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Inter-company deposits between sister-subsidiaries not deemed dividend under domestic law

In KIIC Investment Company (Taxpayer),  the Taxpayer was a Mauritius-based investment company, holding substantial interest in Indian companies, I Co 1, I Co 2 and indirectly, in I Co 3. During the tax years under consideration, I Co 1 had placed Inter Corporate Deposits (ICDs)  with I Co 2 and advanced amounts to I Co 3.  The Indian Tax Authority treated both the ICDs and advances  as deemed dividend under the ITL, taxable in the hands of the Taxpayer, being common shareholder in both the parties to the ICD/ advance.

The Mumbai Income Tax Appellate Tribunal (Tribunal) observed that deemed dividend provision of the ITL should be strictly interpreted since it taxes dividend on an artificial basis.  Based on the board resolution/ financial statements of I Co1 and terms of ICD agreement between I Co 1 and I Co2, the Tribunal held that the amount advanced by I Co 1 to I Co 2, is in the nature of a deposit and not a loan. Hence, such amounts cannot be taxed in the hands of the Taxpayer as deemed dividends under the ITL.  However, the Tribunal did not accept the alternate contention of the Taxpayer to the effect that ICD is not taxable as “dividend” under the Treaty. The Tribunal observed that where an amount is regarded as “deemed dividend” under the ITL, the same would also qualify as dividend under the provisions of the Treaty. Basis this, the amount paid by I Co1 to I Co 2 would qualify as dividend under the Treaty, subject to taxation at a lower rate of 5%, instead of the rate of 42.23% as computed by the Tax Authority. 

Article referred: https://www.ey.com/Publication/vwLUAssets/MumbaiTrideemed/%24FILE/MumbaiTrideemed.pdf

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