In India, there are numerous instruments available for an investor wherein he can park his fund and reap a bonus/reward. Depending on the type of instrument, this bonus/reward has been named differently. When the investment instrument is debt, the bonus/reward is termed as interest and when it is equity, it is referred to as dividend.

There has been much debate on the tax treatment of dividend earnings.

At the first instance, they were taxed as a part of the total income of the shareholder; however, due to reasons of revenue leakage and for easier single point collections, a new method of taxing dividend was introduced (by The Finance Act, 1997).

Again this new method was abolished (by The Finance Act, 2002) and the earlier method was re-introduced with some amendments.

Dividends

Once again, the older practice (as introduced by The Finance Act, 1997) was re-introduced with amendments (by The Finance Act, 2003).

In the recent Budget (2020), as well, there has been a considerate switch in the system of taxing dividends.

In this article, we shall be focusing on the pre-budget and the post-budget methods of taxing dividends, the reasons for such changes and their allied implications.

THE PRE – BUDGET 2020 SCENARIO

Section 115-O of the Act, provides that, in addition to the income tax chargeable in respect of the total income of a domestic company, any amount declared, distributed or paid by way of dividends shall be charged to additional income tax @15%* (plus applicable surcharge and health & cess)

The tax so paid by the company (called Dividend Distribution Tax or DDT) is treated as the final payment of tax in respect of amount declared, distributed or paid by way of dividend.

The government followed the above practice citing the reason that it was easier to collect tax at a single point i.e. from the company rather than to collect it from the shareholders individually.

*{Section 115-O(1B) provides that dividend, referred above, shall be grossed up to such an amount that after deducting the DDT on such grossed up amount, the resultant figure is the amount of dividend distributed.

So, if the dividend of Rs. 100 is to be paid, then Rs. 100 -shall be increased to such an amount;

-as would after reduction of tax on such increased amount; -@15%

-would be equal to dividend of Rs. 100 distributed.

If the dividend is Rs. 100, then

100 x [100% ÷ 85%] = 117.64706

The rate of 17.64706% shall be increased by surcharge of 12% and health and education cess of 4%. Therefore the effective rate of DDT is 20.555%}

Such dividend is exempt in the hands of shareholders by virtue of Section 10(34) of the Act.

However, The Finance Act, 2016 introduced Section 115BBDA which provided that if total dividend received is in excess of Rs. 10 lakh by a shareholder (except domestic companies, non residents, foreign companies and religious and charitable trusts), then such dividend is taxable in the hands of shareholder @10% and the company also pays DDT under Section 115-O on such dividend.

[This was done to rationalize the tax provisions as the richer are liable to pay tax @30% (plus applicable surcharge and cess), however, the DDT rate was 15%* (*grossed up rate 20.555%). Thus, to ensure fair revenue collections, an additional tax @10% under 115BBDA was introduced for dividends received by an individual of over Rs. 10 lakh as this, if would have been taxed in the hands of the individual, otherwise, would have made him to pay the tax in the highest bracket i.e. 30% (plus applicable surcharge and cess)].

Let’s now understand the pre-budget status in the hands of an individual through an illustration.

Situation Tax Implication on
the Company
Shareholding and Dividend
received by Shareholder (Mr. X)
Tax Implication on the
Shareholder (Mr. X)
Situation
I. Dividend of Rs. 1,000 distributed by the company A in the year 2019

(Rs. 10 per share on its 100 shares)

Rs. 206 (approx.)

Notes:

Tax @ 20.555%* on Rs. 1000 shall be paid by the company as DDT.

No. of Shares Dividend Amount NIL

Notes:

Exempt by virtue of Section 10(34).

50
shares
Rs. 500
(Rs. 10 x 50 shares)
 

II. Dividend                of   Rs.
1,00,00,000 paid by Company               A the
year 2019 (Rs. 1,000 per share on its 10,000 shares)

Rs. 20,55,500

Notes:

Tax @ 20.555%* on Rs. 1,00,00,000 shall be paid by the company as DDT.

No. of Shares Dividend Amount Rs. 20,800

Notes:

Exempt up to Rs. 10,00,000 under section 10(34).

Tax @10% (+4% health & education cess) payable under Section 115BBDA on dividend received over Rs. 10 lakh.

1200 shares Rs. 12,00,000 (Rs. 1,000 x 1200
shares)
III.

Dividend                of  Rs. 10,00,000 paid by Company A, B and C each in the year 2019

(Rs. 100 per share on their 10,000 shares each)

Rs. 2,05,550 each

Notes:

Tax @ 20.555%* on Rs. 10,00,000 shall be paid by each company A, B and C as DDT respectively.

No. of Shares Dividend Amount Rs. 20,800

Notes:

Exempt up to Rs. 10,00,000 under section 10(34).

Tax @10% (+4% health & education cess) payable under Section 115BBDA on dividend received over Rs. 10 lakh.

3000
shares
of Co. A
Rs. 3,00,000
(Rs. 100 x 3000 shares)
5000
shares
of Co. B
Rs. 5,00,000
(Rs. 100 x 5000 shares)
4000
shares
of Co. C
Rs. 4,00,000
(Rs. 100 x 4000 shares)

THE POST – BUDGET 2020 SCENERIO

Currently in the case of dividends, the incidence of tax is on the payer company and not on the recipient, where it should normally be.

The Finance Bill, 2020 suggested that the dividend is income in the hands of the shareholders and not in the hands of the company.

The incidence of the tax should therefore, be on the recipient.

Moreover, the present provisions levy tax at a flat rate on the distributed profits (dividends), irrespective of the marginal rate at which the recipient is otherwise taxed.

The provisions are hence, considered, iniquitous and regressive.

Further, the present system of taxation of dividend in the hands of company was reintroduced by the Finance Act, 2003, since it was easier to collect tax at a single point and the new system was leading to increase in compliance burden. However, with the advent of technology and easy tracking system available (i.e. TDS), the justification for current system of taxation of dividend has outlived itself.

In view of above, The Finance Act, 2020 amended the provisions with regard to dividends and provided that dividends shall be taxable in the hands of shareholders at the applicable rates (slab-wise) and the domestic company shall not be required to pay any DDT.

The amendment, thus, abolished Dividend Distribution Tax (DDT) as provided under section 115-O w.e.f. 1st April, 2020. The dividends received are now to be taxed as income of the shareholder as per respective individual slab rates applicable to them.

Let’s now have a look at the respective section wise changes that are made effective by The Finance Act, 2020:

S. No. Section Amended Effect of the Amendment
1. 115-O  [DDT] This shall now be applicable to dividends declared, distributed or paid by a domestic company on or before 31st March, 2020 only.
2. 10(34) [Exempts     dividend in the          hands of
shareholders]
This shall not apply to any income, by way of dividend, received on or after 1st April, 2020.
3. 115BBDA

[Taxes dividends    in excess of Rs. 10 lakh in the hands of
shareholders @10%]

This shall now be applicable to dividends declared, distributed or paid by a domestic company on or before 31st March, 2020 only.
4. 194  [TDS on Dividend] Earlier, as the dividends received (under Section 115-O) were tax exempt in the hands of shareholders, no TDS was deducted on such dividend distributed. However, The Finance Act, 2020 has now made dividends taxable in the hands of shareholders and thus, TDS provisions have been made effective. TDS @10% shall now be deducted by the company, on dividends distributed of any amount in excess of Rs. 5,000 to its shareholders. No TDS shall be deducted up to threshold provided of Rs. 5,000.
5. 195

[TDS on Dividend for Non-Residents]

As stated above, as dividend was tax exempt in the hands of shareholders, no TDS was applicable. However, from now on, TDS shall be deducted on dividend payments to the Non-Residents. The exemption provided earlier in the section has been deleted.
6. 57 [Deductions] Any expense incurred on earning exempt income is not deductible. Thus earlier, the interest paid to banker on loans taken for investment in dividend reaping securities was not deductible. However, as the dividends are now no longer tax exempt in the hands of shareholders, The Finance Act, 2020 has now allowed deduction of such interest expense up to 20% of such dividend income which is included in the total income of the shareholder in a financial year without any deduction under this section.

Let’s now understand the post-budget status in the hands of an individual through an illustration.

Situation Tax Implication in the hands of the Company Shareholding and Dividend
received by Shareholder (Mr. X)
Tax Implication in the hands of the  Share holder (Mr. X)
I. Dividend of Rs. 1,000 distributed by the company A in the year 2019

(Rs. 10 per share on its 100 shares)

NIL

Notes:

1. DDT has now been abolished. Thus, no tax shall be paid by the company.

2. No TDS shall be deducted on dividend  distributed to Mr. X and  others (as per Section 194) as the amount of dividend is less than Rs.5,000

No. of Shares Dividend Amount The amount of Rs. 500 shall be included in Mr. X’s total income and shall be chargeable to tax (as per slab rate applicable) as income under head other sources.

Notes:

Exemption under Section 10(34) has been removed.

50
shares
Rs. 500
(Rs. 10 x 50 shares)
 

II.

Dividend of Rs.  1,00,00,000 paid by  Company A on 10th  April, 2020 (Rs. 1,000 per share on its 10,000 shares)

NIL

Notes:

1. DDT has now been abolished. Thus, no tax shall be paid by the company.

2. TDS @10% shall be  deducted by the company on dividend  paid to Mr. X (and others, if applicable) in excess of Rs. 5000 (as per Section 194). Thus, Rs. 1,20,000 shall be deducted before payment to Mr. X.

No. of Shares Dividend Amount The amount of Rs. 12,00,000 shall be included in Mr. X’s total  income and shall be chargeable to tax (as per  slab rate applicable) as income under head other sources.

Notes:

1. Exemption under Section  10(34) has been removed

2. Section 115BBDA shall not be applicable on dividends  received after 31st March, 2020

3. TDS deducted can be adjusted by Mr. X while filing income tax return /payment of tax against his total income.

1200 shares Rs. 12,00,000

(Rs. 1,000 x 1200
shares)

III.

Dividend of Rs.  10,00,000 paid by  Company A, B and C each on 2nd May, 2020  (Rs. 100 per share on their 10,000 shares  each)

NIL

Notes:

1. DDT has now been  abolished.  Thus, no tax shall be paid by the company A, B and C.

2. TDS @10% shall be  deducted by each company A, B and C on dividend paid to Mr. X (and others, if  applicable) in excess of Rs. 5000 (as per Section 194). Thus Rs. 30,000,  Rs. 50,000 and Rs. 40,000 shall be deducted before payment by each  company A, B and C respectively to Mr. X..

No. of Shares Dividend Amount The amount of Rs. 12,00,000 shall be included in Mr. X’s total income and shall be chargeable to tax (as per slab rate applicable) as income under head other sources.

Notes:

1. Exemption under Section 10(34) has been removed.

2. Section 115BBDA shall not be applicable on dividends received after 31st March, 2020.

3. TDS deducted can be adjusted by Mr. X while filing income tax return /payment of tax against his total income.

3000
shares
of Co. A
Rs. 3,00,000
(Rs. 100 x 3000 shares)
5000
shares
of Co. B
Rs. 5,00,000
(Rs. 100 x 5000 shares)
4000
shares
of Co. C
Rs. 4,00,000
(Rs. 100 x 4000 shares)

In a nutshell, the entire system of taxing dividend earnings has once again been switched to that done by The Finance Act, 2002.

The shareholders are made responsible for paying taxes as per their respective applicable slab rates and the companies have been made free from the statutory requirement of paying DDT. However, they have now been obligated with the responsibility of deducting TDS on such dividend distribution as per the necessary applicable provisions.

The above change has been made by The Finance Act, 2020 on the premise that the earlier system (DDT) was regressive and iniquitous.

The incidence of tax, under the direct taxes, shall always be on the recipient of such income and not on the payer.

Thus, the amendment made is valid, keeping in view, the fundamental aspect of direct taxes.

Author Bio

Qualification: CA in Practice
Company: U J & CO.
Location: Delhi NCR, New Delhi, IN
Member Since: 29 Apr 2020 | Total Posts: 13
A first class commerce graduate from Delhi University, a Company Secretary and a practicing Chartered Accountant. Also a Co-Founder at UJ LEGAL LLP and Content Writer at TaxGuru. View Full Profile

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5 Comments

  1. V Seetha Rama Murthy says:

    Good presentation on DDT., latest direction to companies to effect TDS @10% ( >5000/-)and said dividend is chargeable in the hands of share holder. Satisfactory presentation.

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