Impact of abolishment of Dividend Distribution Tax

Typically, foreign companies provide services such as technical services/ training services, etc. to its subsidiary companies in India for repatriation of funds to their home country.

Typically, foreign companies provide services such as technical services/ training services, etc. to its subsidiary companies in India for repatriation of funds to their home country. Due to COVID-19 and the subsequent lockdown in India, such foreign companies are not able to provide their services. At the same time, income tax authorities may also raise concerns over the expenditure relating to the repatriation of funds by Indian subsidiaries  to its foreign companiesduring the lockdown period.

In such a situation, foreign companies may consider repatriation of funds by way of distribution of dividend by Indian subsidiaries to them. Recently a major amendment has been made in the Income tax law in India pertaining to taxation of dividend income through the abolishment of the Dividend distribution tax on the same w.e.f. April 01, 2020. The abolishment of the Dividend distribution tax has impacted not only the domestic companies and taxpayers in India but also the foreign companies having Indian subsidiaries. Before analysing said impact, it is imperative to briefly understand Dividend distribution tax in India.

Dividend distribution tax (DDT) is the tax imposed by the Indian Government upon domestic companies according to the dividend paid to their shareholders/investors. The concept of DDT 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.

At present, DDT is removed by the government in the financial Budget 2020 to increase the attractiveness of the Indian equity market and to provide relief to a large class of investors. 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. Accordingly, the classical system has been adopted for dividend taxation under which the companies would not be required to pay DDT. The dividend shall be taxed only at the hands of the recipients at their applicable rates.

Table below provide a gist of earlier law pertaining to DDT and law post abolishment of DDT

Earlier law (DDT applicable) Post abolish of DDT
DDT shall only be payable on dividends declared, distributed or paid by a domestic company on or before March 31, 2020. Domestic Companies do not require to pay any DDT w.e.f. April 01, 2020.
Domestic companies to pay DDT @ 15% plus surcharge and cess (effective rate - 21.17%) on the dividend declared, distributed or paid to its shareholders. DDT shall be paid by the domestic company within 14 days of dividend declared, distributed or paid whichever is earlier. Domestic company is under an obligation to withhold TDS @ 10% of dividend paid to resident shareholder over and above a higher threshold exemption of INR 5,000. In case of non-resident, the domestic company is under obligation to withhold the TDS @ 20% plus surcharge & cess or lower beneficiary rate as per Double Taxation Avoidance Agreement (DTAA).

Though the government had claimed that the abolishment of DDT will result in tax foregone of INR 25,000 crore, however, it is pertinent to analyse the impact of such removal on varied fragments.

Impact on Domestic Companies – Increase in compliances

  1. 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 since such companies need to maintain the below mentioned details for the purpose of deducting TDS:-
  • List of shareholders
  • PAN details of shareholders
  • Individual computation for each shareholder
  • Obtaining Lower/ No TDS deduction certificate from shareholder.
  1. In case the total 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 a deduction is only available where the first domestic company distributes the dividend to its shareholders on or before one month prior to the due date of filing of return of income. Failure to comply with the same within one month shall result in the deduction of TDS on such dividend income, resulting double taxation.

Impact on Promoters of Domestic Companies – May subject to High rate of tax

Tax on the promoters of the Domestic Company may have an adverse impact on certain investors falling under higher tax brackets (i.e. 30% plus surcharge and cess).

Earlier, the  tax on income from dividend in the hands of promotors of the domestic company was NIL (in case income from dividend upto INR 10 lacs) and 10% (above INR 10 lacs).

W.e.f. April 01, 2020 i.e. post abolishment of DDT, promotors of the Domestic Company will have to pay according to their respective income-tax, tax slabs which may be as high as 30% plus surcharge and cess.

Impact on Dividend distribution amongst shareholders – Lower dividend distribution

  1. The Domestic companies may distribute lower dividends amongst their shareholders (as per mutual agreement) thereby diverting funds towards further development of the business in terms of purchase of capital assets/ technology, etc.
  1. The high stake shareholders/ promoter shareholders also might not prefer to receive dividend and instead would prefer professional/ technical fees subject to GST @ 18%.

Impact on Foreign companies having subsidiaries in India - Benefit of Treaty available

Benefit of lower rate of tax as per the treaty is now available to such foreign companies as against the fixed and higher rate of DDT @ 21.17% paid earlier by Indian subsidiary Company.

The rate of tax mentioned in DTAA with Germany is 10%, USA is 15% or 25%, UK is10% or 15%, Singapore is 10% or 15%.

Impact on Foreign/ non-resident shareholder - Benefit of Treaty available

The benefit of lower rate of tax as per the treaty as discussed above will be available to foreign/ non-resident shareholder.

Conclusion

The proposal for abolition of Dividend Distribution Tax is certainly a welcome move to small shareholders and foreign companies/ investors but increases the compliances of domestic companies and tax liability at the hands of large shareholders.

In terms of the tax part, while some categories of shareholders will now enjoy lower tax incidence on dividend incomes post abolishment of DDT, others will end up paying exorbitant prices in the form of higher taxes which may be as high as 43%. However, the foreign companies/ investors will now can take the benefit of lower tax rate as per the treaty thereby getting direct benefits financially.

In terms of compliances, though, the resident shareholders are required to file the income tax return, however, the non-resident shareholder shall not be required to file the income tax return if the total income consists of dividend and the TDS is deducted by the domestic company. In such cases, the non-resident shareholder is required to submit the documents to the domestic company to obtain the beneficial rate of withholding the tax rates such as Tax Residency Certificate of Home Country, Tax Identification Number of Home Country, Contact Details, Permanent Account Number (if available).