Bombay High Court Rules DDT Must Follow DTAA Limits: Clear Win for Non-Residents and Foreign Investors

The taxation of dividends has long been a complex and debated issue in India’s tax regime, especially under the now-abolished Dividend Distribution Tax (DDT) regime that existed until 31 March 2020. Recently, the Bombay High Court delivered a landmark judgment in Colorcon Asia Pvt. Ltd. vs. JCIT, clarifying that Dividend Distribution Tax (DDT) paid by an Indian company on dividends to a foreign shareholder cannot exceed the dividend tax rate prescribed under the relevant Double Taxation Avoidance Agreement (DTAA). This ruling reinforces treaty protections for non-resident shareholders and potentially opens the door for substantial refunds where excess DDT was paid.

Facts and Issue of the Case

In the case of Colorcon Asia Pvt. Ltd. vs. JCIT, the taxpayer, Colorcon Asia Pvt. Ltd. (“Colorcon India”), is an Indian subsidiary of a UK tax-resident company, Colorcon Limited (“Colorcon UK”). During the financial years relevant to assessment years 2016-17 to 2018-19 (and an interim dividend in 2019-20), Colorcon India declared and distributed significant dividends to Colorcon UK. In accordance with Indian law at the time, Colorcon India paid Dividend Distribution Tax (DDT) under Section 115-O of the Income-tax Act, 1961 on these dividends at the domestic effective rate of approximately 20–20.56%.

Colorcon India filed an application before the Board for Advance Rulings (BFAR) under Section 245Q, asking two critical questions:

1. Whether the rate of tax on dividends paid by Colorcon India to Colorcon UK should be capped at 10% under Article 11(2)(b) of the India-UK DTAA.
2. If so, whether such a reduced rate needs to be grossed-up for computation.

The BFAR, however, ruled against the taxpayer. It held that DDT did not fall within the scope of taxes covered by the India-UK DTAA and therefore could not be restricted by the treaty’s dividend tax cap. The ruling relied on the reasoning that DDT is a tax on the company’s income, not on the shareholder’s dividend income. It also cited a Special Bench decision of the Income Tax Appellate Tribunal (ITAT) in Total Oil India Pvt. Ltd., which held that non-resident shareholders could not seek DTAA benefits in respect of DDT.

Dissatisfied with the BFAR decision, Colorcon India appealed to the Bombay High Court, arguing that the BFAR misinterpreted the law and failed to apply relevant treaty and constitutional principles.

Observation by the Court and Tribunal

Bombay High Court’s Observations

The High Court undertook a detailed assessment of both the domestic tax statute and the relevant provisions of the India-UK DTAA. The key observations of the court are as follows:

(a) Dividend Remains Shareholder Income

The court underscored that dividend, by its very definition, is income in the hands of the shareholder, not the company. Section 2(22) of the Income-tax Act defines dividend as income distributed by a company to its shareholders. The court cited Supreme Court authority in Union of India vs. Tata Tea Co. Ltd., which held that the character of dividend income remains unchanged regardless of how taxes are collected.

(b) DDT is an “Additional Income-Tax” Covered by DTAA

Section 115-O labels DDT as an “additional income-tax” imposed on any amount declared or paid by way of dividends. The High Court noted that Article 2 of the DTAA includes “income tax including any surcharge … and any substantially similar taxes.” Accordingly, the court held that DDT qualifies as a tax covered by the treaty.

(c) Treaty Conditions Fully Satisfied

Under Article 11 of the India-UK DTAA, dividend tax benefits apply when certain conditions are met: dividend must be paid by a resident of one contracting state to a resident of the other, and the recipient must be the beneficial owner. In this case, those conditions were satisfied: Colorcon India is an Indian resident, Colorcon UK is a UK resident with a valid Tax Residency Certificate (TRC), and Colorcon UK beneficially owned the shares receiving the dividend.

(d) Treaty Prevails Over Domestic Law

Under Section 90(2) of the Income-tax Act, tax treaty provisions prevail over domestic law if they are more beneficial. The court emphasized binding Supreme Court precedents (including Azadi Bachao Andolan and Engineering Analysis Centre of Excellence Pvt. Ltd.) that India must honor treaty protections and cannot unilaterally override them through domestic law. Thus, the tax rate on dividends paid to non-resident shareholders cannot exceed the treaty rate.

Contrast with ITAT and Other Tribunals

Before the Bombay High Court ruling, the ITAT Special Bench in Total Oil India Pvt. Ltd. had taken the opposite view, holding that DDT is a tax on the company and not on the shareholder, and hence treaty benefits do not apply unless explicitly mentioned. However, High Court disagreed with that approach, finding it contrary to statutory language and binding Supreme Court jurisprudence.

Law Applicable

Understanding this decision requires clarity on the interaction between Indian domestic tax law and international tax treaties:

(a) Dividend Distribution Tax (Section 115-O)

Under the pre-2020 regime, Indian companies distributing dividends were liable to pay DDT at a domestic rate (~20%). This tax was collected from the company, but the fundamental subject matter of the tax — dividend income — remains in the hands of the shareholder.

(b) Double Taxation Avoidance Agreements (DTAAs)

DTAAs are bilateral treaties that, among other things, provide maximum tax rates on certain types of income (including dividends) that one contracting state may impose on residents of the other. Article 11 of the India-UK DTAA caps the source country’s tax on dividends at 10%. DTAA benefits under Section 90(2) of the Act apply when they are more beneficial than domestic tax law.

(c) Supreme Court Precedents

Supreme Court decisions establish that:

• The incidence of tax (who pays) does not change the character of the underlying income.
• Treaty obligations cannot be overridden by unilateral domestic law changes.
  This legal backdrop was crucial to the High Court’s ruling.

Conclusion by the Tribunal or Court

In the final analysis, the Bombay High Court set aside the BFAR ruling, holding that:

• DDT must comply with the maximum dividend tax rate specified under the applicable DTAA.
• The fact that DDT is collected from the company does not change the essential nature of dividend as shareholder income.
• Article 2 and Article 11 of the India-UK DTAA encompass DDT as a “tax covered” and limit India’s taxing rights to 10%.
• The taxpayer (Colorcon India) is entitled to treat the tax on dividends paid to a UK resident parent at the treaty-mandated 10% rate.

This decision is a major relief for non-resident shareholders and foreign investors, reinforcing that treaties protect cross-border dividend income even under complex domestic tax regimes. It also opens opportunities for claiming refunds of excess DDT paid before abolition of the regime in 2020 to the extent that domestic DDT rates exceeded treaty caps.