Abolition of Dividend Distribution Tax

Dividend Distribution Tax (DDT) is a tax levied on dividends distributed by companies out of their profits among their shareholders. The Dividend Distribution Tax is taxable at source and is deducted at the time of the distribution

Dividend Distribution Tax is the Tax which is required to be paid @ 15% by the Company who has declared, distributed or paid any amount as Dividend. The provisions of Dividend Distribution Tax are governed by Section 115-O under Chapter XII-D and were introduced by the Finance Act 1997.

The company has to deposit DDT within 14 days of declaration, distribution or payment of dividend whichever is the earlier. In case of non-payment within 14 days, the company shall have to pay interest at the rate of 1% of the DDT.

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.

In the Union Budget 2020, FM Nirmala Sitharaman proposed to remove the very unpopular dividend distribution tax (DDT). All kinds of dividend income i.e. dividend income received from mutual funds and shares will now be taxable in the hands of taxpayers. The dividend so earned will be taxable at applicable income tax rates. With the addition of 12 per cent surcharge and a 3 per cent education cess, the actual effective DDT rate comes to 20.35 per cent.

According to industry experts, the DDT obstructs the flow of foreign direct investment. And abolishing this can give a major push to investment making Indian equities more attractive.

Triple tax is levied on all dividends. The first one is the tax which a company pays on its profits. A company’s after tax profits are distributed as Dividends. Then, Dividend Distribution Tax is levied. Companies which are not liable to pay any other tax shall also pay DDT if dividend is announced. And, third is the 10% tax on anyone who earns dividend income of Rs 10 lakh or above called as Super Rich Dividend Tax. No other country levies this kind of a tax. This was introduced in India in 1997, scrapped in 2002 and reintroduced in 2003 as the government claimed that it was easy to collect tax at a single point.

This move was decided to curb the strategy of using buybacks to avoid taxes. The minister said revenue foregone due to DDT removal will be Rs 25,000 crore. But, the analysts say that any loss in revenue will get offset by the tax that shareholders pay.

Dividend is the income of the shareholder which means where the shareholder is below the threshold of tax limits, no tax is payable on dividend. Vice versa, an individual under the higher tax basket receiving dividend will pay higher tax. This progressive system of taxing dividend addresses horizontal equity consideration in tax policy. DDT, however, was working the other way.

The centre added that abolition of DDT would encourage low-income earners, who have total income up to Rs 5 lakh, to invest in capital market. Also, the decision will provide relief to a large class of investors. It would boost debt mutual fund market as most individuals would have to pay tax at lower rate on income received by debt fund.

On the other hand, Indian promoters and high net-worth individuals (HNIs) will face a significant increase in the overall tax incidence to 57% (versus 47% in FY20) on dividend income. And the gap/ disparity between Indian and MNC promoters will increase. Indian promoters will be liable to pay tax at 43% whereas foreign promoters will be charged 22%, or even lower if they are located in a country where the tax treaty provides beneficial rates. 

The issue of buyback of shares to avoid paying taxes will still prevail as buybacks will be taxed @ 23% against 43% for HNIs. Many companies might curtail dividends.

The foreign companies looked for mechanisms to repatriate profits to the home jurisdiction because of the following factors:

  1. Dividend distribution by Indian companies (which are wholly owned subsidiaries of foreign companies) paid DDT @ 20% and above. So the dividend that the holding company would receive would be reduced by the amount of DDT.
  2. Normally, the foreign company will have to pay tax on the dividend received in its home jurisdiction. But, the foreign company would not be able to claim foreign tax credit on the amount paid towards DDT as it is a tax for the Indian subsidiary and the holding foreign company is not paying taxes directly on such dividend income in

This created a double trouble as an organization as a whole, the foreign companies suffered double taxation. 

In fact, some foreign companies have been even arguing that in cases where the tax treaties limit tax on dividend for the shareholder to a rate lower than the rate of DDT, the recipient of dividend would be entitled to a refund from tax authorities, even though DDT was paid by the Indian subsidiary. In the light of the above discussion, following are the major impact areas:

  • The dividend income received by a foreign company from its Indian subsidiary would be taxable in India under Section 115A of the Act. So, they can opt for a Tax treaty, if applicable.
  • Exemption to foreign companies from requirement of filing their tax returns in India will continue if their only taxable income in India consists of dividend, but with an added condition that tax on such dividend income has been withheld under the provisions of the Act. Thus, where the foreign company opts for lower rate under the treaty in respect of dividend income, it would be required to file its tax returns in India.

Overall, abolition of DDT is a very welcome step. It would provide relaxation to foreign holding companies intending to invest in India without having to worry about innovative structures to repatriate the profits earned in India.