Recently, the Mumbai bench of ITAT has given its final order in the case of Morgan Stanley Mauritius Co. Ltd. v. DCIT, holding that dividend payments made by a foreign company to its domestic depository which were subsequently transferred to IDR holders are not taxable in India under the Indo-Mauritius DTAA. Despite the dividend income being taxable under the provisions of the Income Tax Act, it could not be brought within the purview of Article 10 of the Treaty since the dividend was not paid by a company resident in India. The Tribunal emphasized that it is the foreign company which is a taxable entity under the DTAA and not its Permanent Establishment in a contracting state.
Facts of the case
- Morgan Stanley Mauritius Co. Ltd (“assessee”) is a company incorporated in, and fiscally domiciled in, Mauritius. The assessee is a tax resident of Mauritius.
- It had invested in the Indian Depository Receipts (“IDR”) issued by Standard Chartered Bank- India Branch (“SCB-India”), with the underlying assets as in the form of shares of Standard Chartered Bank PLC (“SCB-UK”) which is a UK based company. These shares of SCB-UK are held by the depository’s custodian which is Bank of New York Mellon, USA (“BNY-US”).
- The dividend declared by SCB-UK is received by BNY-US and subsequently transferred to SCB-India. SCB-India transfers this amount to the investors including Foreign Institutional Investors, after deducting any applicable fees, taxes, duties, charges, costs and expenses.
- IDR holders are not the shareholders and they do not get these dividends in their right as a shareholder. They are only entitled to get the proportionate amount of cash dividends, as received by the Indian depository in respect of such shares.
- SCB-UK is a company listed in London Stock Exchange, and the IDRs issued in respect of its shares are listed in India. During the assessment year 2015-16, the assessee received Rs. 9,74,66,595, from SCB-India, in respect of dividends for the underlying shares related to the IDRs in which the assessee had invested.
Movement of the shares of SCB-UK
Movement of dividend on shares of SCB-UK
Whether the amount received by the assessee from SCB-India, in respect of the shares of SCB-UK was chargeable to tax in India under the Income Tax Act and the Indo-Mauritius DTAA.
What are IDRs?
Indian Depository Receipt is a derivative financial instrument, i.e., a financial instrument that draws its value from the underlying asset and is tradable on one or more approved stock exchanges in India. While IDR is issued by an Indian Depository, it derives its value from the underlying asset in the form of equity shares of a foreign company. The benefits accruing from the underlying shares are passed on to the IDR holders, and, in that sense, the IDR holders are beneficiaries of the underlying shares in the foreign company. The IDRs provide a mechanism in which an investor in the Indian market can have the benefits flowing from the shareholding in participating foreign companies.
Arguments by the Assessee
- The receipt is not taxable in India since the dividends are in respect of a foreign company, (SCB-UK) and are received abroad by BNY-US. Hence, these dividends neither accrue or arise nor are received or deemed to be received in India, which is a requirement under Section 5 of the Act. Subsequent remittance of the dividend by SCB-India to the IDR holders in India will not trigger receipt-based taxation as per the provisions of the Act.
- Section 9(1)(iv) provides that dividend paid by an Indian company outside India is deemed to be an income or arising in India but since the dividend is in respect of a UK based company, this deeming fiction does not come into play.
- The income received has no business connection with India under Section 9(1)(i) by virtue of CBDT Circular F.NO. 500/17/2015-FT&TR-IV, dated 26th March 2015, which states that the dividends paid by the foreign companies, even if such companies have underlying assets in India, cannot be brought to tax in India.
- Article 10 of the treaty reads that, dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State. This Article comes into play only when a resident of one of the contracting states pays a dividend to the resident of the other contraction state. However, since SCB-India is only an Indian branch office, i.e., permanent establishment, of a UK tax resident, these requirements of Article 10 is not fulfilled.
- Since the payment is by a UK resident to a Mauritius resident which is not covered by the scope of Article 10, it would fall under Article 22 as residual income, which is in the domain of exclusive taxation in the residence jurisdiction, Mauritius.
Findings of the Assessing Officer
- The income was received in India since the first point of receipt of such dividend is when it is deposited in the bank accounts of the IDR holders in India. Therefore, it falls within the purview of Section 5 of the Act. Further, the money continued to be in the possession of SCB-UK, and the payment was directly made in the Indian bank accounts of the IDR holders. The Dispute Resolution Panel confirmed the action of the AO.
- Further, the DRP denied treaty protection to the assessee on the ground that SCB-India is a resident of India and falls within the purview of Article 10 of the DTAA. Hence, the receipt of the dividend from IDR is liable to be taxed under the Income Tax Act and the DTAA.
- The Assessing Officer thus proceeded to propose tax these dividends under Section 115(1)(a) at the rate of 20 percent plus surcharge and cess.
Findings of the Appellate Tribunal
- Income accrues to the IDR holders at the time when SCB-India works out the amount payable to IDR holders and then pays it accordingly. Therefore, the income is received by the assessee in India, within the purview of Section 5 of the Act.
- The income cannot be taxed under Section 9(1)(iv) since it is a dividend income other than that from an Indian company (SCB-UK).
- The shares of SCB-UK are owned by SCB-India as its property, though through a custodian abroad. The primary source of income received by the assessee is the shares of SCB-UK which are held by an Indian depository and constitute assets of the SCB-India. Therefore, the receipts have a significant business connection in India.
- The Circular relied upon by the assessee was not applicable to the present case since it deals with situations where a foreign company has no other business connection with India except some underlying assets being stored in India. Presently, SCB-UK has a significant business connection with India and its shares are owned by its Permanent Establishment located in India.
- Article 10 of the treaty cannot be employed to tax the income since it is not dividend paid by a company which is a residence of India (SCB-India) but by a UK based company (SCB-UK).
- The unit of taxability is not SCB-India, i.e., PE of a foreign company, but the foreign company itself, and the place of management of the UK-based company is United Kingdom. The tribunal relied upon the decision by Hon’ble Supreme Court, in the case of CIT v. Hyundai Heavy Industries Ltd., where it held that a taxable unit is a foreign company and not its branch or PE in India.
- The dividends can be treated as having been paid either by the SCB-UK itself or by its Permanent Establishment, SCB-India. Whichever way one looks at it, none of these payments can be treated as by an Indian resident since neither of the companies is a resident in India.
- Since the income received by the assessee is not covered under Article 10 of the treaty and there is no other article dealing with such income, it would fall under the residual head, Article 22, which grants Mauritius the exclusive rights to tax this income.
The Tribunal upheld the plea of the assessee that the income received by way of IDR dividends in question cannot be taxed in India on the facts of this case. The primary take-away from this decision is that income received from IDR investments which derive their value from the shares of a foreign company is not taxable in India by virtue of Article 22 of the DTAA. However, it must be noted that Article 22, inter alia, was amended by a Protocol in 2016 to encapsulate source-based taxation instead of the previous regime of residence-based taxation under the Article. Therefore, any residual income arising from one contracting state, which has not been dealt with under other provisions of the DTAA, shall be liable to tax in that contracting state. While this grandfathering clause has been given prospective application and therefore, was not applicable to the present case, its application must be considered on a case-to-case basis for Financial Year 2017-18 and beyond.
 ITA No.: 7388/Mum/19, decided on 28.05.2021.
 CBDT CIRCULAR No. 4/2015, Dated 26th March 2015
 (2007) 291 ITR 482 (SC).