Dutch FPIs face tax concerns following apex court ruling

In its verdict, the Supreme Court clarified that the most favoured nation (MFN) clause in a tax treaty is not automatically triggered and has to be notified separately by the central government.

It is common for FPIs based in the Netherlands to believe that their dividends will be subject to a 5% withholding tax in India. However, the recent ruling by the apex court has clarified that they will be subject to a 10% withholding tax instead. This means that all Netherlands-based entities receiving dividends must pay an additional withholding tax. The verdict on the issue of withholding tax has put FPIs in a quandary, as they have in the past taken advantage of the 5% withholding tax rate, according to tax experts.

This decision has become more significant now, as many FPIs are currently undergoing an audit by the tax department for their 2021-22 filings. Every year, the revenue department selects a sample of FPIs for auditing purposes.

Also, the verdict has exposed FPIs to potential reassessment by the tax department. Reassessment is an exercise where the tax department can re-examine the tax filings of an entity from the past if they believe some income has not been properly assessed.

“FPIs who had previously asserted their entitlement to the 5% rate on dividends should closely re-evaluate their position considering this Supreme Court ruling. It’s conceivable that these cases may now be subject to reopening, resulting in the collection of tax differentials, along with interest and penalties,” said Suresh Swamy, partner, Price Waterhouse & Co. Llp. “The Supreme Court ruling emphasizes that treaties must undergo legislative processes to become enforceable in India. This verdict sets a valuable precedent, providing clarity on the interpretation and application of DTAAs in the Indian context,” he added.

According to the original India-Netherlands tax treaty, the withholding tax applicable on dividends is 10%. However, the nation also enjoys an MFN status, meaning after India’s signing of a DTAA with the Netherlands, if India signs a treaty with some other country offering better tax rates, then Dutch entities will also be eligible for such lower tax rates.

In the current case, Dutch FPIs imported provisions from tax treaties India signed with Slovenia, Lithuania and Colombia, where the withholding tax was 5%. However, the apex court ruled that such provisions aren’t automatically applicable, but the Indian tax department must notify the same. And since India did not notify the 5% withholding tax for Netherlands-based entities, they will be subject to the original 10% rate.

“The Supreme Court judgment has put a condition for invoking the MFN clause now that a separate notification would be required to implement this clause and the third country becoming OECD (Organisation for Economic Co-operation and Development) member later would not trigger MFN clause,” said Amit Maheshwari, tax partner, AKM Global.

“The judgment will result in the revival of pending matters in the form of fresh action by tax authorities by initiating proceedings, raising demands or denying lower withholding in respect of these remittances made in the past. Moving forward, the tax withholding rate will be 10% now instead of 5% for the Netherlands dividend recipient.”

The Netherlands is a key source of FPI investment in India. Many global funds choose to route their investments through the Netherlands since it enjoys a favourable tax treaty with India. According to the depository data, 120 FPIs from the Netherlands have invested in India.

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Updated: 22 Oct 2023, 11:35 PM IST