With a view to boost investors’ confidence in the Indian market and put India in a competitive position in terms of taxing rights as compared to other countries in APAC region, the Government of India proposed to abolish Dividend Distribution Tax (also known as DDT) with effect from 01 April 2020.
Currently, any amount declared, distributed or paid by a company in the form of dividends would be charged to a tax rate of 15%[1], subject to grossing up, applicable surcharge and cess resulting in an effective tax rate of 20.56%[2]. This tax is in addition to the corporate tax paid by the company. Such dividends are generally exempt in the hands of the shareholders except in certain cases.
Since DDT is an additional levy of the Indian companies and tax credit of such DDT in the hands of the foreign shareholders has been subject matter of continuous debate, there was a need for removal of DDT from a long time. The intent behind the introduction of DDT was to collect tax at a single point and reduce the compliance burden. However, with the advancement in technology and easy tracking systems, the existing method of taxing dividends was not justifiable.
The existing regime resulted in the following setbacks:
- Cascading tax effect for assessee receiving the dividend beyond the stipulated limit of INR 1m, as the same is received after being subject to DDT, which is in turn over and above the corporate tax paid by the company;
- Applicability of a single rate for taxpayers in different tax brackets
- Non-availability of credit of DDT to most foreign investors in their home country results in reduction of rate of return on equity capital.
Given the criticality of foreign investments and the need to protect small and medium investors, it has become crucial to substantiate the moto “sabka saath, sabka vikas.”, the Honourable Finance Minister, on 1 February 2020, proposed to abolish DDT and reinstate the classical system of taxing dividends in the hands of the shareholders with effect from FY 2020-21.
Under the proposed regime, the shareholders would be required to pay tax on the amount of dividend received. However, to ensure that the dividends does not go tax free, the domestic companies would now be required to withhold tax before distributing dividends to their shareholders. For a better understanding, the shareholders have been categorised into resident and non-resident investors.
Resident Investor
Section 194 of the Act requires a company to withhold tax at the rate of 10% where the dividend to be distributed is in excess of INR 5,000. The investor entitled to receive such dividend would be required to furnish its Permanent Account Number (PAN). Where the PAN is not furnished, the company would be required to deduct tax in terms of section 206AA at a higher rate of 20%.
Non-resident Investor
Section 195 of the Act read with section 115A requires a company to withhold tax at the rate of 20% (plus applicable surcharge and cess). Where tax is deducted at the said rate, there may not be a requirement for such an investor to file its tax return in India. Further, the non-resident investor would now be able to claim a credit of the taxes withheld in India unlike the existing DDT regime wherein credit of the DDT paid was not available in the foreign jurisdiction.
A non-resident investor from a country with which India has a Double Tax Agreement (DTA) may avail the benefit of a lower withholding tax rate, such as 10%/ 15% in case of Singapore, 5%/ 15% in case of Mauritius, etc. Under the existing regime, a non-resident is only required to provide a Tax Residency Certificate to avail this benefit. However, under the proposed regime, the non-resident would also be required to file its return of income in India. Accordingly, for filing its tax return in India, the non-resident would be required to obtain a PAN. This is an additional compliance and may have an impact on multinational enterprises having substantial operations in India.
Impact for Listed Companies
It may so happen that the Know your Customer (KYC) details of the investors may not be updated, i.e. non-availability of PAN with the listed companies. This may result in listed companies withholding tax at a higher rate in terms of section 206AA. It is pertinent to note that the listed companies would be required to deduct tax accordingly, issue Tax Deducted at Source (TDS) certificates to all its investors and thereafter file TDS statements. Given this, the new regime may have made the process cumbersome for listed companies.
Understanding section 80M
The proposed amendments have reintroduced section 80M to provide relief in the hands of the domestic company receiving dividends from another domestic company.
Under the existing DDT regime, dividend distributed by a domestic company is subject to tax after reduction of dividend income received from:
- Its subsidiary domestic company that has paid tax on the dividend distributed to its parent under section 1150;
- Its foreign subsidiary where tax has been paid by the domestic company under section 115BBD.
Under the proposed regime, the dividend distributed by a domestic company is subject to a reduction of the dividend income received from any domestic company. However, the beneficial provisions of section 80M do not extend to dividend income received from foreign companies, thereby leading to double taxation in respect of such dividends, i.e. in the hands of the domestic company and thereafter in the hands of the shareholders of such domestic company. This may have a significant impact on Indian group structures with foreign subsidiaries.
Further, it is pertinent to note that the dividend though received from a domestic company and not declared to the shareholders but reinvested into business and declared in the subsequent years would again be taxed, as deduction under section 80M of the Act would not be available to the domestic company declaring dividend.
Expense Deduction
The abolishment of DDT as proposed would bring an end to litigation currently prevalent in respect of expenditure in relation to exempt (dividend) income disallowed by the tax authorities under section 14A of the Act on the premise that the dividend income would now be taxable in the hands of the investors.
A relief has been provided to taxpayers in the form of deduction of interest expense (not exceeding 20% of dividend income) against the dividend income.
Considering that the disallowance under section 14A of the Act read with rule 8D of the Income-Tax Rules, 1962 by using the formulary approach sometimes exceeded the amount of dividend earned itself which in turn attracted litigation, it was expected that the government at least grant deduction of interest expenditure (specifically attributable to the earning of dividend income) equivalent to the dividend income.
Conclusion
After the abolishment of DDT, the tax outgo in case of Indian promoters/ investors who hold companies/ investments in their individual capacity would substantially increase. Most promoter groups hold equity individually or in trusts and are in the upper tax bracket. Therefore, they may end up paying tax at the rate of 42.74%[3] on dividends from 01 April 2020. Accordingly, such holding structures may need to be re-visited.
Earlier, companies would look at alternative ways to distribute profits to investors (such as buyback) given the high DDT rate. However, with the proposed amendment and the benefit of reduced tax rates under the treaties, this gives a positive outlook for investing in India. Accordingly, abolishment of DDT is likely to be welcomed by most taxpayers as India is moving from a high tax jurisdiction to a low one. This shall be considered as one of the steps towards increasing ease of doing business in India, paving the way for a USD 5 trillion economy.
[1] Section 115-O
[2] Surcharge @ 12% and health and education cess @ 4%
[3] Surcharge @ 37% and health and education cess @ 4%
Author:
Aditya Narwekar, Partner – Deals, PwC India
Himanshu Aggarwal, Associate Director – Deals, PwC India
The views expressed in this article are personal. The article includes input from Navneet Rander – Senior Associate – Deals, PwC India
Now will it be possible for an investor to provide Form 15G/H to the respective listed companies for non deduction of 10% tax on dividends if they exceed Rs.5000/-? Kindly clarify.