Indian company's capital reduction triggers deemed dividend liability despite shareholder's treaty claims and accounting standard disputes

ITAT Mumbai ruled on deemed dividend under section 2(22)(d) involving capital reduction by an Indian company. The tribunal upheld the AO's determination of accumulated profit using Ind-AS figures rather than IGAAP, rejecting the assessee's argument that reinstated figures were merely comparative. The court found that transition to Ind-AS required adoption of new accounting policies, making reinstated figures the actual financial position. Exemption under section 10(34) was denied as the Indian company failed to pay DDT, and the assessee being the controlling shareholder couldn't benefit from this failure. The MFN clause claim was dismissed as time-barred. Capital gains on share alienation were held taxable in India under Article 13(5) of the tax treaty. However, the tribunal allowed relief on surcharge and cess computation, directing the AO to levy only treaty rates without additional charges.

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Issues Involved:
1. Treatment of capital gains as dividend under section 2(22)(d) of the Income-tax Act.
2. Applicability of Section 115-O and exemption under section 10(34) of the Act.
3. Tax rate on dividend under the India-Netherlands tax treaty.
4. Taxability of capital gains under Article 13 of the India-Netherlands tax treaty.
5. Levying of surcharge and education cess on the tax treaty rate.
6. Initiation of penalty proceedings under Section 270A of the Act.

Summary:

Issue 1: Treatment of Capital Gains as Dividend
The assessee, a Netherlands-based company, held shares in an Indian company, Novateur India. During AY 2017-18, Novateur India undertook a capital reduction, and the assessee received compensation. The Assessing Officer (AO) treated part of the capital gains as dividend under section 2(22)(d) of the Income-tax Act, based on accumulated profits. The assessee contended that the accumulated losses should be considered as per Indian GAAP, not Indian Accounting Standards (Ind-AS). The Tribunal upheld the AO's view, stating that the reinstated figures under Ind-AS reflect the actual financial position and should be used for computing accumulated profits.

Issue 2: Applicability of Section 115-O and Exemption under Section 10(34)
The AO denied the exemption under section 10(34) of the Act, arguing that section 115-O, which applies to dividends distributed by domestic companies, does not cover deemed dividends under section 2(22)(d). The Tribunal agreed with the AO, noting that the assessee, as a holding company, could not claim the benefit of section 10(34) due to the failure of Novateur India to pay Dividend Distribution Tax (DDT).

Issue 3: Tax Rate on Dividend under India-Netherlands Tax Treaty
The assessee argued for a 5% tax rate on dividends under the Most Favoured Nation (MFN) clause of the India-Netherlands tax treaty. The Tribunal rejected this claim, citing a CBDT circular that requires bilateral consultation and notification under section 90(2) of the Act for MFN benefits. The Tribunal also noted that the claim was time-barred as per the treaty's protocol.

Issue 4: Taxability of Capital Gains under Article 13 of the Tax Treaty
The assessee claimed that capital gains from the cancellation of shares were taxable only in the Netherlands under Article 13(5) of the tax treaty. The Tribunal held that the capital gains were taxable in India, as the reduction of share capital constituted an alienation of shares to a resident of India (Novateur India). The Tribunal dismissed the argument that the transaction fell under corporate reorganization, which would have made the gains taxable only in the Netherlands.

Issue 5: Levying of Surcharge and Education Cess
The Tribunal directed the AO to follow the decision in Sunil V. Motiani v. ITO, holding that the tax rate under the treaty is inclusive of surcharge and education cess. Thus, the AO should not levy additional surcharge or cess on the 10% tax rate.

Issue 6: Initiation of Penalty Proceedings under Section 270A
The Tribunal found the ground premature for adjudication and dismissed it.

Conclusion:
The appeal was partly allowed, with the Tribunal upholding the AO's treatment of capital gains as dividend, denial of exemption under section 10(34), and taxability of capital gains in India. The Tribunal directed the AO to exclude surcharge and cess from the treaty tax rate and dismissed the penalty proceedings as premature.

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