While drastically changing the erstwhile provisions regarding taxability of Dividend Income, there remains an anomaly in relation to cascading effect scenario. The same is dealt hereunder:
In the erstwhile provisions, to avoid cascading effect (i.e. multi-level taxation of same dividend income), the tax rate u/s 115O was calculated on the amount of dividend distributed as reduced by the amount of dividend, if any, received by the domestic company during the financial year, if such dividend is received from its subsidiary and, the subsidiary has paid the tax on it. Accordingly, the tax rate was calculated on net amount of dividend i.e. after reducing dividend from subsidiary co.
However, as per Finance Act, 2020, to avoid cascading effect (i.e. multi-level taxation of same dividend income), the new section 80M has been inserted as under:
80M(1): Where the gross total income of a domestic company in any previous year includes any income by way of dividends from any other domestic company or a foreign company or a business trust, there shall, in accordance with and subject to the provisions of this section, be allowed in computing the total income of such domestic company, a deduction of an amount equal to so much of the amount of income by way of dividends received from such other domestic company or foreign company or business trust as does not exceed the amount of dividend distributed by it on or before the due date.
After carefully analysing the cascading effect scenario under erstwhile provisions vis a vis new provisions, there can be a situation where the company will actually suffer from cascading effect in case the company is having brought forward business loss/unabsorbed depreciation under Income Tax and no resultant Gross Total Income will be left over to actually claim deduction u/s 80M of the IT Act. In such a situation, the brought forward business loss/unabsorbed depreciation which was otherwise available for set off under the erstwhile provisions of law will no longer be available for set off, to the extent of dividend received from subsidiary, since that would be first adjusted before deduction u/s 80M.
Further Amendments of Dividend Income while passage of FA Bill, 2020:
The Finance Bill, 2020 was passed by the Lok Sabha on March 23, 2020, with more than 50 amendments to the Bill. The Bill later received the presidential assent and has become an Act (“Finance Act”). The new provisions proposed by the Bill, for taxing dividends have also been amended to expand the scope of certain benefits and to provide more clarity surrounding the applicability of these provisions. With this write up, I would like to discuss changes pertaining to taxation of dividends.
As per the erstwhile section 115-O of the Income-tax Act,1961 (“IT Act”), distribution of dividends by a domestic company was subject to an additional income tax, called Dividend Distribution Tax (“DDT”), in the hands of the company at an effective rate of 20.56% (inclusive of the applicable surcharge and cess). Such tax was treated as the final tax on dividends and the dividends were generally exempt from any further incidence of tax in the hands of the investors. Further, in order to reduce the cascading effect of DDT, domestic companies while computing the amount of dividends on which DDT is paid were allowed a deduction for dividends received from its subsidiary (i.e. where the company holds more than 50% of the shareholding of the subsidiary), provided DDT was paid by the subsidiary during the same financial year. Similar deduction was also available on account of dividends received from a foreign company on which tax was payable by the domestic company under section 115BBD of the IT Act, provided the domestic company held at least 26% equity shareholding in the foreign company.
Pursuant to various representations made, the Bill had proposed to abolish the DDT regime and re-introduced the classical system of taxing dividends, wherein the shareholder is liable to pay tax on such dividends. Simply put, DDT will not be payable in respect of dividends declared, distributed or paid by a domestic company after March 31, 2020, and such dividends will be taxed in the hands of the shareholders. In line with the erstwhile provisions, the Bill had also proposed to introduce a deduction for dividends received by one domestic company from another domestic company, in computing the total income of the shareholder company. This deduction was proposed to be limited to the amount of dividend distributed by the investor company before the due date i.e. one month prior to the date of furnishing the return.
However, no such deduction was proposed in the Bill in relation to the dividends received from a foreign company or dividend distribution received from a business trusts (i.e. REITs and InvITs), thereby leading to double taxation of such dividends i.e. once in the hands of the domestic company receiving such dividends and secondly, in hands of its shareholders. To remedy this situation, the Finance Act, in addition to allowing for the aforementioned proposals, has also extended this deduction in respect of dividend income received from foreign companies and business trusts.
It will be pertinent to note that unlike the erstwhile provisions, where the deduction for dividends received from a subsidiary or a foreign company was contingent upon the domestic company holding a specified percentage of shares in the subsidiary or the foreign company, the proposed provisions provides this beneficial deduction, irrespective of the percentage of shareholding.
The Finance Act has also exempted unit holders from taxation of distributions of dividend received by a business trust. Under the erstwhile regime, dividends distributed by the special purpose vehicle, where the business trust holds the entire equity shareholding (subject to certain exceptions), out of its current income, were not subject to DDT. Such dividends were treated as pass through income in the hands of the business trust and were also exempt in the hands of the unit holders. However, the Bill had proposed to abolish the DDT regime, and it was proposed that the dividend income distributed by a special purpose vehicle, where the business trust holds a majority interest (subject to any threshold prescribed in the relevant regulations), will be treated as pass through income in the hands of the business trust and the same will be taxed in the hands of the unitholder. Additionally, the business trust would be required to withhold tax at the rate of 10% on such distributions to both residents and non-residents unitholders.
The Finance Act, in addition to accepting the aforementioned proposals, has exempted the dividend distributed by the business trust in the hands of the unit holders, provided the special purpose vehicle distributing the dividends has not opted to be taxed under the recently introduced 22% tax regime under section 115BAA of the IT Act. Further, the Finance Act has also made corresponding amendment to section 194LBA, dealing with the withholding tax obligations on distributions made by the business trusts. It would be relevant note that unlike the erstwhile regime, where all kinds of dividends distributed by business trusts were exempt, the amended provisions extend this exemption to only those cases where the special purpose vehicle has not opted for the 22% tax regime.
The Bill had proposed to levy withholding tax on dividends being paid to both resident and non-resident shareholders. It was proposed that dividend income would be taxed in the hand of the non-resident shareholder at the rate of 20% (plus applicable surcharge and cess), while the tax was required to be withheld on such dividend paid to non-resident shareholder at ‘rates in force’, which as per the First Schedule of the Bill was 30% / 40% (plus applicable surcharge and cess), subject to any treaty relief. This mismatch in the withholding tax rate and the rate of taxation would have caused undue hardships for non-resident shareholders. To address this issue, the Finance Act, while allowing the aforementioned proposal has made relevant amendments to provide a uniform withholding tax rate of 20%.
When the Finance Minister had introduced the proposal to abolish DDT and tax dividend in the hands of shareholders, various companies were contemplating declaring dividends before the proposed provisions came into effect. However, as per the literal interpretation of the proposed provisions, there was a view that the dividend declared by companies before March 31, 2020, may be subject to double taxation. This was because as per the provisions proposed by the Bill, only dividends declared, distributed or paid on or before March 31, 2020, would be subject to DDT. Further, it also proposed that any dividend received on or after April 1, 2020, would no longer be exempt in the hands of the shareholder. Thus, in the event a company declared dividend before March 31, 2020, and the same was received by the shareholders after April 1, 2020, such dividend could have been subjected to double taxation both in the hands of the company (as DDT) and in the hands to shareholders. Now, the Finance Act, has clarified that dividend received by shareholders on or after April 1, 2020, shall not be included in his/her income if tax has already been paid on such dividends by way of DDT.
These amendments play a big role in casting away the ambiguity surrounding the applicability of the newly proposed provisions. Further, they instil investors’ confidence in the new mechanism of taxing dividends by proposing to re-introduce the existing benefits available to various stakeholders. Considering the current economic scenario and uncertainties surrounding COVID-19, these amendments provide a ray of sunshine to the investors and other capital market stakeholders.