Finance Minister, Nirmala Sitharaman in her budget speech has proposed to abolish the much-abhorred dividend distribution tax "DDT" on companies/mutual fund. The Budget proposes a shift to classical system of taxing dividend in the hands of shareholders/unit holders from 1st April, 2020.

Pre-budget Scenario (Applicable before 1st April, 2020)

DDT was levied at a rate of 15% (effective rate being 20.56%, including surcharge and cess) on the dividend declared and distributed by an Indian company. This was over and above the income-tax paid by a company on its net profit.

The dividend income in the hands of the shareholders was exempt, except a certain category of resident individual shareholders who earned dividend income in excess of INR 10 Lakhs (Paid an additional tax of 10%)1.

This exemption further extended to foreign shareholders. However, foreign shareholders did not receive the benefit of credit since, DDT was paid by Indian Company. This fundamentally resulted in cascading of taxation and acted as an impediment for Foreign Investments.

Rationale behind the shift

The dividend so distributed is income in the hands of the recipient instead of the company. Therefore, the incidence of the tax should have been on the recipient.

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 (15%) on dividend distribution, irrespective of the marginal rate at which the recipient would have otherwise been taxed. Hence, the provisions were considered iniquitous and regressive.

Post-budget Scenario (Applicable after 1st April, 2020)

After the proposed amendment, dividend income from shares/units is taxable in the hands of recipient at the applicable tax rates.

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, 5002. Earlier no such deduction was allowed for such dividends.

Moreover, the government abolished additional tax of 10% on dividend income in excess of Rs. 10 lakh per year for Resident non-corporate taxpayers3.

Companies:- For corporate shareholder the dividend shall be taxable as per the effective tax rates, which would range from 25.17% to 34.94%4.

Mutual Funds:- The budget has proposed to insert Section 194K under 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, non-resident shareholders can claim benefit of lower tax rates under respective treaties.

Now, the foreign shareholders will also get credit of such withholding tax against tax payable in their home country. The proposed amendment will boost the sentiment of foreign investors.

Table 1 – Impact on Residents and Non-Residents

Particulars

Before

Proposed

Residents

DDT was taxable in the hands of an Indian Company at an effective rate of 20.56%.

Dividend or income from units are taxable in the hands of shareholders or unit holders. The dividend shall be taxable as per the applicable slab rates.

Non-Residents

Foreign shareholders did not get credit of DDT as the same was taxable in the hands of Indian company.

The Indian company shall be liable to withhold taxes at 20% on payment of dividend to a non-resident shareholder. The foreign shareholder will get the credit of such withholding tax against tax payable in their home country.

Removal of Cascading Effect

To remove the cascading effect of tax paid, domestic holding companies receiving dividend income from other domestic companies will be allowed to set off such amount from their total taxable income. This set off shall not exceed the amount of dividend further distributed by holding company up to 1 month prior to the filing of return5.

Related Provisions

It has been further proposed that 'deduction for expense'6 shall not be more than 20 per cent of the interest expenses on account of dividend income.

Section 14A of the ITA disallowed deductions against expenditure in relation to income not forming part of the total taxable income. Since dividend income was exempt in the hands of shareholders by virtue of Section 10(34) of the ITA, no deduction could be claimed against expenditure incurred by a shareholder in relation to such income.

By making dividends taxable in the hands of shareholders, the Budget has rendered Section 14A inapplicable in computing such dividend income.

Table 2 – Summary of Relevant Changes

Particulars

Before

Proposed

Incidence of Tax

The incidence of tax was on company distributing surplus profit.

Dividend or income from units are taxable in the hands of shareholders or unit holders at the applicable rate (Respective tax slab rates)

Cascading Effect

The tax base of Holding Company for DDT (i.e. the dividend payable in case of a company) is to be reduced by an amount of dividend received from its subsidiary.

Domestic Holding Companies receiving dividend income from subsidiaries will be allowed to set off such amount from their total taxable income. This set off shall not exceed the amount of dividend further distributed by it upto 1 month prior to the filing of return.

Double Taxation

Resident non-corporate taxpayers needed to pay Additional Tax of 10% on dividends in excess of Rs. 10 lakh per year. This was over and above the DDT paid by companies.

The Additional tax of 10% on dividends in excess of Rs. 10 lakh per year for Resident non-corporate taxpayers has been done away with.

Amicus Comments

There are two visible advantages of DDT abolition. First, foreign investment would increase in Indian companies. Second, it will remove double taxation for resident shareholders7.

Shareholders who used to enjoy tax-free dividends will now have to pay tax on such dividends. The new provisions will benefit investors in low tax brackets while those in higher brackets have been left worse off.

In addition, TDS will be deducted at 10% for dividends above INR 5,000 in a year.

Moreover, the Indian company will be liable to withhold taxes at 20% on payment of dividend to a non-resident shareholder.

This amendment is a positive move for foreign investors who did not 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 benefit under tax treaty.

However, the Budget has not proposed corresponding amendments to Section 115BBD of the ITA, which imposes a 15% tax on inbound dividends received by an Indian company from "specified foreign subsidiary companies"8. Such dividends continue to remain taxable at 15% in the hands of the Indian company but without the benefit of set-off through a Dividend Received Deduction (DRD). 


1. Section 115BBDA of Income Tax Act,1961

2. Section 194 of Income Tax Act, 1961

3. Section 115BBDA of Income Tax Act, 1961

4. Including Surcharge and cess

5. Proposed Section 80M

6. Section 57 of the Income Tax Act, 1961

7. Section 115BBDA of Income Tax Act,1961

8. Foreign company in which the Indian company holds 26% or more in the equity share capital of the company.

Source- Taxmann