To provide some relief to India Inc., Finance Minister Nirmala Sitharaman has proposed the abolition of Dividend Distribution Tax (DDT) in her Budget Speech of 1 February 2020. Even the Task Force constituted by the Government to draw new direct tax laws had recommended the removal of DDT.
DDT is currently levied at an effective rate of 20.56% on the dividend declared and distributed by an Indian company. This is in addition to the income-tax paid by a company on its net profits. Such dividend income is exempt in the hands of the shareholders, except a certain category of resident individual shareholders who pay an additional tax of 10% (excluding surcharge and cess) on dividend income in excess of INR 1m. In addition, dividend is exempt in the hands of foreign shareholders and DDT is a tax on the Indian company; most foreign shareholders do not get credit of DDT paid by the Indian company in their home country. This fundamentally results in cascading taxation and acts as an impediment.
Given the significance of attracting foreign investments to arrest the domestic slump, abolishing DDT was indeed necessary.
Under the new regime, which would be effective from 1 April 2020, it has been proposed to remove the DDT and adopt the classical system of dividend taxation, under which companies would not be required to pay DDT. The dividend shall be taxed only in the hands of the recipient at their applicable rate as follows:
• For resident individual shareholder: The dividend shall be taxable as per the applicable slab rates. This system of taxation is reflective of the progressive system of direct taxes. Therefore, for an investor whose effective tax rate is below 20%, it would be beneficial; however, individuals who fall under highest bracket of 42.74% would pay significantly higher tax on dividend as compared to DDT at 20.56%, under the current regime.
• For resident corporate shareholder: The dividend shall be taxable as per the applicable tax rates, which would range from 25.17% to 34.94%. In certain circumstances, this could result in higher taxability than the current DDT mechanism.
It is proposed to allow deduction to the Indian company equal to the amount of dividend received from any other domestic company. This is a significant relief in the direction of eliminating the cascading effect of taxes and making an environment conducive to holding structures.
However, note that dividend received from a foreign company would continue to be taxed at applicable rates in the hands of a domestic company and only dividend received from domestic company is sought to be allowed as a deduction.
• For non-resident corporate shareholder: The Indian company shall be liable to withhold taxes at 21.84% on payment of dividend to a non-resident corporate shareholder. This rate could be lower if the benefit under the tax treaty is available to such shareholder. Many tax treaties, including with Singapore, Mauritius, Netherlands, Australia, United Kingdom, USA, provide for a lower withholding tax rate of 5% to 15%. The foreign shareholder will get the credit of such withholding tax against tax payable in their home country. The proposed amendment would boost the sentiment of foreign investors.
One question requiring deliberation is how a listed company, paying dividend to non-resident shareholders, such as FPI and NRI, would obtain the benefit of deducting tax at lower rates.
The illustrative impact on various shareholders is tabulated here:
Note 1- It is assumed that the resident company is availing the benefit of lower corporate tax and is not distributing the dividend further.
The Finance Bill proposes that no deduction shall be allowed on dividend income, except for interest paid up to 20% of such dividend income.
This is a welcome move for Indian companies and their shareholders, as the burden of tax shifts to the shareholder, resulting in surplus funds that could be used for expansion and growth. The proposed amendment would result in renewed interest of foreign investors in the Indian investment landscape, which would help achieve the dream of a US$5tn economy. Some resident shareholders may be adversely impacted by this proposed change; however, it seems the Finance Minister has taken this calculated risk to attract foreign investment.
Although the Budget projects a revenue loss of INR 2,50,000m pursuant to removal of DDT, the additional tax on shareholders could compensate some of this loss.
Author- Alok Saraf, Partner, Deals, PwC India, Bhumika Shah, Manager, Deals, PwC India, Article includes inputs from Mohak Ghelani, Associate, PwC India