Budget 2020 & Dividend Distribution Tax – New Challenges

A brief visit on history shows that DDT was introduced in 1997, removed in 2002 only to be re-introduced in 2003 till it is now slated to be removed in 2020.  DDT was mandated under section 115O.  There are 2 major reasons why DDT is proposed to be removed.

First, as expected on persistent demand from non-resident investors Dividend Distribution Tax (DDT) has been abolished from the financial year 2020-21.  The DDT which was approximately 20.56% (15% + Surcharge & Cess) was a major concern for non-resident investors.  Also as DDT is a tax obligation of the distributing company (i.e. it is not in the nature of TDS), such DDT is not available as a credit to the non-resident shareholder in his country and hence not eligible for refund of this tax.  Now under the new regulations Indian companies paying dividend to non-resident investors need to comply withholding tax provisions albeit at a lower rate as prescribed under the respective country treaty.   The treaty rates are beneficial to non-resident investors and it is usually between 10% to 15% in most of the cases.  This move is intended to attract foreign investments as non-residents have lower tax rates in virtue of tax treaties. 

Second, to avoid a flat rate on the distributed profits across the board irrespective of the marginal rate at which the recipient is otherwise taxed DDT is slated to be removed.  Now with the incidence of tax passing on to shareholders they will have to discharge their tax liability depending on their income slabs.  This brings in more equity among tax payers.

The below are the challenges on removing DDT.

1. This new tax regime puts the resident investor at a disadvantageous position as the highest tax rate may be as high as 42.74% for individuals and 34.94% for resident companies on dividends received as against DDT of 20.56% currently.   Representations have been forwarded to finance ministry to tax dividends separately (something similar to the removed section 115BBDA) at the rate of 10% for dividend amounts upto Rs.10 lakhs and at 20% for dividend amounts above Rs.10 lakhs per annum.   
2. The new DDT regime proposes to introduce section 80M to avoid cascading effect on dividend tax.  A company which has multiple layers viz subsidiaries can set off dividend income from their Indian subsidiaries and also from Indian companies, Section 80M provides relief from cascading effect on all dividends received from domestic companies.  However if a company receives dividends from foreign companies section 80M does not provide set off relief and this dividend received is not set off against dividend income in hands of recipient.   
   ‘80M. (1) Where the gross total income of a domestic company in any previous year includes any income by way of dividends from any other domestic company, there shall, in accordance with and subject to the provisions of this section, be allowed in computing the total income of such domestic company, a deduction of an amount equal to so much of the amount of income by way of dividends received from such other domestic company as does not exceed the amount of dividend distributed by the first mentioned domestic company on or before the due date.
3. Reading section 80M provision is available only when tax is paid under normal provisions of the Income Tax Act.  If a company is paying tax under section 115JB (Book Profit - MAT) then section 80M cannot be applied.  This needs an amendment to the section 115JB and section 80M
4. Buy back of shares under section 115QA has an effective tax of 23.29%.  For individual persons receiving tax highest rate of tax will be 42.74%.  This in effect means for this category of shareholders buyback of shares offers a lower rate and there are chances of more share buyback than dividend for domestic companies for the years after April 2020.
5. Transitional provision.  A company has 14 days for disbursal of dividend from the date of declaration of dividend.  There is confusion as to if dividend is declared in last week of March 2020 and actual payment is effected in April 2020 will there be double tax – in March DDT and in April individual tax?  Clarification is required from Government on this subject.
6. Section 194 has been amended by finance Act 2020 to enable TDS @ 10% to be deducted for dividends exceeding Rs.5,000 per year
7. Amendment to Section 115A provides that a non-resident should file return in India if his dividend income has been subject to TDS which is less that the rate prescribed under Chapter XVII-B.  In practice most of the non-resident entities will be covered under a treaty and will have a rate lower than the one provided in Chapter XVII-B.  In short most of the non-residents will be mandated to file income tax returns in India for dividend income and also would be required to file form 3CEB

A Quick look at Mutual Fund dividends

A new section 194K is introduced in budget 2020 to provide that any person responsible for paying to a resident any income in respect of units of a Mutual Fund will deduct income-tax (TDS) there on at the rate of 10% if the amount exceeds Rs.5,000 per annum.  This 194K has cast a doubt on investors’ minds, whether only dividends will be subject to 10% TDS or also capital gains arising out of mutual fund withdrawals are subject to TDS.   A suitable clarification is expected from Government on this soon. 

Conclusion

Removal of DDT is a welcome step for the industry albeit for some promoter held entities whose promoters will be required to pay tax at a higher rate.  Government has to come out with clear answers / guidelines to remove all concerns of industry relating to the points mentioned above to bring in high level of clarity and seamless implementation of this change.