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DDT is scrapped: Would dividends suffer lower tax or is there a catch?

DDT is scrapped: Would dividends suffer lower tax or is there a catch?

DDT is scrapped: Would dividends suffer lower tax or is there a catch?
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By Shripal Lakdawala   | Chintan Shah  Feb 6, 2020 5:08:47 PM IST (Updated)

While the government has removed DDT, the overall impact thereof for various classes of investors and assets would be considerably different.

Up till now, companies in India were subjected to income tax on the profits earned during the relevant year. Further, companies were also required to pay Dividend Distribution Tax more popularly referred to as DDT, on the profits distributed to shareholders. Those other than corporate shareholders were required to pay an additional tax on receipt of dividend at the rate of 10 percent plus an applicable surcharge for dividends received, in excess of Rs 10 lakh.

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Mutual funds were also required to pay DDT on the dividend distributed by them to unitholders. However, the unitholders were not subject to income tax on such dividend.
Special Purpose Vehicles engaged in the infrastructure sector (SPV) and held by a Business Trust (INVIT) were specifically exempted from DDT. The Business Trust and unitholders were also exempted from income tax on dividend received from the SPV.
There were good arguments for and against DDT. While it was convenient to administer and collect DDT, it had several drawbacks:
  • DDT was considered as regressive as it applied equally on dividends distributed to the super-rich investors and to significantly small retail investors.
  • DDT resulted in a cascading effect in the case of corporate holding structure where the corporate shareholder held less than 50.01 percent in the company distributing dividend.
  • Tax paid on DDT was not creditable in the hands of shareholders. So both resident (other than corporate shareholder) and non-resident shareholders were required to pay tax on receipt of dividend.
  • Considering that the negatives far outweighed the positives it was considered expedient to eliminate DDT. Over the years, recommendations were made to the finance ministry to consider eliminating DDT. With the Finance Bill 2020, the finance minister has accordingly proposed the elimination of DDT.
    The amendment proposed by Finance Bill 2020
    Dividend distributed by companies / mutual funds
    • A company / mutual fund is no longer required to pay DDT on dividend distributed by it. Instead, dividend would be taxed in the hands of the shareholders/unitholder.
    • In case the shareholder of a company is another company, it gets a deduction against the dividend income received by it to the extent it, in turn, distributes dividend to its shareholders one month before the due date for filing its tax return.
    • Dividend distributed by a business Trust
      • Dividend would be taxed in the hands of unitholders at the tax rates applicable to the unitholders.
      • Expenses incurred to earn dividend
        • Investors would not be entitled to tax breaks on expenses incurred for earning dividend income except for interest expense up to 20 percent of the dividend income.
        • Withholding tax
          • Withholding tax would be applicable at 10 percent on payment of dividend income by a company / mutual fund / business Trust exceeding INR 5,000.
          • The impact of the amendment
            On dividend distributed by the company
            To understand the impact on dividend distributed by a company, let us look at a few simple scenarios tabulated below. We assume that in all the scenarios, the company distributing dividend opts for a corporate tax rate of 25.17 percent. Therefore, assuming that the company earns Rs 100, post payment of corporate tax of Rs 25.17 there would have been a distributable surplus of Rs 74.83. Let us evaluate the following three scenarios in this background:
            Scenario 1: A shareholder who is a tax resident of Singapore to whom the tax treaty between India and Singapore would apply.
            Scenario 2: A resident individual shareholder or private Trust who has income exceeding Rs 5 crore.
            Scenario 3: A resident company shareholder.
            ParticularsNon-resident shareholderResident individual shareholder or private trust Resident company shareholder
            Profit after tax (entirely distributed to the shareholder)74.8374.8374.83
            Tax on dividend payable by the shareholder7.4831.9818.83
            Shareholder’s income (net of tax) (A)67.3542.8556
            Total income-tax (100 – A)32.6557.1544
            It is worthwhile to note the below considerations as well to understand the impact on dividend distributed by companies:
            • A non-resident shareholder may or may not be subject to further income tax in the home jurisdiction on the dividend income. It may also avail credit of income tax paid on dividend in India against that payable in the home jurisdiction. Nevertheless, the amendment is significantly beneficial to this category of shareholders since DDT was a sunk cost as it was not considered to be a creditable income tax in majority of foreign jurisdictions.
            • Resident individual shareholder or Private Trust would have to pay a higher income tax on dividend since he falls in the highest slab and pays tax at the maximum marginal rate of 42.74 percent. The amendment results in higher tax outgo since the total combined tax outgo of the shareholder and the company under the existing regime would have been lower by around 10 percent.
              • Though in the case of resident company shareholders, there would be a higher income-tax of 25.17 percent on dividend income received by it as against DDT applicable at 17.47 percent, such shareholders would be better off compared to a resident individual shareholder under the amended provisions.
              • On dividend distributed by a mutual fund
                The dividend would be taxed in the hands of unitholders at tax rates applicable to them.
                On dividend distributed by a business Trust
                The amendment withdraws the exemption available to the unitholders of a business Trust on dividend received from an SPV and makes it taxable at the normal income-tax rates applicable to the unitholders.
                Conclusion
                While the government has removed DDT, the overall impact thereof for various classes of investors and assets would be considerably different. It would be necessary for investors to evaluate the exact impact the proposed amendment would have on different classes of assets owned by them.
                Shripal Lakdawala is Partner and Chintan Shah is Senior Manager at Deloitte Haskins & Sells LLP. The views are personal.
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