article 10(5) includes income from shares, jouissance shares, mining shares, founders' shares, or other rights participating in profits (not being debt-claims), as well as income from other corporate rights treated as dividend income under the domestic law of the source country.

Business Connection Exception

Under Article 10(6), if the beneficial owner carries on business through a permanent establishment in the source country, and the shareholding generating the dividends is effectively connected with that PE, the dividends are taxed as business profits under Article 7 rather than under Article 10. This is an important exception for companies with PE presence in India.

Documentation Required

To claim the reduced DTAA rate on dividends, the following documentation is mandatory:

Tax Residency Certificate (TRC)

The US resident must obtain a Tax Residency Certificate from the US Internal Revenue Service (IRS). The TRC serves as the primary document proving tax residency in the treaty partner country. Without a valid TRC, the Indian payer cannot apply the reduced withholding rate.

Form 10F

The non-resident must also furnish Form 10F to the Indian payer, providing additional details such as status (individual, company, etc.), nationality, taxpayer identification number, and period of residential status. Form 10F can be filed online on the Income Tax e-filing portal.

Self-Declaration and No-PE Certificate

A self-declaration confirming that the recipient does not have a permanent establishment in India and that the income is not attributable to a PE is typically required. This is often provided in the form of a no-PE declaration or beneficial ownership declaration.

Withholding Procedure for Indian Payers

Indian companies paying dividends to US residents must follow specific withholding procedures under Section 195 of the Income Tax Act:

Section 195 Compliance

Under Section 195, any person responsible for paying to a non-resident any sum chargeable to tax must deduct TDS at the rates in force. When a DTAA provides a lower rate, the payer can apply the treaty rate directly, provided the recipient has furnished the TRC, Form 10F, and other required documents.

Form 15CA and Form 15CB

For remittances exceeding INR 5 lakh in a financial year, the remitter must file Form 15CA (declaration of remittance) online and obtain Form 15CB (certificate from a Chartered Accountant) confirming that TDS has been deducted at the appropriate rate. Form 15CB must reference the applicable DTAA article and confirm that treaty conditions are satisfied.

• Remittance up to INR 5 lakh: Only Form 15CA Part A required
• Remittance exceeding INR 5 lakh: Form 15CA Part C + Form 15CB from a CA
• With Section 195(2)/195(3)/197 certificate: Form 15CA Part B

Quarterly TDS Return (Form 27Q)

After deducting TDS, the payer must deposit the tax with the government by the 7th of the following month and file quarterly TDS returns in Form 27Q. The TDS return must correctly reflect the treaty rate applied and the relevant DTAA article number.

Common Disputes and Judicial Precedents

Several areas of dividend taxation under the India-USA DTAA have been the subject of disputes and judicial interpretation:

Domestic Rate vs Treaty Rate for Portfolio Investors

Since the treaty rate for portfolio investors (25%) can exceed the domestic rate (20% before surcharge and cess), tax practitioners routinely apply the lower of the two rates. Section 90(2) of the Income Tax Act provides that DTAA provisions apply only to the extent they are more beneficial to the taxpayer. This means for dividends received by individual US investors from Indian companies, the domestic rate of 20% (plus surcharge and cess) may effectively apply rather than the treaty rate of 25%.

Beneficial Ownership Challenges

Indian tax authorities have increasingly scrutinized beneficial ownership claims, particularly where dividends are routed through intermediary entities. Courts have held that mere receipt of dividends does not establish beneficial ownership; the recipient must have the legal and economic right to use and enjoy the income independently.

LOB Clause Denials

Treaty benefits have been denied where the US recipient failed the Limitation of Benefits test under Article 24. In several rulings, the Income Tax Appellate Tribunal (ITAT) has upheld denials where the US entity was a passive holding company with no active trade or business in the USA.

DTAA Primacy Over Domestic Law

In a landmark ruling, the Bombay High Court established that DTAA provisions take precedence over domestic tax collection mechanisms. The Court held that the treaty rate caps the maximum tax that can be charged on dividend income, irrespective of the domestic mechanism used to collect it. This ruling has significant implications for the interplay between domestic tax law and treaty provisions.

Practical Examples and Calculations

Example 1: US Parent Company Receiving Dividends from Indian Subsidiary

A US corporation holds 100% of the shares in an Indian subsidiary. The Indian subsidiary declares a dividend of INR 1,00,00,000 (INR 1 crore).

• Domestic rate: 20% = INR 20,00,000 (plus surcharge and cess)
• DTAA rate (Article 10(2)(a)): 15% = INR 15,00,000
• Tax saving under DTAA: INR 5,00,000 (minimum, excluding surcharge and cess savings)

The US parent company provides a valid TRC, Form 10F, and beneficial ownership declaration. The Indian subsidiary deducts TDS at 15% and remits INR 85,00,000 to the US parent.

Example 2: US Individual Investor Receiving Dividends from Indian Listed Company

A US individual investor holds 500 shares in an Indian listed company. The company declares a dividend of INR 5,00,000.

• Domestic rate: 20% = INR 1,00,000 (plus surcharge and cess)
• DTAA rate (Article 10(2)(b)): 25% = INR 1,25,000
• Applicable rate: 20% (domestic rate is lower, so Section 90(2) applies)
• TDS deducted: INR 1,00,000 (plus surcharge and cess)

In this case, the domestic rate is more beneficial, and the investor is better off claiming the domestic rate rather than the DTAA rate. This is a common scenario for US individual investors with portfolio holdings in Indian companies.

Example 3: US Company Failing the LOB Test

A US holding company, 80% owned by residents of a third country, receives dividends from its Indian subsidiary. Despite having a valid TRC, the holding company fails the ownership/base-erosion test under Article 24 because more than 50% of its shares are not owned by US residents or citizens. Treaty benefits are denied, and the domestic withholding rate applies.

Frequently Asked Questions

What is the dividend tax rate under the India-USA DTAA?

The DTAA rate depends on the level of shareholding. Companies holding 10% or more of the voting stock of the paying company are subject to a maximum of 15% under Article 10(2)(a). All other shareholders, including individual portfolio investors, face a maximum rate of 25% under Article 10(2)(b). However, if the domestic Indian rate (20% plus surcharge and cess) is lower, that rate applies instead under Section 90(2).

Is the US covered by India's MLI modifications?

No. The United States has not signed the OECD Multilateral Instrument (MLI). Therefore, the India-USA DTAA is not a Covered Tax Agreement under the MLI, and the original treaty provisions apply without MLI modifications such as the Principal Purpose Test.

What documents do I need to claim the reduced DTAA rate on dividends?

You need a valid Tax Residency Certificate (TRC) from the IRS, Form 10F filed on India's e-filing portal, a self-declaration of beneficial ownership, and a no-PE declaration if applicable. For remittances exceeding INR 5 lakh, Form 15CA and Form 15CB must also be filed.

Can a US individual investor claim the 15% DTAA rate on Indian dividends?

No. The 15% rate under Article 10(2)(a) is available only to companies holding at least 10% of the voting stock. Individual investors fall under Article 10(2)(b) with a 25% treaty cap. Since the domestic rate of 20% (before surcharge and cess) is lower, individual investors typically pay at the domestic rate.

What is the Limitation of Benefits (LOB) clause in the India-USA DTAA?

Article 24 of the India-USA DTAA contains a robust LOB clause that requires US residents to pass either an active trade or business test, an ownership/base-erosion test, or obtain a competent authority determination before they can claim treaty benefits. This prevents treaty shopping through shell companies.

How does Section 90(2) affect the applicable dividend tax rate?

Section 90(2) of the Income Tax Act provides that DTAA provisions apply only to the extent they are more beneficial to the taxpayer. If the domestic rate (20% plus surcharge and cess) is lower than the DTAA rate (25% for portfolio investors), the domestic rate applies. This ensures the taxpayer gets the benefit of the lower rate.

What happens if the Indian payer does not deduct TDS at the correct rate?

If the Indian payer deducts TDS at a higher rate than required under the DTAA, the US resident can claim a refund by filing an income tax return in India. Alternatively, the US resident can apply for a lower withholding certificate under Section 197 before the payment is made. The payer may face penalties for non-deduction or short deduction under Section 201.