Income Tax

Taxation of Dividends FY 2020-21

CA Adityavikram Banka

The Budget 2020 has announced to abolish the Dividend Distribution Tax (DDT) payable by Indian Companies and restoring the classical system of Taxing Dividends in the Shareholders’ Hands. This was a much-awaited move and a constant demand by various stakeholders.

  • What is Dividend?

Section 2(35) of the Companies Act, 2013 says ‘Dividend includes interim dividend’. As per generally accepted definition, dividend includes the portion of company’s profit distributed to shareholders in proportion of their paid up capital.

  • What is Dividend Distribution Tax?

Every Domestic Company in India which distributes dividend to its shareholders must pay tax on the dividend. This tax is called Dividend Distribution Tax (DDT). Tax is to be paid @ 15% and effective tax rate amounts to 20.56 % (after including cess and surcharge and grossing up). Provisions of DDT are governed under section 115-O of the Act.

* The Finance Act, 2020 has abolished the dividend distribution tax (DDT).

  • Amendment in Finance Act, 2020 :

Memorandum to Finance Bill proposes for moving towards classical system of taxing dividend in the hands of shareholders/unit holders. The dividend is income in the hands of shareholders and not company. Therefore, the incidence of tax should fall on the shareholders.

• Section 115O, 115R, 115BBDA, 10(34), 10(35) will remain operative till 31 March 2020.

• Section 57 of Act has been amended for capping the deduction of interest paid in earning dividend income to the extent of 20% such income

• Amendment in section 194 to include dividend for tax deduction.

• Amendment in section 194LBA to provide for tax deduction by business trust on dividend income paid to unit holder, at the rate of ten per cent for resident. For non-resident, it would be 5 % for interest and 10% for dividend.

  • Implication of Amendment on Domestic Companies :

• No Obligation to pay DDT, Companies have been relieved from the obligation of paying DDT on dividend declared, distributed or paid.

• Companies will now be required to deduct TDS @ 10% on the distribution of dividend, provided that the dividend paid per recipient exceeds Rs 5,000 in an FY.  TDS will be deducted u/s 194 of the Act.

• Introduction of Section 80M  in Finance Bill 2020, for the sake of avoiding cascading effect on dividend.

• As per section 80M, if domestic company received dividend from another domestic company, then the company receiving dividend can claim deduction of such dividend from its Gross Total Income u/s 80M. However, dividend deduction could be availed if:-

a) Dividend is declared by recipient domestic company to its shareholders at last before 1 month of due date of return filing

b) Amount of dividend is limited to dividend received or dividend declared by it, whichever is lower.

  • Implications of Amendment on Shareholders :

• Shareholders need to pay Income Tax on Dividends, which ranges from 0% (Nill) to 43%, depending on their slab rates.

• Abolition of DDT is disadvantageous to High Income Tax payers- Tax Payers receiving dividend and falling under lower tax rate structure would benefit from abolition of DDT. However, Promoters/Taxpayers falling under higher income group would have to pay taxes on dividend., which ranges from 34% to 43%, depending on their slab rates.

• One alternative of avoiding high tax obligation in the hands of shareholders on account of dividend distribution could be buyback of shares. As per section 115QQA of the Act, companies going for buyback of shares would have to pay tax @ 23.3% [20% + 12% (surcharge) + 4% (cess)] on buyback consideration. Though this route is beneficial for promoters in terms of tax savings, however it results in dilution of promoters’ shareholding in the Company.

  • Implications of Amendment on Tax cost of Foreign Companies :

a) Scenario Prior to Amendment :

In the existing dividend taxation system, dividend received by NRI Investors and foreign companies from domestic companies is exempt from tax u/s 10(34) in India. However, such dividend income becomes taxable in their home country. Moreover, these foreign investors do not get any tax credit of DDT paid on their dividend by the domestic companies. Thus, foreign investors end up paying taxes on dividend income in their home country, without getting any tax credit of DDT paid in India.

b) Scenario Post Amendment :

With the advent of new system, exemption u/s 10(34) is withdrawn and dividend income is now taxable in India in the hands of foreign investors @20% (plus tax plus surcharge) as per amended section 115A of the Act. But unlike before, non-resident shareholders can avail credit of tax paid in India in their home country. Moreover, Tax rate on dividend defined in Article 10 of Double Taxation Avoidance Agreement ranges between 5%-15% with most of the countries.

CA Adityavikram Banka
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