[By Ekta Jhanjhri]
The author is a fourth year student at Institute of Law, Nirma University, Gujarat.
Stimulating foreign equity investment in the Indian landscape has always been of prime importance to the Indian Government. Thus, the Hon’ble Finance Minister (“FM”) has proposed to abolish Dividend Distribution Tax (“DDT”) in the Budget Session for financial year 2020-21. In her budget speech, the Hon’ble FM has explained that the elimination of DDT is expected to increase the attractiveness of the Indian equity market, and provide relief to a large class of investors. The FM further claims that the measure is expected to result into revenue erosion of Rs.25000 crores.
Though abolition of DDT has been extolled by the industry as well as from retail investors, the measure is viewed with suspicion by others. In this article, the author has attempted to put forth the industry concerns over payment of DDT and analyze the impact of elimination of DDT.
Why DDT was in place and its evolution
The concept of DDT was first introduced vide the Finance Act, 1997 through insertion of Section 115-O as a measure for easy tax collection and administration since it was difficult to track down the receipt of dividend income in the hands of thousands of shareholders. Thus, the then newly introduced provision mandated the domestic companies to pay DDT on dividend distributed, declared or paid by them.[i]
Simultaneously, a new clause was added in the Income Tax Act, 1961 (“the Act”) which excluded the dividend income from the ambit of total income.[ii] The upshot was exemption of dividend income in the hands of shareholders, except those whose aggregate dividend income in a year exceeded Rs. 10 lakhs.[iii] Furthermore, it intended to deter domestic companies from employing their surplus into distribution of dividend, rather plough them back into lucrative business prospects.
However, the incidence of taxability of dividend income was again shifted to shareholders when the DDT was scrapped vide Finance Act, 2002. Interestingly, DDT was re-instituted through the Finance Act, 2003 and had been in force until 31st March, 2020 at an exorbitant effective rate of approximately 20.56% including surcharge and cess, falling as liability of the concerned company. The ebb and flow of DDT has been a bone of contention within the corporate sector.
Concerns raised by the industry
The corporate sector has expressed deep dismay when it comes to the payment of DDT. Firstly, it has been asserted that the imposition of DDT results into double taxation in two facets.
- From the perspective of shareholders: DDT was contemplated as an evil eye by the investors whose aggregate income from dividend exceeded Rs.10 lakh per year. Such investors faced an additional tax rate of 10% on their dividend income. It is thus argued that when the domestic company has already been subjected to DDT u/s 115-O, imposition of additional tax u/s 115-BBDA on such investors amounts to double taxation.
- From the perspective of corporates: The levy of DDT is considered to be a hex by the corporates. Let us understand this with the help of an example. A company has earned a profit before tax of Rs.100 and company pays corporate tax @ 25%. This makes the profit after tax of the company as Rs.75. The company then declares Rs.50 as dividends. As per Section 115-O, a company declaring or paying dividend, is required to pay DDT @ 15% along with applicable surcharge and cess. As discussed above, with applicable cess and surcharge, the effective rate becomes 20.56%. Thus, the company foots the bill of Rs.10.28 as DDT to the Government. This way the income of the company is taxed twice i.e. in the form corporate tax and DDT.
Secondly, it is also argued that DDT is a blanket levy regardless of the tax slab in which a particular retail investor files its return. For instance, dividend income of a retail investor having total income less than Rs.10 lakhs, is taxed at a flat rate of approximately 20%. Even though the levy is on domestic company, the ultimate sufferer are the shareholders as they lose something out of their kitty.
Thirdly, the levy of DDT has proved to be a double whammy for foreign investors: As per Section 115-O, neither the domestic company nor the shareholders are entitled to claim credit of DDT already paid under the said provision. Consequently, a foreign investor who is subject to taxation in a different jurisdiction has tax liability under that said jurisdiction subject to the respective tax treaty India has with such jurisdiction. This acts as a stumbling block for foreign investor to channelize their fund into Indian territory as it makes their return on investment uncompetitive.
Fourthly, foreign companies receiving dividend from an Indian subsidiary will be able to avail the benefit of tax treaties as the requirement of shelling out DDT has been removed from Section 115A of the Act. The said provision levies tax @20% on dividend income received by foreign companies.
Impact of Abolition of DDT
The measure has received heterogenous response from the industry. The natural corollary of the abolition implies that the dividend income will now fall within the purview of total income and is taxable as per the applicable tax slab rate. Firstly, this comes as big sigh of relief for the disgruntled retail investors whose total income from dividends does not exceed Rs.10 lakhs.
Secondly, the move has also calmed down the exasperated foreign investor as it addresses their woes of double whammy. These majorly include investors who file their tax returns in jurisdictions with which India has favorable tax treaties. However, the Finance Bill, 2020 proposes to omit the proviso,[iv] which excludes payment of dividend to non-resident from the operation of Tax Deducted at Source (“TDS”).[v] The immediate impact of such omission is that payment of dividend to non-resident is made subject to TDS.
Thirdly, the proposed measure would result into additional chunk of income with the corporates to invest in lucrative business prospects. This is seen in consonance with the reduction in corporate tax rate from 35% to approximately 25%.
However, the measure to eliminate DDT has been viewed as a bolt from the blue by High Net-worth Individuals (“HNIs”). The reason being that dividend income of HNIs will now be taxable in accordance with the tax slab they fall in. This is problematic particularly for those individuals whose total income in a year exceeds Rs.10 lakhs. Similar jolt has been received by the promoters of domestic companies who fall in the highest tax bracket paying out at effective tax rate of approximately 42.7%.
Moreover, Indian Companies will no longer get deduction of dividend received from specified foreign companies when the Indian Company distributes dividend to its shareholders. For instance, ‘A’ an Indian Company has a subsidiary company ‘B’ in foreign. Under the previous regime, the amount of dividend, say Rs.1000, received by company ‘A’ from company ‘B’ was allowed as deduction when company ‘A’ declared dividend of, say Rs.1500, to its shareholders. Thus, company ‘A’ was liable to pay DDT at only the difference amount which is Rs.500 (Rs.1500-Rs.1000) at the rate of 20%.[vi] However, the benefit of claiming deduction has been withdrawn with the abolition of DDT and company ‘A’ has to bear the tax burden on entire dividend income of Rs.1000 received from company ‘B’ though there is no tax liability to declaration of dividend by company ‘A’ to its shareholders.
Furthermore, there exists an unintended discrimination against Indian companies having threshold shareholding stake in specified foreign company as opposed to having shareholding stake in domestic company. This is visible in the proposed insertion of Section 80M in the Bill, 2020.[vii] This provision allows a domestic company to claim deduction on dividend income received by it from another domestic company. The raison d’etre was removal cascading effect of taxation. Sadly, such deduction is no longer available when a domestic company received dividend from specified foreign company and it appears that cascading effect has not been addressed in entirety.
Yet another inadvertent aftermath of abolition of DDT is that companies may resort to buying back shares rather than paying dividend. Since, the ultimate decision maker of the companies are promoters and as already discussed, promoters are hit-hard by the abolition of DDT, it is not improbable that they may prefer buy back over dividends as buy-back is taxable at an effective rate of 23%.[viii]
Therefore, undeniably, abolition of DDT will facilitate foreign equity investment in the Indian market, however it is evident that the move of abolition of DDT has witnessed varied response from the corporate sector. Pertinently, the step has certain unintended prejudice towards one class than others and it is anticipated that the Government will redress the same sooner. Also, it is expected that the revenue erosion of Rs.25000 crores claimed by the Government will to some extend get recompensed by the changes introduced vide Finance Bill, 2020.
[i] Income Tax Act, 1961, Section 115-O(1).
[ii] Income Tax Act, 1961, Section 10(34).
[iii] Income Tax Act, 1961, Section 115BBDA.
[iv] Finance Bill, 2020, Clause 85.
[v] Income Tax Act, 1961, Section 195.
[vi] Income Tax Act, 1961, Section 115-O (1A) (i) (b).
[vii] Finance Bill, 2020, Clause 40.
[viii] Income Tax Act, 1961, Section 115QA.