Top 10 impacts on investors - Indian dividend tax

A well-played inning of 17 long years come to an end when the special provisions of ‘Dividend Distribution Tax’ (DDT) were proposed to be abolished in the Indian Union Budget of 2020 tabled on 1st February 2020. Dividends are considered as an appropriation of after-tax profits and in many jurisdictions, the concept of taxation of dividends is non-existent. DDT in a way served two purposes, the first one being a notion in the minds of investor (corporates and individuals) that they are receiving the dividends tax-free and the second one being efficient tax collection mechanism for the government by making companies responsible for paying taxes on dividends @ 15% in one stroke on behalf of the investors.

The biggest flaw in the above-mentioned system was that it provided equity but not equality in an economy which has the progressive nature of taxes being deep-rooted in its tax culture. The indirect effect was for a small investor paying taxes @ 15% on his small dividend amount. On the other hand, to bring equality, the government in Budget 2016 announced a super-rich tax @ 10% for receipt of dividends exceedings INR 1 Million which ultimately lead to multiple layers of taxation.

With the technological advancement in tracking the dividends payouts, it is now easy to link dividends directly to the income of the taxpayer. Considering the same, Budget 2020 has proposed dividends to be taxed in the hands of the shareholder. It is important therefore to understand what would change post 1 April 2020 for an investor like you and also for the companies that are investors including the foreign investor companies.

Top 4 impacts for individual investors:

1. TDS on dividends: The companies declaring the dividends would be required to withhold tax under Section 194 of the Income-tax Act, 1961 (the Act) on the dividend income in excess of INR 5,000 @ 10%. Such withholding would be given as a credit in yearly tax compliance.
2. TDS on dividends for non-residents: For a non- resident individual, the TDS on dividends would be governed by Section 195 of the Act, wherein the rates in force would be governed by Section 115A of the Act and the withholding of taxes by the company would be made at the rate of 20% (plus applicable surcharge and cess). If the non-resident wants to take benefit of the treaty, for lower withholding of taxes appropriate documentation including Tax residency certificate, Form 10F needs to be provided.
3. Filing of return of income: For a non-resident (with PAN) or a resident, who in the normal course is not required to file a return of income, due to the low level of income, would have to file the return of income to claim refund if the withholding of taxes on the dividend has resulted in higher taxes being paid than the tax liability.
4. Interest paid could be taken as a deduction: As per the proposed amended provisions of Section 57 of the Act, an interest expense (on borrowings) could be considered as a deduction to the extent of 20% of such dividend income. Something that an individual investor could be happy off who has taken a personal loan.

Top 6 impacts for foreign and domestic investor companies 

1. TDS on dividends to domestic companies: Similar to cases of individuals, the domestic company paying dividends to another domestic investor company would need to deduct taxes @ 10% (plus applicable surcharge and cess). Such TDS would be offset against the overall tax liability of the company for the respective assessment year.
2. TDS on foreign companies: Under Section 195 of the Act, Dividends would get covered in other income thereby making the payer company liable to tax deduction @ 40% (plus applicable surcharge and cess).
3. Foreign company to obtain Certificate under Section 197 in order to avail a lower rate of tax withholding: In case the foreign company wants to avail treaty benefits and accordingly inform the deductee company to withhold TDS on dividends at a preferential rate, the foreign company would have to make an application to the assessing officer for a grant of lower tax deduction certificate. For a foreign company, to avail treaty benefits the provisions of Section 90(4) of the Act would be applicable, hence TRC requirement for obtaining lower tax withholding certificate or filing of return of income is a must. This step is not compulsory, however, many companies with substantial foreign company holding may like to clarify the tax position in advance.
4. Filing of return of income by the foreign company receiving dividends: Further, post-application of preferential treaty rates, the same needs to be claimed by the foreign company by filing return of income in India. The non-filing of a return by a non-resident under Section 115A for dividend income is only applicable for a tax deduction under normal provisions of Section 195 and does not cover treaty claims.
5. No cascading effect of taxation for domestic company investor: Section 80M of the Act is reintroduced with a new twist. A deduction of dividend income received by the 1st layer entity is provided as a credit against dividend income of the 2nd layer entity if the 1st layer entity declares dividend 1 month prior to the due date of filing of return of income.
6. Transfer pricing and dividend distribution: Prior to the abolishment of DDT, dividends were treated as an appropriation of profits and were reported as an international transaction. However, post such abolishment of DDT, there could be far-reaching impacts on the transfer pricing of dividends. The author would cover the same in great detail in the follow-up article.

With the wave of complexity around the topic, it is recommended for an investor to seek a well rounded professional advice on the taxability of dividend and prepare himself towards additional compliance requirements for dividend income.

Includes some thoughts by Mr. Ramesh Khaitan – Sr. Vice President (Direct Taxes) – Lupin Pharma group.

Written and conceptualised by CA. Akshay Kenkre

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