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It’s almost a month since the Union budget was presented and by now taxpayers and other stakeholders have gone through the fine print to understand the implications of various announcements. While some proposals brought cheer to taxpayers, certain other proposals are a mixed bag. One such budget announcement which has brought relief to taxpayers is the proposal to abolish the dividend distribution tax (DDT) payable by Indian companies and restoring the classical system of taxing dividends in the shareholders’ hands. This was a much-awaited move and a constant demand by various stakeholders.

Taxability of dividends till FY20

Currently, Indian companies are required to pay DDT on the dividends declared, distributed or paid to shareholders at the rate of 15% plus applicable surcharge and cess taking the effective rate to 20.6%

At present, the dividends are not subject to tax in the hands of the shareholders, except for certain category of resident taxpayers where dividend income exceeding 10 lakh attracts an additional tax at the rate of 10% under section 115BBDA of the Income-tax Act, 1961 (the Act). This category comprises resident shareholders other than a domestic company, i.e. individuals, Hindu undivided family, association of persons (AOP) and body of individuals (BOI), partnership firm or an LLP. It is pertinent to note that resident corporate shareholders, foreign companies and non-residents are not subject to pay this additional tax of 10% on dividends received from Indian companies.

Even after the concessional tax rates introduced by the Taxation Laws (Amendment) Act, 2019, the total levy of corporate tax, including DDT, took the effective tax rate to about 45%, which is arrived at by adding the effective concessional corporate tax rate of 25.2% (i.e. 22% plus applicable surcharge and education cess) and effective DDT at the rate of 20.6% (i.e. 15% on grossed up basis). The effective tax rate of 45% was high as compared to other countries and India was seen to be gradually losing its competitive edge, especially from a foreign investment perspective.

Post deletion of DDT, dividend income will be taxed in the hands of all shareholders at applicable tax rates. The impact of these changes for resident and non-resident shareholders are discussed in the ensuing paragraphs.

Impact on resident shareholders

Resident individual taxpayers, Trusts, etc., falling under the highest slab and with income above 5 crore who are subject to the maximum rate of 30% (plus surcharge at 37% and cess at 4%) with an effective tax rate of 42.7%, stand to forgo more tax on the dividends now.

Earlier, the effective tax rate on their dividend income was 34.8% [i.e. DDT at 20.6% plus income tax at 14.2% (ie. tax at 10% plus surcharge at 37% and education cess at 4%) under section 115BBDA].

On the other side, resident individual taxpayers falling under the lowest slab who are subject to tax at the effective tax rate of 10.4% (10% plus education cess at 4%) stand to gain from the new regime, with lower tax outgo.

Similarly, Indian firms and LLPs will also be liable to tax on the entire dividend income resulting in higher tax outflow under the new dividend taxation regime. Under the earlier regime, they were subject to tax at an effective rate of 32.20% [DDT at 20.6% plus tax at 11.60% (10% plus surcharge at 12% and education cess at 4%) under section 115BBDA], whereas under the new regime they will have to forgo tax at 34.90% (tax rate of 30% plus surcharge at 12% and education cess at 4%).

The resident corporate shareholder may also be at a loss as under the earlier regime the company declaring dividend was required to pay DDT at 20.60% whereas under the proposed regime the corporate shareholder opting for the new concessional tax rate under section 115BAA of the Act will be liable to pay tax at 25.20% on the dividend income. However, the Budget also proposes to eliminate the cascading tax effect in case of inter-corporate dividends by providing a deduction under section 80M in respect of dividends received by a domestic company to the extent such dividend is distributed to its shareholders. Such deduction shall be allowed only if the dividend is distributed by the company at least one month prior to due date of filing of return of income.

Deduction for interest on borrowings taken for investments on which dividend income is being earned shall be restricted to 20 per cent of dividend income. Only resident shareholders would be eligible for this deduction and no other deductions would be allowed to the shareholder against dividend income

It is pertinent to note that the dividend paid to resident shareholders will be subject to tax withholding at the rate of 10% on dividend above `5,000.

Impact on NRI shareholders

The key beneficiaries of the proposed amendment are likely to be foreign companies and non-residents who receive dividend income from Indian companies. This is due to the fact that the tax treaties with most of the countries limit the taxation on dividends between 5% to 15%. Thus, companies in the US, Mauritius, Singapore, etc., who have subsidiaries in India and are eligible to avail the benefit under the tax treaties would be major beneficiaries.

The Indian company distributing dividend would be liable to withhold taxes at 21.84% (i.e. tax rate of 20% plus applicable surcharge and cess) on payment of dividend to a non-resident shareholder. However, this rate could be lower if the benefit under the tax treaty is availed by the non-resident taxpayer/shareholder. Further, foreign shareholders may get credit in their home country for the taxes paid in India. Although, the proposed amendment would boost the sentiment of foreign investors, it will increase compliance burden for them as they will have to file income tax return in India if they avail tax treaty benefit. In the earlier DDT framework, the non-resident investors were not able to claim a tax credit with respect to the DDT paid by Indian companies.

The other side of the coin

It appears an unintended fall out of this change in tax regime is on Real Estate Investment Trusts (REITs) and Investment Infrastructure Trust (InvITs). With deletion of DDT and taxation of dividend in the hands of shareholders, the unitholders of InvITs and REITs would be required to pay tax on the dividend income at applicable tax rates plus surcharge and education cess. Under the existing structure, the dividend received and paid by REITs were exempt at all three levels i.e. special purpose vehicles (SPVs) were not required to pay DDT, InvITs and REITs were exempt from tax on dividend received from SPV and unitholders of InvITs and REITs were exempt from paying tax on dividend received. The budget 2020 has shifted the burden of tax on dividend income to investors. While nothing changes for SPVs and the trusts as they still won’t pay tax, unitholders of InvITs and REITs are no longer exempt.

We understand that representations have been made to the government to re-consider the tax impact of this proposal on REITs and InvITs and their unit holders.

The proposed amendment is a welcome step and aligns the taxability of dividend income with that of other countries. The tax payers need to evaluate the impact of this change on their overall income and tax from dividends.

Sidharth Sipani contributed to this article. Vikas Vasal is national leader-tax at Grant Thornton India LLP

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