Budget 2020: Presently, in addition to the corporate tax, companies pay Dividend Distribution Tax (DDT) at the time of distributing profits to shareholders. The effective DDT rate is 20.56 per cent. While recently, the government vide the Taxation Amendment Act, 2019, had reduced the effective corporate tax rate to 25.17 per cent/ 17.16 per cent, once the DDT is factored, effective tax rate for corporates would still be 37.93 per cent.
Historically, dividend was always taxable in the hands of shareholders. The concept of DDT for the first time was introduced by Finance Act, 1997. Dividend that was subjected to DDT was made exempt in the hands of the shareholders. The Finance Act, 2002, replaced DDT with the earlier system of taxing dividends in the hands of the shareholder. DDT was then re-introduced vide Finance Act, 2003. Several changes were made to the provisions relating to DDT in the past, including those that remove the cascading effect of dividends received from subsidiaries, grossing up mechanism, changes in the rate of tax, etc.
Finance Act, 2016 gave another turn with regard to taxation of dividend, whereby dividends earned in excess of Rs 10 lakh from domestic companies was made taxable in the hands of resident individuals, partnership firms, private Trusts, etc. at 10 per cent rate (plus surcharge and cess) on a gross basis.
The tax treaties entered by India with various countries, largely limit taxation on dividends in India at 10 per cent and the shareholder has the ability to claim credit for the tax deducted in India, in its country of residence. Since, DDT is levied on the Indian company distributing dividend, it was believed that the tax treaty provisions are ineffective. Also, shareholders faced challenges in claiming credit for DDT in their home country which typically resulted in high tax cost for foreign shareholders.
Indian companies with foreign investments have been contending before tax authorities to restrict the levy of DDT on dividend distributed to non-residents by applying the beneficial tax rate as per the respective tax treaty. Many Indian corporates went down the path and made a claim in the scrutiny or appeal proceedings to restrict the DDT paid on dividend declared to non-resident shareholders by claiming tax treaty benefits. Recently, the Delhi Tribunal passed an order in the case of Maruti Suzuki wherein the additional ground in relation to application of the lower rate was admitted. The Delhi High Court dismissed the Revenue's writ challenging Delhi Tribunal's interim order admitting additional ground raised by Maruti Suzuki praying for restricting the levy of DDT to the beneficial rate of 10 per cent as per tax treaty.
Additionally, there is protracted litigation in relation to section 14A of the Income-tax Act, 1961 which relates to disallowance of expenses incurred to earn exempt dividends earned from investment in shares and mutual funds.
The Finance Bill, 2020 proposes to abolish DDT. The proposal is to replace DDT with a classical system of taxation i.e. instead of levying DDT on companies, the tax should be levied in the hands of shareholders. The prospective abolishment of DDT in India would now put to an end the litigation in relation to reduction in the rate of DDT. In so far as deduction of interest expenses relating to dividend is concerned, the proposal suggests that the deduction has to be restricted to 20 per cent of dividend income. No other deductions would be allowed. Further, foreign tax credit in respect of dividend would be available to non-resident shareholders much easier than when DDT was payable.
Non-resident shareholders would be in a position to restrict the tax on dividend to 5 per cent/10 per cent/15 per cent applying the beneficial tax treaty provisions. The beneficial tax treaty provisions would be subject to the anti-abuse provisions of the India income-tax law and provisions of Multilateral Instruments which is effective from 1 April 2020.
Resident shareholders, being domestic companies, will be allowed a deduction of dividend received from a domestic company provided the receiving company has distributed dividend equal to the dividend received before the due date.
The present provisions levy tax at a flat rate on the distributed profits, across the board irrespective of the marginal rate at which the recipient is otherwise taxed. The provisions are, therefore, iniquitous and regressive. The removal of DDT is a welcome and much-expected move in line with the recommendations of the Direct Tax Code Panel which will bring in vertical equity amongst taxpayers.
(By Vijay Dhingra, Partner; Anjana Singh, Director; and Urvashi Agarwal, Deputy Manager with Deloitte Haskins and Sells LLP)