Hon'ble Finance Minister, in her budget speech had proposed to abolish the much-abhorred dividend distribution tax "DDT" on companies/mutual fund. The Budget proposed a shift to classical system of taxing dividend in the hands of shareholders/unit holders from 1st April, 2020.
After the amendment made by the Finance Act, 2020, now dividends are taxable in the hands of the recipients. It is to be noted that the provisions of section 115-O of Income tax Act, 1961 (the Act) are applicable to the dividends declared, distributed or paid on or before 31st March 2020. Likewise, the provisions of section 115BBDA of the Act are applicable to the dividends declared, distributed or paid on or before 31st March 2020.
POSITION PRE-BUDGET 2020
The concept of distribution taxes in the hands of the Indian company was introduced in India in 1997. Under this distribution tax regime, Dividend Distribution Tax ('DDT') was paid by the company on the dividends and the income was exempt in the hands of the shareholders. This was considered as an efficient mechanism to collect tax on distributed income of the company.
Prior to the amendment, domestic companies were liable to pay DDT at 15% (plus applicable surcharge and cess) of the aggregate dividend declared, distributed or paid. The effective DDT rate after considering surcharge and education cess was 20.56 per cent. Such payment of DDT was treated as the final payment of tax in respect of such dividend paid to non-residents. However, in most cases involving foreign investors, credit for DDT was not available in their home countries, which ultimately result in a reduction of rate of return on equity capital.
Under the extant provisions of the Act, the resident shareholder (other than domestic companies, fund specified under Explanation to section 115BBDA of the Act and trust registered under section 12A or section 12AA of the Act) was required to pay tax at 10% (plus applicable surcharge and cess) on dividend income exceeding INR 1 million.
RATIONALE BEHIND AMENDMENT
Under pre-budget regime, the incidence of tax was actually on the payer company/mutual fund.
Moreover, the pre-budget provisions levied tax at a flat rate of 15% on dividend distribution, irrespective of the marginal rate at which the recipient would have otherwise been taxed. Hence, the provisions were considered unfair and regressive.
POSITION POST-BUDGET, 2020
A new section has been inserted in the Income-tax law, wherein dividend received by an Indian company from an Indian company shall not be taxable to the extent it is distributed by such company. It is a welcome change, as it allows the removal of the cascading effect in multi-tier corporate structures, irrespective of shareholding in the Indian company. Until now, moving funds by way of dividend attracted DDT and credit was available only in holding-subsidiary situations.
For Resident Shareholder
Individual: - For individual shareholder the dividend shall be taxable as per the applicable slab rates.
Towards this, a TDS will be deducted at 10% on dividends received above INR 5,000 in a year instead of INR 2, 500. Moreover, the government abolished additional tax of 10% on dividend income in excess of Rs. 10 lakh per year for Resident non-corporate taxpayers.
Companies: - For corporate shareholder the dividend shall be taxable as per the effective tax rates, which would range from 25.17% to 34.94%.
Mutual Funds:- The insertion of section 194K under the Act in which Mutual Funds, on payment of dividend to residents, will be required to deduct TDS at the rate of 10%.
For Non-Resident Shareholder
Indian companies shall be liable to withhold taxes at 20% on payment of dividend to a non-resident shareholder. This rate could be lower if the benefit under the tax treaty is available to such shareholders. Tax treaties with Singapore, Mauritius, Netherlands, Australia, United Kingdom and USA provide for a lower withholding tax rate of 5% to 15%. Hence, nonresident shareholders can claim benefit of lower tax rates under respective treaties.
Now, the foreign shareholders/ investors will also get credit of such withholding tax against tax payable in their home country. The amendment in Finance Act, 2020 will boost the sentiment of foreign investors.
Now, with the abolition of DDT, companies will be able to successfully distribute dividend within the group without incurring DDT cost. This will be particularly helpful to listed companies, which will be able to receive dividend from their joint venture/ subsidiary/ associate and distribute the same to the ultimate shareholder without incurring DDT cost.
Even in unlisted companies/ groups, dividends may be received from the joint venture/ subsidiary/ associate with a one-time tax cost, where dividend is retained at the recipient company level.
This amendment will also be a positive move for foreign investors who do not currently receive the benefit of DDT tax credit in their home jurisdictions. Such foreign investors will now be able to avail credit of such taxes withheld, subject to the availability of the benefit of the tax treaty.
However there are certain grey areas which are untouched such as if dividend is distributed by companies to the ultimate non-corporate shareholder, it may be taxed at 30% plus applicable surcharge and cess, which may be as high as 42.75%. Comparatively, non-resident shareholders, whether corporate or not, pay a 20% tax plus applicable surcharge and cess, which, in most cases, is reduced to 10% owing to the applicability of the tax treaty with foreign countries.
Cascading relief is not available in the case of dividend received by an Indian company from a foreign company. This seems to be an oversight by the government, as a similar deduction of dividend from a foreign subsidiary company is allowed to an Indian company in the current DDT regime. Dividend received from foreign companies may also be brought in the same regime.
This content is purely an academic analysis under "Legal intelligence series".
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