India, France near deal on tax treaty, to lower levy on dividends paid to French parent companies

The impending revision of the Double Taxation Avoidance Agreement (DTAA) between India and France marks a significant development in international taxation and bilateral economic relations. This move is not an isolated event but rather a part of India's broader strategy to align its tax treaties with global best practices, curb treaty abuse, and attract genuine foreign investment, especially in the wake of the OECD's Base Erosion and Profit Shifting (BEPS) initiative.

**Background Context and What Happened:**

Double Taxation Avoidance Agreements (DTAAs) are bilateral economic agreements between two countries that aim to prevent income earned in one country from being taxed in both countries. These treaties provide clarity and certainty to investors, thereby promoting cross-border trade and investment. India has DTAAs with over 90 countries. The existing India-France DTAA, like many older treaties, needed revision to reflect evolving international tax norms and India's economic priorities.

The proposed revised treaty introduces two key changes. Firstly, it aims to reduce the dividend tax rate for French parent companies holding more than a 10% stake in Indian entities to 5%. This is a notable reduction from potentially higher rates, making dividend repatriation more attractive for significant investors. Conversely, the dividend tax for minority shareholders (those holding 10% or less) will be increased to 15%. This differential treatment incentivizes larger, strategic investments while ensuring a reasonable tax collection from smaller, possibly portfolio-driven investments. Secondly, and perhaps more significantly, the agreement proposes to allow India to tax share sales by any French entity. This shifts the taxation of capital gains from a residence-based approach (where the investor's home country taxes the gains) to a source-based approach (where the country where the asset is located, i.e., India, taxes the gains). This is a crucial move towards enhancing India's tax sovereignty.

**Key Stakeholders Involved:**

* **Governments of India and France:** These are the primary negotiators, aiming to balance their respective revenue interests with the goal of fostering bilateral economic ties and investment. The Indian Ministry of Finance and its French counterpart are leading these discussions.

* **French Parent Companies/Major Investors:** These entities stand to benefit directly from the reduced dividend tax (5%), making India a more attractive destination for long-term, strategic investments. Companies like Airbus, Dassault Aviation, and other French conglomerates with significant operations in India are key beneficiaries.

* **Minority Shareholders:** These investors will face an increased dividend tax rate (15%), which might impact their returns and investment decisions.

* **Indian Revenue Department (CBDT):** The department gains enhanced taxing rights, especially concerning capital gains arising from the sale of shares by French entities in India, which could lead to increased tax revenue.

* **Indian Economy:** The broader Indian economy is a significant stakeholder, as increased FDI from France can lead to job creation, technology transfer, and overall economic growth.

**Significance for India:**

This revised DTAA holds immense significance for India. From an economic perspective, lowering dividend tax for major French investors could stimulate Foreign Direct Investment (FDI) from France, a key partner in sectors like defence, aerospace, and renewable energy. This aligns with India's 'Make in India' and 'Atmanirbhar Bharat' initiatives, which seek to boost domestic manufacturing and self-reliance by attracting foreign capital and technology. Politically, a stronger economic partnership with France reinforces India's strategic alliances, especially given France's role as a permanent member of the UN Security Council and a significant player in the European Union.

The shift to a source-based capital gains taxation framework is a major victory for India's tax policy. Historically, India has faced challenges with treaty shopping, where investors routed investments through countries with favorable DTAAs (like Mauritius or Singapore) to avoid capital gains tax in India. The amendment of DTAAs with these countries in the past, and now with France, reflects India's consistent effort to implement source-based taxation, ensuring that capital gains generated from assets located in India are taxed within India. This aligns with the principles of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Action Plan, particularly Action 6 (Preventing Treaty Abuse) and Action 7 (Preventing the Artificial Avoidance of Permanent Establishment Status).

**Constitutional and Legal Framework:**

The power to enter into and implement international treaties and agreements, such as DTAAs, is vested in the executive branch of the Indian government. However, for such treaties to have legal force within India and affect domestic law, Parliament often needs to legislate. **Article 253 of the Indian Constitution** empowers Parliament to make any law for implementing any treaty, agreement, or convention with any other country or any decision made at any international conference, association, or other body. Once ratified and notified, the provisions of a DTAA, under **Section 90 of the Income Tax Act, 1961**, generally override the provisions of the Income Tax Act to the extent they are more beneficial to the taxpayer. This means that a French company or individual can choose to be governed by either the Income Tax Act or the DTAA, whichever results in lower tax liability.

**Future Implications:**

This revised DTAA with France sets a precedent and indicates India's continued commitment to modernizing its tax treaties. It suggests that India will likely pursue similar revisions with other partner countries, pushing for source-based taxation of capital gains and differentiated dividend tax rates to attract strategic investment. This will enhance India's tax revenue potential and reduce opportunities for tax avoidance. However, the increased tax for minority shareholders might lead to some re-evaluation by smaller investors. Overall, the move is expected to foster a more predictable and robust tax environment, encouraging long-term foreign investment and strengthening India's position in the global economic landscape.