The Finance Minister has announced the Union Budget 2022 with renewed focus on making India resilient and better digital prowess. Amongst the amendments proposed in the Finance Bill towards various objectives, one of the measures to augment tax revenue of the Government is the proposed withdrawal of the concessional tax regime for foreign dividends.
Section 115BBD of the Income Tax Act, 1961 (‘the Act’) provides for a concessional tax rate of 15% in case of dividend received by an Indian company from a foreign company in which the said Indian company holds 26% or more of the nominal value of equity shares (‘specified foreign company’). This tax rate was at par with the tax rate of the erstwhile Dividend Distribution Tax (‘DDT’) levied under the provisions of section 115-O of the Act.
The Finance Act, 2020 abolished the DDT and moved towards the classical system of taxation wherein dividend is presently taxed in the hands of the shareholders at applicable rates plus surcharge and cess.
In order to provide parity in the tax treatment in case of dividends received by the Indian companies from specified foreign companies vis-à-vis from the Indian companies, the provisions of section 115BBD is proposed to be discontinued from assessment year 2023-24 onwards.
Since under the Foreign Exchange Outbound Investment regulations, LLPs and partnership firms are also eligible to make outbound investments, there has been a logical expectation of a similar concessional tax rate of 15 % on the foreign dividends which may accrue to partnership firms/LLPs from their foreign investments. However, the Government perhaps had a different intent – understandably an intent to minimize avenues of tax generosity to meet the end of fiscal objectives.
In light of the above amendment, dividends from foreign companies will now be taxed at the applicable corporate tax rate to the Indian companies adversely impacting the effective tax rate of the Indian companies having an equity stake of 26 % or more in overseas companies. The corporate tax rates range from 15 to 30 % (plus surcharge and cess) depending on the type of company.
The Indian companies or start-ups planning global expansion may have to rethink and re-evaluate their group structures and returns while expanding their business operations overseas. The proposed amendment may to some extent impact India outbound structures, compelling such business groups with profitable foreign operations to relocate their headquarters to certain geographies which have Nil or low dividend tax rates or to some jurisdictions which grant participation exemption subject to certain criteria. In summary, the abolition of the concessional tax rate on foreign dividends would be a consideration point for India outbound investments.
The withdrawal of the tax concession may, to some extent, discourage repatriation of profits back into India which may indirectly impact the forex inflow of the country too.
It is important to note a possible sweet spot arising out of this proposed amendment. With the amendment in place, there is a perceived relief in terms of claiming of expenses incurred for the purpose of earning foreign dividends, as the erstwhile provisions under section 115BBD of the Act provided for taxability on gross basis without allowing deduction of any expenditure.
Therefore, the assessee can claim the deductions of all those expenses which have been incurred to earn that dividend income such as collection charges, interest on loan etc, in case of dividends being assessable to tax as business income. On the contrary, if dividend is taxable under the head ‘Income From other sources’, the assessee can claim deduction of only interest expenses which has been incurred to earn that dividend income to the extent of 20 % of total dividend income.
Companies claiming deduction under section 80M may not be impacted by this amendment to the extent of the quantum of deduction claimed. The deduction under section 80M may nullify the impact of the proposed amendment. This may in turn result in the tax cost of repatriation of the funds back into India remaining unchanged in situations where the dividends so received by the Indian companies are further distributed to its shareholders within specified timelines (before filing the tax return).
To consider holistically, though this proposed amendment may increase the tax cost for Indian companies earning foreign dividend, it brings in uniformity as regards taxability of dividend income.
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Authors: Zainab Bookwala is a Senior Manager with Deloitte Haskins and Sells LLP & Prachi Shah is a Deputy Manager with Deloitte Haskins and Sells LLP.
