Dividend Distribution and its Tax Implication

The Dividend Distribution Tax was first introduced in the year 1997 but replaced in the year 2002 and further re-introduced in 2003 to encourage companies to retain their earnings and facilitate administration of Single Point collection of Tax on Dividend Income instead of many compliances by the company and shareholders.

Under the current scheme, the dividend declared, distributed or paid by domestic company to its shareholders is subject to Dividend Distribution Tax at the rate of 15% plus surcharge and cess (Effective Rate is 21.17%).  The Dividend Distribution Tax shall be paid by the domestic company within 14 days of dividend declared, distributed or paid whichever is earlier.

The current regime raised the following commercial and legal challenges to the shareholders:

  1. The domestic company is required to pay the Dividend Distribution Tax on dividend declared, distributed or paid irrespective of residential status of its shareholder and / or whether such shareholder is taxable in India or not.
  1. The resident or non-resident shareholder cannot take a credit of Dividend Distribution Tax paid by the domestic company.
  1. An additional tax applies to the dividend income that is declared, distributed or paid by a domestic company to a person resident in India if the aggregate dividend income of the recipient exceeds INR 1 million per annum.
  1. Only specified domestic companies receiving dividends from another domestic company are eligible to get dividend received deduction in computing net distributed profits.

The Finance Bill 2020 announced that dividend is an income in the hands of the shareholders and not in the hands of the company. The incidence of the tax should, therefore, be on the recipient instead of the company. Therefore, it is proposed that dividend declared, distributed or paid by domestic companies to shareholders is not subject to Dividend Distribution Tax but would be taxable to shareholders as per applicable tax rates.

The dividend declared, distributed or paid by domestic companies is under an obligation to withhold the tax at the rate of 10% subject to applicable threshold. In case of non-resident, the domestic company is under obligation to withhold the tax at the rate of 20% plus surcharge & cess or lower beneficiary rate as per Double Taxation Avoidance Agreement.

Key aspects of the proposal are as follows:

  1. Domestic Companies
  1. The Dividend Distribution Tax shall only be payable on dividends declared, distributed or paid by a domestic company on or before March 31, 2020. The Domestic Companies do not require to pay any Dividend Distribution Tax with effect from 1st April’ 2020.
  • The domestic companies required to withhold Tax at the rate of 10% on Dividend payable to resident shareholder over and above a higher threshold exemption of INR 5,000. In case of non-resident shareholders, the domestic company is under obligation to withhold the tax at the rate of 20% plus surcharge & cess or lower beneficiary rate as per Double Taxation Avoidance Agreement. The domestic company having several shareholders both resident as well as non-resident, may find it practically challenging to correctly discharge their withholding tax obligations.

  • In case gross total income of a domestic company in a particular year includes any income by way of dividend from any other domestic company, the taxable income of first domestic company shall be computed after deducting an amount equal to the dividend received from the other domestic company. Such deduction is only available where the first domestic company distributes dividend to its shareholders on or before one month prior to the due date of filing of return of income.
  1. Resident Shareholders

  1. The Tax exemption provided on dividend declared, distributed or paid by domestic companies to resident shareholders shall not be applicable with effect from 1st April’ 2020. The additional tax on shareholders on excess of INR 10 million of dividend declared, distributed or paid by domestic company to resident shareholders shall also not be applicable with effect from 1st April’ 2020.
  1. The Finance Bill 2020 proposed that no deduction shall be allowed from dividend income other than deduction on account of interest expense and such deduction shall not exceed 20%.
  1. The dividend income is chargeable to tax as ‘income from other sources’ at applicable tax rates in India. The judiciary and Income Tax Department have different opinions in the specified cases of whether dividend income earned by the shareholder requires to be taxable as Income from Other Sources or Business Income.
  • Western States Trading Co. (P.) Ltd. V CIT (1971) 80 ITR 21 (SC): held that the amount of dividends would form a part of the income from the business of the taxpayer if the shares were a part of the taxpayer’s trading assets and the taxpayer would be entitled to a set-off as claimed against the loss from its business incurred during the previous years.
  • Similarly, in case of CIT v. Excellent Commercial Enterprises and Investments Ltd. (1980) 147 Taxman 558 (Delhi), held that, shares held by the taxpayer as a stock-in-trade and the income whether directly or incidentally from holding of such shares as stock-in-trade, would be business income, then it cannot be said that the dividend income would fall as an income from other sources.

The controversy on dividend income was settled earlier with the introduction of Dividend Distribution Tax making the dividend income exempt in the hand of shareholders. However, it may be introduced again with the latest amendment in Finance Bill to tax dividend income to shareholders instead of Dividend Distribution Tax.

  1. The resident shareholder required to do all compliance namely Obtaining Permanent Account Number, payment of advance tax, filing of Income Tax Return. The resident shareholder can take a credit of withholding tax deducted and deposited by the company.
  1. Non-Resident Shareholders
  1. The Tax exemption provided on dividend declared, distributed or paid by the domestic company to non-shareholders shall not be applicable with effect from 1st April’ 2020. The dividend income is chargeable to tax as ‘income from other sources’ at applicable tax rates in India.
  1. The Income Tax at the rate of 20% plus surcharge and cess or lower beneficiary rate as per Double Taxation Avoidance Agreement chargeable to non-resident shareholders on dividend declared, distributed or paid by domestic company. The rate of Tax mentioned in Double Taxation Avoidance Agreement with Germany (10%), USA (15% or 25%), UK (10% or 15%), Singapore (10% or 15%). The lower rates under Double Taxation Avoidance Agreement are usually restricted to a recipient being the ‘beneficial owner’ of the income received. Therefore, it is important to evaluate whether the non-resident shareholder is a beneficial owner or not.
  1. The non-resident shareholder shall not be required to file the income tax return if total income consists of dividend and income tax at prescribed rate is deducted by the domestic company. The non-resident shareholder required to submit the documents to the domestic to obtain the beneficial rate of withholding tax rate such as Tax Residency Certificate of Home Country, Tax Identification Number of Home Country, Contact Details, Permanent Account Number (if available) namely.
  1. The non-resident shareholder can take a credit of withholding tax deducted by the domestic company subject to the Taxation law in their home country and Double Taxation Avoidance Agreement.

Conclusion

  • The proposal for abolition of Dividend Distribution Tax is certainly a welcome move to small shareholders but increases the compliances of domestic companies and tax liability in the hand of large shareholders.
  • Dividend Distribution Tax is not applicable with effect from 1st April’ 2020 and taxable in the hand of shareholders with effect from 1st April’ 2020.
  • The company is required to withhold tax at the rate of 10% in the case of resident shareholders. In the case of non-resident, companies are required to withhold the tax at the rate of 20% plus surcharge and cess or lower beneficiary rate as per Double Taxation Avoidance Agreement.
  • The resident shareholder is required to file the income tax return; however, non-resident shareholders are exempted from filing of income tax returns in case withholding tax deducted by the company.
  • It is important to evaluate whether dividends earned by resident shareholders falls under the category of business income or income from other sources.
  • The non-resident shareholders are required to submit the essential documents to obtain the benefit of a lower rate in the Double Taxation Avoidance Agreement.

In case of any clarification or queries regarding any of these pronouncements or other related issues, write to us at office@indialawoffices.com.

Contact India Law Offices