Budget 2020: Government Abolishes Dividend Distribution Tax

In a move that will offer some relief to India Inc., the Narendra Modi-led government eliminated the dividend distribution tax that is levied on dividends issued by companies.

Dividend income will now be taxed only in the hands of investors as per the tax rate applicable to their income, Finance Minister Nirmala Sitharaman announced in her Union Budget 2020 speech. “Further, in order to remove the cascading effect I propose to allow deduction for the dividend received by a holding company from its subsidiary.”

So far, companies were required to pay DDT at 15 percent, though including surcharge and cess put the effective rate at 20.56 percent. DDT was introduced in 1997 at a 7.5 percent flat rate in an effort towards efficient tax collection.

But the DDT rate has increased over the years and the tax has drawn criticism for unfairly burdening companies—for having to adjust payouts for tax liability, as well as shareholders—those who were paying a higher tax rate on dividend income than their overall income. Some have also argued it amounted to double taxation—after paying a corporate tax at 25 percent, the effective tax rate, including DDT, for India Inc. worked out to 48.5 percent.

Worse still, foreign companies received no credit for DDT paid by their Indian subsidiaries.

This will help improve the attractiveness of the Indian market, Sitharaman said. The move will result in an annual revenue forego of Rs 25,000 crore.

Impact

The provisions relating to the abolition of DDT will be effective from April 1.

As per the amendments to the Income Tax Act:

• Dividends declared between April 1, 2003, and March 31, 2020, will be subject to DDT under the old regime, while those declared after April 1, 2020, will be excluded.
• Prior to the abolition, dividends distributed by a domestic company weren’t included in the total taxable income of an assessee. Now, dividends will form part of the taxable income of an assessee under the head “income from other sources”.
• Income distributed by a mutual fund registered with Securities and Exchange Board of India or a specified company after April 1 will be taxable in the hands of the assessee.
• Dividend received by a business trust from a special purpose vehicle will not form part of trust’s taxable income with effect from April 1, 2021. Distribution of income by a business trust will become taxable in the hands of unitholder.
• An Indian company declaring dividends covered under Section 2 of the Income Tax Act must deduct income tax at the rate of 10 percent if the amount distributed exceeds Rs 5,000.

What Analysts Said

The abolition of the DDT, according to analysts, would benefit companies in the long run. “By removing DDT, the quantum of profit available for distribution would get significantly enhanced,” Nand Kishore, partner at DSK Legal, told BloombergQuint.

“By taxing dividend in the hands of the shareholder, double tax avoidance agreement would become applicable in case of a foreign equity investor and the rate of tax would be determined depending on his shareholding and residence. For instance a U.S. company investing in India will be liable to pay dividend tax at 15 percent if its shareholding exceeds 10 percent as per the DTAA (double taxation avoidance agreement),” Kishore said.

“The rate would be 25 percent in case of a lesser holding. Foreign equity investors will get the benefit of credit dividend tax paid in India while filing return in his resident country, which was not available under the DDT regime,” Kishore said.

SR Patnaik, partner and head-taxation at Cyril Amarchand Mangaldas, said the Indian company distributing dividends is also required to withhold tax at 10 percent. “This will enable non-resident shareholders to also (i) claim credit against the tax payable by them in their home country; (ii) apply for a certificate for lower withholding tax in case the applicable DTAA provides for a lower withholding tax. However, it must be noted that most of the DTAAs executed by India provides for a withholding tax of 10 percent.”

Dividends distributed by an Indian subsidiary of a multinational company were subject to DDT in India. Foreign jurisdictions like the U.S., however, didn’t allow any deduction to the MNC for the DDT paid by its Indian subsidiary. This resulted in a cascading effect for such companies as they also paid tax on the received dividend in their home jurisdiction.

Amit Maheshwari, partner at Ashok Maheshwari LLP, said this would benefit multinational corporations as they would be able to take credit in their home jurisdiction for the tax paid in India. “Many existing tax treaties have a 10 percent tax rate while the U.K. and U.S. have a 15 percent tax rate on dividend income,” he said.

“Abolition of DDT will benefit taxpayers as net receipt in their hands after taxes will increase. It will be neutral for taxpayers in 20 percent tax bracket, while taxpayers in the 30 percent tax bracket will have to suffer more tax,” he said.

Watch | Nirmala Sitharaman speaking about the dividend distribution tax in her budget presentation