India, France Sign DTAC Protocol to Revamp Dividend and Capital Gains Tax Rules

India and France have also signed an amendment to the Double Taxation Avoidance Convention that their countries have signed to conform to international standards in taxation. The new agreement will substitute the 10% dividend withholding tax with a 5 and 15 percent rate respectively to investors holding at least 10 percent equity, and other investors. It also gives rights to source based taxation on capital gains related to the sale of shares which enhances the power of India regardless of the ownership requirements. Most-Favoured-Nation has been eliminated and new provisions of Fees for Technical services, Service permanent establishment and tax information exchange have been implemented. The protocol will come into effect upon domestic ratification between the two countries.

Incentives to Strategic Investors: Dividend Tax Restructured

The reorganisation of dividend taxation is a great feature of the amended DTAC. A differentiated two-tier system has also replaced the former uniform 10% withholding tax. The beneficial owners who own a minimum of 10 percent of the equity- usually long-term strategic investors like parent companies- will now enjoy an 5 percent reduced rate. A rate of 15 percent will be imposed on portfolio investors having small investments.

This shift is an indicator of a shift in policy in favour of long-term capital investments, as opposed to the short-term flow of capital in portfolio. India and France target to increase the integration of corporations as opposed to merely speculative investments by providing incentives to hold large shares.

The increased rate on minority investors may, however, impact on fund inflows by the French portfolio investors. The transition is a balancing exercise between attracting investment and protecting revenues and thus is in line with global trends of working towards narrow target tax relief and not general concessions.

Capital Gains Rebalance Enhances India Taxing Rights

The protocol makes a great difference in taxation of the gains on sale of shares. Within the new system, the taxation of capital gains associated with selling shares is to be carried out in the home country of the company- full source-based taxation will be introduced.

In the past, it used to be limited as the taxation capability of India on such gains was limited to scenarios where the investors had substantial stakes usually exceeding 10% in a given company. Eliminating ownership thresholds gives India more powers and this could affect French portfolio investments estimated to be 22.69 billion.

This change enhances the fiscal sovereignty of India, but could also change the investment calculus of foreign investments. Whereas it increases transparency and minimises the chances of treaty-shopping, investors will be keen on efficient taxation and compliance provisions. The reform highlights the overall policy of narrowing capital gains entitlements within its network of treaties.

MFN Clause eliminated, Tax co-operation intensified

The other structural change is the removal of Most-Favoured-Nation (MFN) clause. This has the effect of preventing automatic claims of lower tax rates that France will negotiate with India in more recent treaties, which has been a historic source of legal conflicts.

Also, definition of Fees for Technical Services (FTS) has been adjusted to the India-US treaty so that there is unanimity in major bilateral frameworks. The implementation of a Service Permanent Establishment (PE) increases the taxation presence of cross-border service providers.

The new provisions on Assistance in Collection of Taxes and the new Exchange of Information mechanisms enhance compliance and transparency. All these measures make the treaty more contemporary in accordance to OECD and global anti-avoidance standards.

The protocol will be implemented once both the states finalise the process of domestic ratification and send and receive official notifications.