Govt takes tough stand on tax treaties with MFN countries

Govt takes tough stand on tax treaties with MFN countries

Recently, the Central Board of Direct Taxes (CBDT) has taken a tough stance on tax treaties with countries with Most Favored Nation (MFN) status.

  • The Finance Act 2020 had amended the taxation on dividend income. This amendment has done away with the Dividend Distribution Tax (DDT) to be paid by companies. Through this amendment a classical system of taxation has been adopted. In this, only dividends in the hands of the investors will be taxed.
  • This has led to discrimination in taxation of dividends among offshore investors in countries with different withholding rates.
  • Investors in Slovenia, Lithuania and Colombia pay only a 5 percent tax on dividends. In comparison, investors from MFN countries pay 10-15 per cent tax.

For example:

  • A provision of 10 percent tax has been made under the Double Taxation Avoidance Agreement (DTAA) between India and the Netherlands.
  • In the year 2021, the Delhi High Court upheld the principle of equality for withholding of tax. At the same time, it was also decided that the Most Favored Nation (MFN) clause under the India-Netherlands DTAA will continue to apply.
  • The principle of equality allows the implementation of the MFN clause with the member countries of the Organization for Economic Co-operation and Development (OECD). Due to this principle, investors in MFN countries have also started paying tax at the rate of 5 per cent after valuation.
  • The Central Board of Direct Taxes (CBDT) has argued that the principle of equality does not apply to countries with MFN status. This is because these countries became members of OECD only after signing tax treaties with India.
  • Contrary to the order passed by the High Court in the past, the new stand of the CBDT is likely to trigger fresh legal disputes on the subject in future.

Key Vocabulary:

  • The MFN principle is subject to the norms of the World Trade Organization (WTO). It is based on the idea that countries should treat all their trading partners equally. According to WTO, all member countries should treat each other equally as Most Favored Nation.
  • Dividend Distribution Tax (DDT) is a type of tax. It is levied on dividends distributed by the companies among the shareholders out of their profits.
  • Double Taxation Avoidance Agreement (DTAA) is a tax treaty. This treaty is concluded between two or more countries. The treaty protects taxpayers from paying double taxes on income earned from the source country as well as the country of their residence.

Source – The Hindu

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