Abolition of Dividend Distribution Tax – A happy ending?

The new corporate tax regime introduced vide Taxation Laws (Amendment) Act, 2019 expressed the government’s desire to provide relief to the corporate sector and industry bodies at large. Market participants were hopeful that Budget 2020 will address their woes of Dividend Distribution Tax (DDT) as well.

The legislative intent behind the introduction of DDT was administrative efficiency in collection of tax. The Finance Act, 1997 introduced DDT thereby shifting the tax liability on dividend income from shareholders to companies. Dividends were again made taxable in the hands of shareholders pursuant to scrapping of DDT by Finance Act, 2002. However, Finance Act, 2003 re-instated DDT thereby exempting dividends in the hands of shareholders.

In accordance with the ask from industry bodies over the years, Finance Minister Nirmala Sitharaman while presenting Finance Bill, 2020, proposed to abolish the DDT levied on dividends distributed by companies. With the proposed amendment, India will again move to the classical system of taxing dividend income in the hands of shareholders / unit-holders.

Summarised below are the key nuances of the existing regime and proposed regime:

Existing regime

• Non-availability of credit of DDT to most foreign investors in their home country results in reduction of rate of return on equity capital.
• DDT is a levy at flat rate on distributed profits, irrespective of the marginal rate at which the recipient is otherwise taxed.
• Disallowance of expenditure incurred for earning exempt income which had become one of the most litigated issues.
• Advent of technology and availability of easy tracking systems.

Proposed regime

• No deduction other than interest expense shall be allowed from such dividend income and such deduction shall not exceed 20% of dividend income.
• Withholding tax implications @5% (residents) and 10% (non-residents) will arise in the hands of companies paying dividends to its shareholders in excess of INR 5,000/-.
• To remove cascading effect, it has been proposed to introduce a new section 80M under the Income-tax Act, 1961 (‘the Act’) whereby a domestic company shall be eligible to deduct from the amount of dividend paid by it such dividend income received from any other domestic company. However, it is imperative to note that dividend received from foreign companies will still be taxed and no deduction shall be allowed.
• Taxable income of individual taxpayers in highest bracket can go up to 42.7% (incl. surcharge and cess)

While this announcement is made in accordance with the representations by Industry bodies over the years, it could also increase the tax bill in following scenarios   

1. In case an Indian company is paying taxes under Minimum Alternate Tax (MAT) provisions and receives dividend from other Indian company, it will still have to pay taxes on dividend so received under MAT provisions. The provisions of section 80M of the Act would only help in increasing the MAT credit in such a scenario.

2. Further, with the Indian sponsor receiving dividend from Infrastructure Investment Trust (InVIT) may not be able to get benefit of section 80M of the Act. That is because the pre-requisite to get benefit of the said section is to receive the dividend from a domestic company and InVIT does not get classified as domestic company as it falls under the definition of ‘Business Trust’ under the Act.

3. In case of non-resident unit holders in INVIT structure, dividends declared by InVIT would suffer withholding tax @10% (plus applicable surcharge and cess) if the non-resident is not eligible for reduced tax rate under the relevant tax treaty. In addition to the taxes so withheld, there could be additional tax payable by the unit holder, if the tax rate under the relevant tax treaty is higher than 10% since under the domestic law, the prescribed tax rate applicable on dividend income in the hands of unit holder is 20% (plus applicable surcharge and education cess).

Receipt of dividend from foreign company

Another issue is in connection with receipt of dividends from a specified foreign company (Indian company holds 26% or more). The dividends received from a specified foreign company are taxed @15% (plus applicable surcharge and cess) and would continue to be taxed in the same manner. Currently, dividends so received are reduced while calculating the DDT on the dividend declared by the Indian company. Since the dividends would now be taxed in the hands of the recipient, no such benefit would be available for dividends received by an Indian company from a specified foreign company.

Conclusion:

On one hand, abolition of DDT will increase the attractiveness of the Indian equity markets and will provide relief to a large class of investors. On the other hand, it will result in heavy compliances on the part of companies to deduct tax at source on payment of dividends to its resident as well as non-resident shareholders. We would have to wait and watch if the open issues are addressed before the Finance Bill becomes an Act or whether it will lead to increased tax in few cases.

Only time can tell whether abolition of DDT is a happy ending or commencement of additional hassles?

Authors:  Shripal Lakdawala is Partner, Pushkar Khire is Director, and Ankit Panchal is Manager with Deloitte Haskins and Sells LLP.