Income Tax 14 Feb,2020
Abolition of DDT: Has the aim missed the game?
Anil TalrejaPartner with Deloitte Haskins & Sells LLP
Aashni ShahAssistant Manager with Deloitte Haskins and Sells LLP.

One of the highlights of the Budget amendments has been abolishment of the dividend distribution tax (DDT) and seemingly, a lot of mixed opinions are being received in this regard. Though the DDT regime was administratively simpler, the reason for the change has been attributed to the advancement of technology and easy tracing systems potentially outliving the rationale for DDT.

To efficiently transit from the DDT regime to a recipient-based taxation, Budget 2020 has proposed many amendments. However, there appears to be confusion and ambiguity arising in the minds of shareholders when one reads the fine print of the change.

Higher tax on dividend paid to foreign companies?

A huge gap is being observed on the taxation of dividend paid to a foreign company. As per the proposed provisions, when in certain cases, a foreign company is liable to pay tax as per the domestic law, it will have to pay tax at the rate of 20 percent. However, there is no corresponding amendment in the schedule annexed with the Finance Bill and thus requiring the company paying dividend to withhold tax on such payments at 40 percent. This results in disparity of tax and if not rectified, will lead to these shareholders filing for refund claims which does not appear to be the intention of the legislature.

Tax cost on dividends:

Dividends received by shareholders after 1 April, 2020 will now be taxed in their hands. Dividends in the DDT regime suffered tax at the rate 20.56 percent in the hands of the company. However it was exempt in the hands of certain classes of shareholders. Now that the dividends are proposed to be taxed in the hands of shareholders, the High Net worth Individuals (HNIs) will pay tax on such inform at rates as high as 42.74 percent.

Many companies are in the process of evaluating the possibility of declaring interim dividend to avail the lower tax rate of DDT. However, will it be possible for all cash rich companies to declare interim dividends in this short period?

Potential double taxation?

On a technical reading of the provisions of the tax laws along with the proposed amendments, any dividend declared by the company on or before 31 March, 2020, will be subject to DDT. However, there is certain ambiguity on the taxation of the same dividend in the hands of shareholders when this dividend is received by the shareholder on or after 1 April, 2020. One reading of the combined provisions of the fine print indicates that in a case a company declares dividend on say 29 March 2020, and the shareholder receives the said dividend on say 10 April 2020, there could be two incidences of taxation – one in the hands of the company viz. DDT and the other in the hands of the shareholders as this will also depend on the method of accounting followed by the shareholders.

Further, cases of dividend warrants which were originally returned unpaid and subsequently received by the shareholder post 1 April, 2020 could also potentially result in double taxation.

Dividends received by domestic companies from its foreign subsidiaries:

The Finance Minister in her speech had mentioned that, "Further, in order to remove the cascading effect I propose to allow deduction for the dividend received by a holding company from its subsidiary". A new section is proposed to be inserted to cater to this aspect of causing a cascading effect. However, this proposed amendment does not provide for deduction in respect of the dividend received from foreign subsidiary, whereas as per the existing provisions dividend received from foreign subsidiary were allowed for the purpose of computing DDT. Indian entities owning companies overseas will not be able to take advantage of the cascading effect with respect to DDT.

Declaration of interim dividend:

Though the idea of declaring interim dividend as a temporary solution to substantially reduce the tax outflow may sound to be hassle-free, certain points will play a pivotal role in determining the companies' ability in declaring interim dividend. The company will be able to declare interim dividend only out of surplus profits after providing for depreciation. In case of inadequacy of profits or absence of profits, the company will have to comply with a different set of rules. It would be critical for the Board of Directors to evaluate the financial position of the company not only at the time of declaring interim dividend, but also to evaluate its future profitability. The entire process is statutorily required to be completed within 30 days of declaring the dividend.

While the long awaited ask for abolition of DDT has been finally addressed by Budget 2020 and may benefit a certain group of investors, especially non-residents claiming treaty benefits and credits in their home country, there are certain investors who may not benefit from this move.

These finer aspects do give an indication of the aim being missed and the need to issue clarification to resolve these doubts, is essential.

Information for the editor for reference purposes only

Anil Talreja is a Partner and Aashni Shah is an Assistant Manager with Deloitte Haskins and Sells LLP