Income Tax 01 Feb,2020
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Budget Breaking - DDT Goes Out
Meenakshi SubramaniamFormer IRS Officer

DDT repels mosquitoes as well as companies. Perhaps, that's why Budget 2020 has finally decided to spray DDT out of existence. The Budget has abolished the much-abhorred dividend distribution tax (DDT) on companies. The Budget proposes moving to classical system of taxing dividend in the hands of shareholders/unit holders.

Dividend Distribution Tax (DDT) is the tax levied on dividends distributed by the companies from its profits. Currently, a company pays income tax on its taxable profit. Thereafter, when it distributes the surplus profit to shareholders it needs to pay DDT at 20.56%. Further, tax payers also need to pay additional tax at 10% (plus applicable surcharge and cess) on dividend above 10 lakhs.

There are two visible advantages of DDT abolition. The foreign investment would increase in Indian companies. It will remove the double taxation for resident shareholders and help rationalize the effective tax rate for companies from 37.93 percent to 25.17 percent.

DDT PROVISIONS (EXISTING)

Section 115-O 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 at the rate of 15 per cent. The tax so paid by the company (called DDT) is treated as the final payment of tax in respect of the amount declared, distributed or paid by way of dividend.

Such dividend referred to in section 115-O is exempt in the hands of shareholders under clause (34) of section 10. In case of business trust, specific exemption is provided under sub-section (7) of section 115-O, subject to certain conditions. Similarly, exemption is provided for distributed profits of a unit of an International Financial Service Centre, on fulfilment of certain conditions, under sub-section (8) of section 115-O.

Similarly under section 115R, specified companies and Mutual Funds are liable to pay additional income-tax at the specified rate on any amount of income distributed by them to its unit holders. Such income is then exempt in the hands of unit holders under clause (35) of section 10.

WHY DDT WENT

The incidence of tax is, thus, on the payer company/Mutual Fund and not on the recipient, where it should normally be. 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, across the board irrespective of the marginal rate at which the recipient is otherwise taxed. The provisions are hence, considered, iniquitous and regressive. The present system of taxation of dividend in the hands of company/mutual funds was re-introduced by the Finance Act, 2003 (with effect from the assessment year 2004-05) 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, the justification for current system of taxation of dividend has outlived itself.

DDT NEW PROVISIONS

In view of above, amendments are proposed so that dividend or income from units are taxable in the hands of shareholders or unit holders at the applicable rate and the domestic company or specified company or mutual funds are not required to pay any DDT. It has also been proposed to provide that the deduction for expense under section 57 of the Act shall be maximum 20 per cent of the dividend or income from units.

BENEFITS TO INDIVIDUAL

As the investor will pay the DDT, he or she would know how much his investment earned and how much went into tax outgo. It will bring transparency in one's investment and return.

There were complaints by investors that mutual fund houses deducted more money in the name of DDT while mutual fund houses used to complain that an investor calculates income on the basis of his or her investment and the return he or she has got. As the mutual fund houses used to pay dividends after deducting the DDT, an investor thought that credited amount was as per mutual fund manager's performance, which was incorrect. Now, an investor will know how much returns are generated on the investor's money.

PITFALLS FOR INDIVIDUAL INVESTORS

  •  Shareholders who have been used to enjoying tax-free dividends will find going tough as such dividends will be taxable in their hands.

  •  It will benefit investors in low tax brackets while those in higher brackets have been left worse off.

  •  In addition, TDS will be deducted at 10% for dividends above INR 5,000 in a year.

  •  Section 14A disallowance continues to haunt investors in DDT matters.

In Rajan Bhatia v CBDT ( 261 taxmann 255) it was held by Supreme Court that DDT was constitutionally valid. It was said that DDT was a matter of policy and the court can't comment on it.

Now that DDT has been knocked out, companies can breathe freely. If DDT is completely removed, everyone can breathe easy.