Budget 2020 : Dividend Distribution Tax (DDT) vis a vis Company Incorporation by Unorganized Sector
MSME’s in India are the largest job providers in the country but however most of them are unorganised or rarely they take corporate outlook. In order to attract fresh investments in manufacturing sector and to promote growth and investment , the Union Government came out with Taxation Law (Amendment) Bill , 2019 wherein Domestic Manufacturing Companies set up and registered after 30th September 2019 and start manufacturing before April 1, 2023 have an option to pay tax @15% provided they forego certain deductions.
This article is written considering the specific cases of MSME’s in informal and unorganised sector who are working as Partnership firms.
Pre budget situation
Before The budget , the new manufacturing MSME had 2 options – either go for partnership and pay tax @30% or choose to set up new company u/s 115BAB and pay tax @15%. However, the major hurdle was if the promoter wants pay out profits from the company apart from salaries , it is only in form of Dividend which attract a dividend distribution tax @ 15% (along with surcharge and Cess which comes around 20%). Thus, a new co. actually paid around 35% of its profit whereas in partnership firm pay tax @30% and the remaining profit was exempt in hands of partner.
Post budget situation
Post budget 2020 , Dividend distribution tax has been abolished with reverting to classical system wherein shareholder will be liable to pay tax on distributed dividend at the rate applicable to him. Thus, MSME co. would now pay tax @15% and promoter can take out profits in form of dividend with tax liability in their individual hands according to applicable rate. However , there has been deduction interest expenses from such dividend income in hands of shareholder subject to maximum of 20% of dividend and also Section 14A is evenly applicable in present case. In this case , however an advantage is that immediate tax liability on company is only 15% and that on partnership is 30% , thus, in case, where promoter don’t want distribution of profits in form of dividend , resort to section 115BAB is beneficial.
Nevertheless , a question arises whether an informal or unorganised MSME who wants to get converted into a corporate is really at any benefit from above provisions. Apart from complex ROC compliances, a big hurdle is for those individuals who are covered by high tax bracket and they may chose to continue in partnership and pay tax @30%. The government , in case really want to boost up the MSME’s , then it should introduce an exemption limit of dividend as well so that more and more SME’s find fruitful to move to company structure.
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