The Indian Finance Minister (FM), Nirmala Sitharaman presented the Union Budget of India for financial year (FY) 2020-21 on 1st February, 2020. One of the biggest announcement was the removal of Dividend Distribution Tax (DDT) of effective rate of 20.56% which was being paid at the company’s level. The Budget proposes taxation of dividend in the hands of the recipient.
As a part of the Direct Tax Practice, our Firm is pleased to share with you a comprehensive analysis (as given here under) of the provisions in connection with taxation of dividend effective 1st April, 2020.
Presently, dividends distributed by a company are subject to Dividend Distribution Tax (DDT) at the rate of 15% plus applicable surcharge and cess, i.e. an effective rate of 20.56%.
Levy on post-tax income of the Company
DDT is levied after the company has already suffered corporate tax on its profits. Such dividend is however exempt in the hands of shareholders up to Rs 10,00,000.
No credit of DDT
DDT caused tax burden as neither the company nor its shareholders could claim credit of the DDT paid by the company against the tax payable by them. This is due to the fact that this income from the securities does not get taxed in their own hands, thus preventing them from claiming Foreign Tax Credit (FTC) in their home country.
Double taxation in case of inter corporate dividends
There was also a cascading effect of taxation particularly in case of holding-subsidiary structures because the dividend paid by the subsidiary company to the holding company had to be clubbed as a part of income of subsidiary company despite the holding company already paying DDT on post tax profits. This resulted in double taxation on the same income.
Additional 10 % tax on dividend in excess of 1 million
In addition to the corporate income-tax paid by the company and the DDT paid by the company. There is also 10% tax levied on income in excess of INR 1 million (Rupees 10 lacs) earned by certain specified classes of taxpayers by way of dividend.
No taxation in hands of Real Estate Investment Trusts / Infrastructure Investment Trusts and its unit holders
REITs/InVITs receiving dividend from investee company (subject to conditions) are exempted from DDT and unitholders of such REITs/InVITs are also not taxed.
Changes proposed under the Budget
Abolition of DDT
The Budget proposes to abolish the DDT. The Company paying dividend would however deduct tax at source at the rate of 10%.
Taxed in the hands of domestic investors
Dividend / Income distributed by mutual funds shall be taxed in the hands of shareholders / unit holders of mutual funds, as the case may be at the applicable maximum tax slab rates. With effect from April 1, 2020, dividend income shall be chargeable to tax as “income from other sources” under Section 56 of the Income Tax Act.
An additional tax of 10% on dividend above Rs. 10 lacs has been done away with.
Taxation in case of foreign resident investors and claiming credit
The dividend earned by foreign investors would be taxed at 20% (plus surcharge and cess) or at such beneficial rates as provided under the tax treaties. The company paying dividend would withhold tax at source, at applicable rates.
The foreign investors will now be eligible to claim a credit in their home jurisdiction for the tax paid on dividends.
Relief in case of inter-corporate dividends
Where the gross total income of a domestic company in a particular year includes any income by way of dividends from any other domestic company, the total income of the first company shall be computed after deducting an amount equal to the amount of dividend income received from the other domestic company, provided that such dividend is distributed on or before one month prior to the due date of filing of return of income.
Dividends received by an Indian company from specified foreign subsidiary companies continue to remain taxable at 15% in the hands of the Indian company.
Taxation of dividend received by unit holders of REIT / InVITs
The budget has taken away exemption in the hands of unit holders of such REITs/InVITs, and they would be subject to tax. This would reduce effective yield in the hands of such unit holders.
Abolition of DDT will ultimately result in greater returns for foreign equity investors. The provisions are particularly beneficial for shareholders residing in countries with which India has executed tax treaties, where dividends are taxed below the 20% rate. The beneficial tax treaty provisions would however be subject to the anti-abuse provisions of the India income-tax law and provisions of Multilateral Instruments which is effective from 1 April 2020.
Taxation of dividends in the hands of non resident recipient is beneficial in a way that it ensures the availability of foreign tax credit in the state of residence of the recipient against the tax payable on distributed income received.
For domestic investors however the same is not equally beneficial. An individual shareholder whose effective rate of tax (ETR) is 20% or less would be better off whereas an individual recipient whose ETR is as high as 43% would end up paying higher tax. The effective tax rate for individuals falling in the highest tax slabs is 42.74 per cent i.e. there will be an additional burden of 28.492 per cent.
Tax rate in tax efficient jurisdictions ranges from 5-15%. This discrimination between resident and non-resident investors, does not create a level playing field for on-shore and off-shore investors, and may discourage resident Indian investors.
Promoters who want to set up trusts as investment holding vehicles and accordingly want to move their shareholding into a trust would have to re-evaluate as to whether a corporate holding structure, LLP or a trust is the more appropriate vehicle. In particular, in case of Discretionary Trusts where the income is taxed on the basis of Maximum Marginal Rate (MMR) as applicable to the beneficiaries, (i.e. highest rate of tax which is applicable to an individual).