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Dividend Distribution and its Tax Implication

In the case of a non-resident, companies are required to withhold the tax at the rate of 20% plus surcharge and cess or lower beneficiary rate as per the Double Taxation Avoidance Agreement.

The Dividend Distribution Tax was first introduced in the year 1997 and was later re-introduced in 2003 to encourage companies to retain their earnings and facilitate the administration of ‘Single Point’ collection of tax on dividend income.

Under the current scheme, the dividend declared, distributed or paid by a 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 is 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:

  • 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 this shareholder is taxable in India or not.
  • The resident or non-resident shareholder cannot take a credit of the Dividend Distribution Tax paid by the domestic company.
  • 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.
  • 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 a 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 was proposed that dividends declared, distributed, or paid by domestic companies to shareholders must not be subject to Dividend Distribution Tax but should 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 the applicable threshold. In the case of a 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 the Double Taxation Avoidance Agreement.

Key aspects of the proposal are as follows:

Domestic Companies:

  • 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 are required to withhold tax at the rate of 10% on Dividends payable to resident shareholders over and above a higher threshold exemption of INR 5,000. In the 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 the 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 the 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 the 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 a dividends to its shareholders on or before one month before the due date of filing of return of income.

Resident Shareholders:

  • The Tax exemption provided on dividends 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 in the excess of INR 10 million of dividend declared, distributed, or paid by a domestic company to resident shareholders shall also not be applicable with effect from 1st April 2020.
  • The Finance Bill 2020 proposed that no deduction shall be allowed from dividend income other than a deduction on account of interest expense and such deduction shall not exceed 20%.
  • 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.
  • In Western States Trading Co. (P.) Ltd. v. CIT, the Supreme Court had held that the number 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 set-off as claimed against the loss from its business incurred during the previous years.
  • Similarly, in the case of CIT v. Excellent Commercial Enterprises, the Court 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 the Dividend Distribution Tax.
  • The resident shareholder is 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.


Non-Resident Shareholders:

  • The Tax exemption provided on dividends 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.
  • 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 a domestic company. The rate of Tax mentioned in the Double Taxation Avoidance Agreement with Germany (10%), USA (15% or 25%), UK (10% or 15%), Singapore (10% or 15%). The lower rates under the 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.
  • The non-resident shareholder shall not be required to file the income tax return if total income consists of dividends and income tax at the prescribed rate is deducted by the domestic company. The non-resident shareholder is 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.
  • 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 the 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 will not be applicable with effect from 1st April 2020 and would be taxable in the hand of shareholders with effect from 1st April’ 2020.

A company is now required to withhold tax at the rate of 10% in the case of resident shareholders. In the case of a non-resident, companies are required to withhold the tax at the rate of 20% plus surcharge and cess or lower beneficiary rate as per the Double Taxation Avoidance Agreement. The resident shareholder is required to file the income tax return; however, non-resident shareholders are exempted from filing income tax returns in case withholding tax is deducted by the company.

It is important to evaluate whether dividends earned by resident shareholders fall 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.

 

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