Return of the “classical system” of dividend taxation in Union Budget 2020
The highlight of the Budget amendments in direct taxes is the abolishment of the dividend distribution tax (DDT) regime and the reintroduction of the classical system of dividend taxation.
The current DDT regime provides the following:
• A DDT of 20.56% is paid by Indian companies declaring dividends;
• While calculating the DDT, the dividend received from a subsidiary company is reduced from the dividend distributed by the holding company;
• Specified recipients of dividends including resident individuals, partnerships, etc., receiving dividends exceeding Rs. 1m are required to pay tax of 10% (plus applicable surcharge and cess).
This DDT regime created a hurdle in the movement of funds and treasury management within corporate groups. Companies which generated funds paid DDT while distributing dividend, which resulted in tax costs for transferring such funds, especially for businesses like infrastructure/real estate/power/others, where special purpose vehicles are required for each project.
In Union Budget 2020, the Finance Minister has reintroduced the classical system of taxing dividends by taxing dividends in the hands of the recipient at their applicable tax rates. In the case of corporate recipients, dividend will be taxable at 30%, 25% or 22% (plus applicable surcharge and cess) as the case may be. Dividend will be taxable in the hands of resident individuals at the applicable slab tax rates. Foreign companies, non-residents and foreign institutional investors will pay tax at 20% (subject to the applicability of the tax treaty benefit) on the dividend received. Withholding taxes shall also be applicable on such dividend payments at 10% in case of resident shareholders and at 20% in case of non-resident shareholders (subject to the applicability of the tax treaty benefit).
A new section has been inserted in the Income-tax law, wherein dividend received by an Indian company from an Indian company shall not be taxable to the extent it is distributed by such company. It is a welcome change, as it allows the removal of the cascading effect in multi-tier corporate structures, irrespective of shareholding in the Indian company. Until now, moving funds by way of dividend attracted DDT and credit was available only in holding-subsidiary situations.
Now, with the abolition of DDT, companies will be able to successfully distribute dividend within the group without incurring DDT cost. This will be particularly helpful to listed companies, which will be able to receive dividend from their joint venture/subsidiary/associate and distribute the same to the ultimate shareholder without incurring DDT cost. Even in unlisted companies/groups, dividends may be received from the joint venture/subsidiary/associate with a one-time tax cost, where dividend is retained at the recipient company level.
This amendment will also be a positive move for foreign investors who do not currently receive the benefit of DDT tax credit in their home jurisdictions. Such foreign investors will now be able to avail credit of such taxes withheld, subject to the availability of the benefit of the tax treaty.
However, a negative of this proposed amendment is that if dividend is distributed by companies to the ultimate non-corporate shareholder, it may be taxed at 30% plus applicable surcharge and cess, which may be as high as 42.75%. Comparatively, non-resident shareholders, whether corporate or not, pay a 20% tax plus applicable surcharge and cess, which, in most cases, is reduced to 10% owing to the applicability of the tax treaty with foreign countries.
Cascading relief is not available in the case of dividend received by an Indian company from a foreign company. This seems to be a "miss" in the proposed law, as a similar deduction of dividend from a foreign subsidiary company is allowed to an Indian company in the current DDT regime. Dividend received from foreign companies may also be brought in the same regime.
Overall, this amendment should provide great flexibility to the corporate sector in treasury management and the movement of funds within the group albeit at the cost of higher tax in the hands of the shareholders.
Authors: Ashutosh Chaturvedi (Partner and TRS North Leader), Ruchi Jain (Director) - MnA Tax, PwC India. The views expressed in this article are personal. The article includes input from - S. Shriram (Assistant Manager), Manasvi Gupta (Associate) - MnA Tax, PwC India.