Adiyu to DDT.

The Hon’ble Finance Minister, Ms. Nirmala Sitharaman, had presented the Union Budget for the financial year 2020-21 on February 1, 2020, and introduced the Finance Bill 2020  (Bill) in the Lok Sabha. The Bill comprised of financial proposals, including taxation related proposals, to amend the provisions of the Income-tax Act, 1961 (“ITA”) for financial year 2020-21. The final Bill, incorporating certain amendments, was passed by the parliament on March 26, 2020 and received the assent of the President of India on March 27, 2020, and has now been enacted as the  Act  (the “Finance Act”).

One major change that came with the Finance Act is removal of dividend distribution tax making section 10(34), 10(35), 115-O, 115R(2) and 115BBDA of the ITA inapplicable with effect from April 1, 2020. 

What was Dividend Distribution Tax which is abolished now? 

Dividend Distribution Tax (DDT) means tax on distribution of dividend by Companies and Mutual Funds. It came in force with the two sections 115-O and 115R(2) of ITA and are explained briefly below for better understanding.

Section 115-O states that an additional tax of 15% is to be paid on any amount declared, distributed or paid by domestic company to its shareholders. Thus, tax is paid by the Company and such dividend income will be exempted in the hands of the shareholders by virtue of section 10(34) of ITA. However, Section 115BBDA of ITA provides additional income tax of 10% if dividend income exceeds Rs. 10 lakhs for individual, HUF, firms.

Section 115R(2) states that the specified companies and mutual funds are required to pay additional income tax on distribution of any amount to their unit holders.

Now, these sections will not be applicable for any dividend income from April 1, 2020. But this is not the first time that dividend income will be taxable in the hands of shareholders. Let’s go through the history of dividend taxation to get to know about the same and understand the everchanging pattern in taxation of dividend.   

Tracing History of dividend taxation 

Under ITA, classical system of taxation was followed by way of taxation of dividend in the hands of shareholders. In fact, the concept of DDT was introduced by the Finance Act 1997. Dividend that was subject to DDT @ 10%, to be paid by companies, was made exempt in the hands of the shareholders. DDT rate was amended to 20% in June 2000 but later switched back to 10% in June 2001.

However, in Finance Act 2002, it was again made taxable in the hands of shareholders removing the concept of DDT. But, in just one year, in 2003, it was said that it will be better to collect the tax on dividend from one place rather than collecting it from different shareholders and thus dividend taxation in hands of shareholders was scrapped on the grounds of ease and DDT was made effective @ 15%.

There have been several changes made from time to time in DDT since 2003. In 2014, grossing up provisions for computing DDT were introduced resulting in effective tax rate of 20.56% inclusive of applicable surcharge and cess.

One of the changes was made in Finance Act 2016 when dividend received by any shareholder (other than domestic company) exceeding 10 Lakhs was made taxable @ 10%. Now as mentioned the change in dividend taxation is made in Finance Act 2020.

Now, DDT has again been abolished and classical system of taxation is effective after 23 years of first introduction of DDT in 1997.

With all this history, one question bubble up in mind as to what made the Finance ministry to switch between tax regime again and again in case of dividend. Lets try and evaluate the same.

What went wrong with DDT?

Against the only advantage of reduction of compliances for taxpayers, there are several issues which arise with DDT, which will be discussed in ensuing paragraphs

One of the issues is cascading effect. Cascading effect is when tax is paid on tax and not on income. Companies used to distribute dividend to their shareholders after paying income tax on the profits earned. But as per provisions of ITA, they had to again pay DDT on the amount to be distributed as dividend. And again, the shareholder had to pay income tax at the rate of 10% on dividend received if the dividend received exceeds Rs. 10 Lakhs. This multiple level of taxation on dividend income was nothing but exploitation of taxpayers which was bound to be removed to provide fair taxation policy. Same goes in case of unit holders receiving dividend from mutual funds and specified companies.

Another technical problem associated with the DDT was that it made foreign treaties ineffective. India has entered into tax treaties with various countries and the treaties include capping the dividend tax at some restricted rate which is beneficial to the foreign investors making investments in Indian Companies. The treaties also enable the foreign investors in claiming credit on income tax paid. But within DDT regime, foreign investors were not able to take credit of the DDT as DDT was paid by the Companies and not by the foreign investors as such.

Another is in relation to retain investors who were charged DDT irrespective of their own income tax slab rate on the basis of their total income. There were taxpayers whose total income doesn’t cross minimum threshold limit and still were charged DDT.

Effective Tax Regime for Dividend after 1-April-2020

With Finance Act 2020, the concept of DDT stands withdrawn and thus domestic companies and mutual funds declaring, distributing and paying dividends to shareholders and unitholders respectively are no longer required to pay DDT. Income tax on dividend income will be paid by the shareholders.

Earlier dividend was exempt in the hands of shareholders and therefore there was no provision which would allow deduction of expenses to earn dividend income. Now with dividend income being taxed in the hands of shareholders, it is allowed to deduct expenses spent on paying interest of loan that was taken to purchase the investments from which the dividend was received but only to the extent of 20% of the gross dividend income by way of insertion of first proviso to section 57 of ITA.

With dividend income being taxable in the hands of the shareholders, section 194K has been inserted to provide for levy of TDS at the rate of 10% on any income above Rs. five thousand, in respect of (a) units of Mutual Fund specified under section 10(23D) or (b) units from the administrator of the specified undertaking or (c) units from the specified company. This TDS rate is further reduced to 7.5% for the period 13th May 2020 to 31st March 2021 due to relaxation provided by the Government on account of Covid-19 pandemic situation.

In order to remove the cascading impact on corporate dividend, a domestic company is allowed a deduction under section 80M of ITA in respect of the dividend received from another domestic company, foreign company or a business trust to the extent such dividend is distributed by the domestic company on or before the due date, i.e. one month prior to the date of furnishing the income tax return. This deduction would be available, irrespective of the percentage of shareholding of the domestic company in the investee company.

The below table represents the summary of effective tax rate on dividend income.

Resident Shareholders	Income tax rate1
Individuals/HUF2	35.88%
Firms, Limited Liability Partnerships	34.94%
Manufacturing Companies – section 115BAB	17.16%
Other Domestic Companies – section 115BAA	25.17%
Other Domestic Companies – not claiming deductions	34.94%
MSME (turnover less than Rs. 400 crore)	29.12%
Non-resident Shareholders3
Individuals2	23.92%
Foreign Companies	21.84%
Notes: Minimum alternative tax not considered. 1 – Maximum marginal tax rate 2 – Surcharge for individuals considered @ 15% 3 – subject to DTAA tax treaty rates

Let us now analyse if this results in betterment of the taxpayers or not.

DDT abolished for good or bad?

DDT abolition sparked debate around taxation of dividend in India. Some of the benefits of abolition of DDT are as follows:

• Removal of DDT will reduce the cascading effect on dividend. The new provisions will erase dividend taxation at multiple levels.
• One of the beneficiaries of removal of DDT, i.e, foreign investors are in a state of delight, for whom removal of DDT is cost saving, in real terms. Now, it’s going to attract more and more foreign investors specially those whose country is already a part of tax treaty of India. The treaty will again be effective and the foreign investors will again be able to invest confidently in Indian companies and claim credit on tax paid on such income from their country. More foreign investors will be beneficial for Indian companies as well.
• With dividend to be taxed in the hands of shareholder, now the companies will have more money in hand and will likely distribute more dividend to the shareholders. This will mean more money to the investors, both domestic & global investors.
• Specifically, the small investors who are falling under lower brackets of income tax are in dilemma, which should not be the case. In the previous regime, they were effectively charged the highest rate of tax by way of DDT paid at Company level and hence dividend was exempt in shareholders’ hands. Now, when these shareholders have to pay tax, they may feel for the tax outflow but effectively they are paying less tax as compared to the previous regime.

However, there is always two sides of the same coin, on one side the new provisions seem favourable but if seen from the other side there are some negative effects as well.

• DDT abolition will not reduce the compliance procedure for companies as they have to still deduct withholding tax on payment of dividend. Dividend payment is a cumbersome and time consuming process for listed entities especially.
• Withholding tax for individual in the range of 7.5% to 20% if PAN is not available. Further, Nil/lower withholding tax certificates needs to be considered. Withholding tax for insurance companies, mutual funds, AIF, FPI, FII, GDR holders need further documentation.
• Additional compliance for Individual Taxpayers in the form of accounting for dividend income and paying taxes accordingly. A resident individual receiving dividends whose estimated annual income is below the exemption limit can submit form 15G to the company or mutual fund paying the dividend. Similarly, a senior citizen whose estimated annual tax payable is nil can submit Form 15H to the company paying the dividend.
• For every non-resident shareholder, the Company need to file Form 15CA self-declaration for all non-resident shareholders. Further, the Company would also seek Form 15CB CA certificate from the shareholder where dividend is more than Rs. 5 Lacs during the financial year along with tax residency certificate and Form 10F for applicability of relevant tax treaty between countries.
• There may be scenarios where the real benefit of DDT abolition might not be passed over to shareholders by way of dividend when the company decides to improve on their reserve & surplus.
• Taxpayers who are high earner but were receiving dividend upto Rs. 10 lacs were earlier paying only 20% (by way of DDT which was paid by the Company), these taxpayers will have to pay income tax on dividend at maximum tax rate now.
• Effectively residents, be it individuals or companies are paying more tax on dividend than the non-residents which is not level playing field for resident shareholders.

With all this being said there is one question that arises here – Is this another attempt by government to provide silver spoon to companies and take away one from its ‘honest taxpayers’. Only time will tell!