New Dividend Taxation Regime: A Compliance Nightmare For Companies
Before April 1, 2020, Indian companies were required to pay Dividend Distribution Tax at an effective rate of 20.56 percent on dividends declared and distributed by them. Consequently, the dividend was exempt in the hands of the shareholder—residents as well as non-residents. From a compliance perspective, the government was able to collect dividend tax from one source i.e. companies and even for companies it was not a compliance burden at all.
What Has Changed?
However, Indian Finance Act 2020 has abolished Dividend Distribution Tax and, with effect from April 1, 2020, dividends declared by Indian companies would be taxable in the hands of shareholders. For resident shareholders, dividends would be taxed in their hands based on tax rates they are governed with. Companies will have to deduct or withhold tax at 10 percent for dividends paid to these resident shareholders.
For non-resident shareholders—foreign shareholders, portfolio and institutional investors and even individuals (including NRIs)—the said dividend would be taxable in India either at the rates prescribed under the Indian tax laws or relevant tax treaties, whichever is beneficial to the taxpayer.
As per the current law, a tax rate of 20 percent (plus applicable surcharge and cess) is provided under the Indian local laws for dividends paid to non-residents or foreign companies. However, the tax treaties provide for lower rates, in the 5-25 percent range, depending on the shareholding percentage and country of the investor.
The tax rates provided in few prominent tax treaties are as follows:
Why This Is A Big Hassle
For determining the withholding tax rate or TDS to be deducted for dividends payable to non-residents and foreign companies, the Indian listed company would have to determine which country the shareholder is tax resident of and whether he is the beneficial owner of the shares or not. It would not be out of place to mention that determining tax residency is not as straight forward as it may seem. The shareholders would have to provide a Tax Residency Certificate which is obtained by them from their tax authorities in the home country to the Indian company in order claim the lower withholding tax rate under the treaty. Similarly, a declaration of beneficial ownership would also have to be obtained by the Indian company from each shareholder.
In addition to these, Indian companies would also have to see the applicability of Multilateral Instrument provisions which are effective from April 1, 2020. The MLI is a convention and instrument designed and negotiated by over 100 countries to implement tax treaty related changes to prevent base erosion and profit shifting. The MLI will apply alongside a tax treaty and modify its application by allowing participating jurisdictions to adopt the BEPS recommendations without having to renegotiate each relevant treaty.
For instance, as an anti-abuse measure, the MLI provides for a minimum shareholding period of 365 days, in order to grant the benefit of favourable tax rates provided under the tax treaties. Currently, the impacted Indian tax treaty countries are Canada, Denmark, Serbia, Slovakia and Slovenia.
Hence in addition to above tax residency certificate and beneficial ownership, Indian companies declaring dividends to shareholders of these countries would also have to check the period of holding for giving the benefit of reduced rate under the tax treaty.
A listed Indian company with large shareholder base would likely have thousands, if not lakhs, of non-resident shareholders. For each shareholder, the company has to determine the right withholding tax rate based on the tax treaty and collect all the requisite documents for applying the tax treaty rate. To add icing to the cake, all this has to be determined based on shareholders on the record date. This would result in lot of paperwork and time and efforts on the part of the Indian companies.
Is There An Easy Way Out?
The alternative would be for companies to withhold tax at a 20 percent rate plus surcharge and cess—which, of course, won’t be acceptable to shareholders, especially large foreign institutions.
In case the company still withholds the tax at 20 percent + surcharge and cess and not the lower or beneficial rate under the tax treaty, the non-resident shareholder or FPI would not be able to claim credit for such excess tax in their home country. Their only option would be to file a tax return in India and claim the excess tax that were withheld as refund from the Indian government. For small shareholders where the dividend income is paltry, this option is not practically feasible, and such excess withholding tax would end up as a tax cost to them.
Is There More Paperwork?
The current law mandates that any payment to a non-resident would require a Chartered Accountant’s certificate in Form 15 CB. Along with the form 15CB the company would also be required to file a self declaration in Form 15CA. The Form 15CB is not required in cases where the payments to that shareholder would be less than Rs 5 lakh during the financial year.
The company will have to exercise its judgement in case of payment of the first dividend for the year whether there would be further declarations during the year and whether such dividends would exceed Rs 5 lakh for each shareholder. Then, these forms have to be uploaded on the Indian income tax portal.
Based on publicly available data on shareholding patterns of various listed companies it can be seen that they have anywhere between 1,000 to 50,000 non-resident or FPI shareholders.
This would result in companies having to generate and file thousands of 15CA/15CB forms whenever dividend is declared.
The entire process of dividend payment has become cumbersome and time-consuming for listed companies as they would have large number of non-resident shareholders. The government should look into this issue and provide for a simplified process, including the possibility of reducing the withholding tax rate—in line with withholding tax rate for residents—on a blanket basis for payments of dividends by listed company.
At the same time, listed companies in India should to brace for the reality and prepare for compliance. They must rely on automated tools rather than doing all this manually, to ensure that compliances are done in time and are also error-free.
Maulik Doshi is Senior Executive Director at Nexdigm (SKP).
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.