REFORMS IN DIVIDEND DISTRIBUTION TAX- ANALYSING THE NEW TAXATION POLICY: BY MRIGANC MISHRA

The Union Budget 2020 saw a significant number of amendments- especially to the Income Tax Law. One of the major amendments brought about by this budget, was the abolishment of the Dividend Distribution Tax (hereinafter as DDT). The Companies will no longer be liable to pay DDT on the dividend declared or distributed on or after 1^st April, 2020.

The implementation of this structure of taxation would mean that now the dividends will be taxed at the shareholders’ level; [for non-residential shareholders (individuals or corporations) the tax would be restricted to rates stipulated by the tax treaty that India has with the country in question.]

After passing of this amendment, any person of general prudence might ask- is this step a profitable move? Do shareholders/investors profit or does the company profit from this amendment? Will it improve India’s economy?

This article reviews the literature of old taxation regime which was applicable in India; the need for a new taxation policy AND the gainers and losers vis-à-vis the taxation policy post the amendment.

DIVIDEND DISTRIBUTION TAX- OLD REGIME

Dividend Distribution Tax, in simple terms, means the tax that a Company and Mutual Fund is liable to pay on the Dividend Distributed to its shareholders. It came into effect with two Sections- 115-O and 115R(2) of the Income-Tax Act, 1961 (hereinafter as ITA). One of the main reasons for the prevalence of DDT, was that the practice of collecting tax at the corporate level proved to be much simpler for the government. Dividends were not taxed at the hands of shareholders. Any domestic company which declared dividend was required to pay DDT at the rate of 15%; which effectively went up to over 20%(Approximately 20.56%).

NEED FOR IMPLEMENTATION OF NEW TAXATION POLICY

The new taxation policy came as a result of certain setbacks associated with the DDT. The major setbacks are discussed in the ensuing paragraphs

One of the major issues was cascading effect on tax. The multiple levels of taxation on the same source of income proved to be nothing but exploitation of taxpayers. Companies, first, used to pay corporate tax on their total net income (approximately 30%). At the next level, as per provisions of ITA, they had to again pay DDT on the amount of dividend to be distributed. On top of this, the shareholders had to pay a “Rich Tax” of 10%, if the amount of dividend received exceeded INR 10 Lakhs. This system was bound to be abolished to provide a fair taxation policy.

Another major issue associated with DDT was that foreign treaties were rendered inefficacious. The treaties enable foreign investors to claim credit on the income tax paid. However, under the DDT regime, foreign investors were not able to claim credit as DDT was paid by the Companies and Mutual Funds, and not by the foreign investors personally. This made India a less attractive platform for foreign investors. 

 

NEW TAXATION POLICY- WHO BENEFITS OUT OF THIS?

1.     Shareholders under the lower tax slab- The abolition of DDT allows companies/mutual funds to share their entire distributable profits with their shareholders, but its impact on dividend receivers is uneven. The shareholders, who fall under the lower tax brackets (i.e. lower than 20% tax slab), benefit the most- for they no longer need to suffer the 20.56% imposition on their dividends, and they in turn have to pay lesser tax out of their pockets.

2.     Foreign Portfolio Investors (FPIs)- The FPIs (that are structured as corporates), now can pay taxes at a much lower rate- i.e. 20% or lower rates, specified in tax treaties that are signed by their home countries. In some countries (ex- Hong Kong), the tax rate stipulated in the tax treaty goes as low as 5%. On top of this, the FPIs can now claim credit for taxes paid on dividends that they have received in India, when assessed for corporate tax back home. This move provides attractive incentives to FPIs, and will definitely act as a catalyst to spur the Foreign Investments in India

3.     Domestic Company in the long run- Another purpose for abolishing the DDT was expansion. The government, instead of deducting a handsome amount of income from the corporates, decided that more cash inflow for the corporates would help them expand at the national and even international level. More cash inflow for corporates would help them expand at a faster rate and generate new employment opportunities.

WHO IS AT A LOSS?

1.     Shareholders under the higher tax slabs- As mentioned above, the impact of abolition of DDT is uneven amongst shareholders. The individual shareholders, who fall under the higher tax brackets (i.e. 20% or higher), will have to shell out higher effective tax on their dividends- which is as high as 43%. Therefore, the promoters of big companies holding equity individually or in trusts will be affected adversely.

2.     Insurance Companies- Insurance companies and other corporate investors in stocks who, unlike mutual funds, do not enjoy a pass-through status will now have to pay tax on dividends at the corporate tax rate. (A pass-through status is a structure that takes away the obligation to pay corporate tax)  

3.     FPIs structured as non-corporates- The FPIs and NRI investors will not be able to claim the benefit of 20 percent tax rate on dividends, and will be compelled to pay taxes at their respective slabs.

 

CONCLUSION

The abolition of DDT comes with a mixed bag of pros and cons. The government has clearly highlighted the importance of FPIs, for they were disadvantaged due to their inability to claim tax credit in their respective home countries. The ability to claim credit will incentivise foreign investors and will help bring in more foreign capital investments.

The government also wants Corporates and Mutual Funds to benefit in the long run, as they will be provided with more cash infusion. Higher earnings for business expansion will create a multiplier effect on India’s GDP.

The analysis of all the pros and cons of this amendment would clearly indicate that the net outcome is positive. Although the shareholders under the higher tax brackets are adversely affected, this amendment acts as a stepping stool to improve the attractiveness of the Indian capital market, while at the same time, increases the quantum of liquidity for all the corporates in the country.