New Delhi – India has significantly altered its tax framework for dividends, replacing a flat 10% rate with a tiered system based on shareholder holdings. The changes, announced by the Indian finance ministry on , also include the removal of a Most Favoured Nation (MFN) clause in its tax treaty with France, impacting dividend taxation for French investors.
Under the revised rules, shareholders holding at least 10% of a company’s capital will be taxed at a rate of 5% on dividend income. All other investors will face a 15% tax rate. This represents a shift from the previous system, where dividends were taxed at a uniform 10% rate. The move follows the scrapping of Dividend Distribution Tax (DDT) in FY21, which previously placed the tax burden on companies rather than individual investors. Prior to FY21, dividend income up to ₹10 lakh per year was tax-free for individual taxpayers, with a 10% tax applied to amounts exceeding that threshold.
The changes are expected to affect a broad range of investors, both domestic, and foreign. Since FY21, companies have been required to deduct Tax Deducted at Source (TDS) at 10% if a shareholder receives more than ₹5,000 in dividends in a financial year. The new tiered structure adds another layer of complexity to dividend taxation in India.
Impact on India-France Tax Treaty
The amendment to the 1992 tax treaty between India and France is particularly noteworthy. The removal of the MFN clause allows India greater flexibility in setting its tax rates for French investors. More significantly, the revised treaty reduces the withholding tax on dividends paid by Indian subsidiaries to French parent companies, effectively halving it to 5%. This aligns with the new 5% bracket for qualifying shareholders under the domestic tiered system.
According to reports, the move was prompted by a desire to streamline tax regulations and encourage foreign investment. The previous MFN clause obligated India to extend any favourable tax treatment granted to other nations to France as well, potentially limiting its ability to tailor tax policies to specific investment relationships.
Geopolitical Context and Implications
The India-France tax treaty amendment comes at a time of strengthening bilateral ties between the two countries. France has emerged as a key strategic partner for India, particularly in the defense sector, with recent announcements regarding the acquisition of Rafale fighter jets bolstering cooperation. The revised tax treaty can be seen as a further step towards fostering a more attractive investment climate for French companies operating in India.
The removal of the MFN clause also reflects a broader trend of countries seeking greater control over their tax policies in a globalized economy. The increasing complexity of international tax regulations has led many nations to renegotiate existing treaties to better align with their economic priorities.
Investor Response and Future Outlook
The immediate reaction from investors has been cautious, with analysts suggesting that the tiered system will require careful consideration by portfolio managers. The impact on dividend yields will vary depending on individual investment holdings and shareholder status. Investors holding smaller stakes in companies will likely see a higher tax burden on their dividend income, while those with significant holdings will benefit from the lower 5% rate.
The changes also raise questions about the potential for companies to adjust their dividend policies in response to the new tax rules. Some companies may choose to reduce dividend payouts to mitigate the impact of the higher tax rates on smaller shareholders. Others may explore alternative methods of returning capital to investors, such as share buybacks.
The Indian government has indicated that it is committed to creating a stable and predictable tax environment for investors. However, the frequent changes to dividend taxation in recent years – from DDT to the current tiered system – highlight the challenges of balancing revenue generation with the need to attract foreign capital. The long-term success of the new tax framework will depend on its ability to strike this balance and provide clarity for investors.
The Ministry of Finance has not yet released detailed guidance on the implementation of the new tiered system, leaving some uncertainty among tax professionals. Further clarification is expected in the coming weeks, outlining the specific procedures for calculating and reporting dividend income under the revised rules. The changes are effective immediately, impacting dividend payments made on or after .
