Taxability of Dividend under new tax regime

A. Existing Provisions relating to dividend taxation:

(i) Tax implication in the hands of company: Under the existing laws, even though dividend constituted income in the hands of the shareholders, the tax on such dividend was payable by the company which declared dividend, @ 15% of the gross dividend under section 115-O (plus surcharge and cess) which amounted to effective Dividend Distribution Tax (DDT) of 20.36% (except dividend covered under section 2(22)(e) , where rate of DDT was 30%). However, no deduction or credit is allowable to the company, in respect of such DDT.

(ii) Tax implication in the hands of the shareholder: Under the existing regime, the dividend which was received by the shareholder and covered under section 115O, was exempt in their hands under section 10(34). However, where a specified shareholder (other than Indian Company / Trust covered under section 12A or 12AA, amongst others), received dividend exceeding Rs. 10 lakhs, such recipient was liable to pay tax @ 10% (plus applicable surcharge and cess), in addition to the DDT paid by the company which leads to double taxation. Even in the case of non-resident shareholders, dividend  received from Indian company is not liable to tax in India.  Accordingly, the Indian Company declaring  dividend was not liable to deduct TDS from  such  dividend. However, in cases, where such dividend was liable to tax in the hands of non-resident in their country  of residence, there was generally no credit available for  the dividend  distribution tax paid by the Indian  Company.

B. Impact of new dividend tax regime:

In order to remove the adverse impact of the existing  regime, the Hon’ble finance minister has re-introduced the classical system of  dividend taxation and this classical system of taxing dividends will be effective from Financial Year 2020-21 and will apply to dividends distributed on or after 01.04.2020.  Correspondingly, the following provisions were inoperative till 31.03.2020.

a) Section 115-O , tax on distributed profits of domestic companies

b) Section 115-R, tax on distributed income to unit holder

c) Section 115BBDA, tax on certain dividends received from domestic companies

d) Section 10(34), dividend income from domestic company

e) Section 10(35), Income from specified mutual fund

Obligation of the domestic companies: The domestic companies shall not be liable to pay DDT on dividend distributed to shareholders on or after 01-04-2020. However, domestic companies shall be liable to deduct tax under Section 194.As per the Section 194, which shall be applicable to dividend distributed, declared or paid on or after 01-04-2020, an Indian company shall deduct tax at the rate of 10% from dividend distributed to the resident shareholders if the aggregate amount of dividend distributed or paid during the financial year to a shareholder exceeds Rs. 5,000.

However, if the resident shareholder fails to submit his Permanent Account Number, the company is required to deduct tax at a higher rate of 20%. Further, the resident shareholder can also approach the tax  authorities for obtaining a lower withholding tax certificate if he believes that the appropriate withholding tax should be lower than 10%.

However, no tax shall be required to be deducted from the dividend paid or payable to Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC) or any other insurer in respect of any shares owned by it or in which it has full beneficial interest. However, where the dividend is payable to a non-resident or a foreign company, the tax shall be deducted under Section 195 in accordance  with relevant DTAA.

C. Tax implications in the hands of resident shareholders:

• Tax implications in the hands of Individual/ HUF: Dividend income earned by resident shareholders being individuals and HUFs will now be taxable in their hands at the slab rates applicable to them. For a shareholder being an individuals and HUFs whose total income exceeds INR 1 Crores, dividend income will be taxable at a maximum effective rate of 35.88% (Including surcharge and cess, whereas maximum surcharge on dividends would be restricted to 15%).
• Tax implications in the hands of Partnership firms and Limited Liability Partnership (LLP): Dividend income received by partnership firms and LLP will be taxable at effective tax rate of 31.2%. If total income of firm / LLP exceeds Rs. 1 Crore then dividend income will be taxable at effective tax rate of 34.94%.
• Tax implications in the hands of domestic companies: Dividend income received by domestic company is taxable at tax rate depend upon whether the company has opted for concessional tax regime under section 115BAA or Section 115BA of Act.

* provided total income exceeds Rs. 10 Crore. If Income exceeds Rs. 1 Crore but less than Rs. 10 Crore then effective tax rate is 33.38%. If income is less than Rs. 1 Crore then effective tax rate is 31.2%.

** Surcharge is at flat rate of 10% irrespective of income excess is more than or less than Rs. 10 Crore.

*** provided total income exceeds Rs. 10 Crore. If Income exceeds Rs. 1 Crore but less than Rs. 10 Crore then effective tax rate is 27.82%. If income is less than Rs. 1 Cr then effective tax rate is 26%.

• Section 80M – Removing cascading impact of the taxes: In order to remove the cascading effect of taxation of dividend, Section 80M is introduced which provides that if the gross total income of a domestic company (eg. Company A), includes any dividend income from any other domestic company (eg. Company B), Company A shall be allowed a deduction against the dividend income, to the extent of the amount of dividend distributed by the company A. However, the deduction will be allowed to the company only in respect of the dividend distributed by company A one month prior to the due date of filing return of income. The benefit of Section 80M is available to those companies which has also opt for lower tax regime under section 115BAA and section 115BAB of Act.
• Deduction for expenditure incurred for earning dividend income: Where dividend is assessable to tax as business income, the shareholder can claim the deductions of all those expenditures which have been incurred to earn that dividend income such as collection charges, interest on loan etc. Whereas if dividend is taxable under the head other sources, the shareholder can claim deduction of only interest expenditure which has been incurred to earn that dividend income to the extent of 20% of total dividend income. No deduction shall be allowed for any other expenses including commission or remuneration paid to a banker or any other person for the purpose of realizing such dividend.

D. Tax implications in the hands of non-resident shareholders including foreign portfolio investor (FPI):

A non-resident person invests in India either directly as a private equity investor or as  FPIs. If non-resident is holding shares as an investment, the income derived there from is taxable as an Income from other source. If such income is attributable to permanent establishment of non- resident in India, it will be treated as business income. In case of FPIs, the investment held will always be treated as a capital asset and not stock in trade.

The dividend income, in the hands of a non-resident person (Including FPI and non-resident Indian citizen) is taxable at 20% without providing for any deduction under any provisions of the Income tax Act. However, where dividend is received in respect of GDRs of an Indian company or Public Sector Company purchased in foreign currency, the tax shall be charged at the rate of 10% without providing for any deductions.

The relevant section under which tax is charged and tax is withheld on dividend distributed or paid to a non-resident shareholder is explained in following table:

• Taxability under DTAA: Dividend income is generally chargeable to tax in the source country as well as the country of residence of the assessee and consequently, country of residence provides a credit of taxes paid by the assessee in the source country. Thus, the dividend income shall be taxable in India as per provisions of the Act or as per relevant DTAA, whichever is more beneficial.

However before making application for treaty benefits, one must consider the careful analysis of beneficial ownership, wordings of the Most Favoured Nation Clause (MFN)  and amendments made under the Multilateral Instruments to which India is a signatory.

However, one of the most significant impact of the current changes in the hands of the non-resident is, that the TDS deducted by Indian company at the time of payment of dividend, will now be available as a credit to the non-resident in its country of residence. The extent of availability of credit shall depend on the respective treaties and on the domestic tax laws of the country of residence.