Dividend Distribution Tax Abolishment: Here’s Something Lost in Translation

The government has said taxes on income received from dividends will now have to be paid by the shareholders instead of the dividend distributing company. The Finance Bill 2020 presented alongside the Union Budget on February 1, 2020 abolished the imposition of Dividend Distribution Tax w.e.f. FY 2020-21. Over two decades ago, the Finance Act 1997 under Income Tax Act, 1961, introduced DDT wherein the taxes on dividend were directed to a single point i.e. to be paid by the dividend distributing company and the incidence of tax shifted from the recipient to the payer. Doing away with this practice, the government has once again reverted to the pre-DDT days. Present rate of DDT is at 15 percent on gross basis plus surcharge and cess, resulting in net tax rate of 20.56 percent.

With a view to provide incentive to Indian companies who had invested in businesses outside India,  a new Section 115BBD was introduced in the IT Act through Finance Act 2011.  This provided for lower tax rate of 15 percent[1]  on the Indian companies which received dividend from a specified foreign company[2], in place of the normal tax rate of 30 percent.

In keeping with such changes, over the years the government also took certain corrective measures to ensure that the dividend income originating from the same source was not taxed in India more than once, including in the hands of ultimate recipients. For instance, in order to remove the cascading effect of DDT on a multi-tier structure where dividend is received by an Indian company from a subsidiary company[3] and is further distributed to its shareholders, tax base for computing DDT in the hands of such Indian company was reduced by amending Section 115-O by Finance Act 2012, by the amount of dividend received from its subsidiary on which DDT had already been paid.

Section 115-O was further amended by Finance Act 2013 to provide similar reduction in respect of dividend received from a foreign subsidiary[4], where tax under Section 115BBD had already been paid by the Indian company.

Now  as we switch back to the old regime from FY 2020-21 onwards, tax on dividend distributed will be payable by the shareholders as per their respective income tax slabs. The dividend distributing company will also be required to withhold taxes as per the prescribed rates under the relevant provisions i.e. Section 194 or Section 195 of the IT Act. However, this time no credit/ set off is available to the shareholders of the Indian company for the taxes already paid by the Indian company under Section 115BBD at the time of receipt of the dividend from foreign company. Hence, the ultimate recipients of dividend will be paying taxes on the entire dividend income, with no benefit whatsoever accruing on account of taxes already recovered by the government on the foreign dividend income from the dividend distributing company. As can be seen, the tax implications on shareholders of an Indian company which receive dividend from a foreign company were much more favourable under the previous regime as compared to the regime proposed in Finance Bill 2020. This might be an unintended anomaly or an oversight. It would be fitting not to make the shareholders of such companies worse off under the proposed regime as compared to the regime under DDT.

It is only fair to expect that a mere shift in tax incidence, re-introduced to make it simple and taxpayer friendly, would not levy additional burden on the dividend recipients. In the Finance Bill 2020, there has been a conscious effort to reduce the overall tax burden on small investors and non-resident investors with treaty benefits. There is no reason why the shareholders of companies receiving dividends from foreign companies should have to pay higher tax under the proposed regime as compared with the DDT regime which is being replaced.

[1] plus applicable surcharge and cess

[2] in which Indian company holds atleast 26 percent equity share capital

[3] in which a company holds more than half of equity share capital

[4] in which the Indian company holds more than half of equity shares capital

This article was authored by Daksha Baxi - Head of International Taxation at the Mumbai office, and Rashi Gupta - Associate in the Tax Practice at the Delhi office, of Cyril Amarchand Mangaldas, and was originally published on the Cyril Amarchand Mangaldas blog.

The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its editorial team.