With dividend income now taxable in the hands of investors, those in the 10% tax slab will benefit as net cash flow in their hands will go up.
The Dividend Distribution Tax (DDT) is a tax levied on dividends that a company pays to its shareholders out of its profits. Earlier, the law stated that DDT is to be levied at the hands of the company, and not at the hands of the shareholders who are the recipients. In the recent Budget, the finance minister has announced that DDT will be taxed in the hands of the shareholders/unit holders. Thus, dividend income from shares and mutual funds will be taxable in the hands of the investors at applicable income tax rates of the respective individual.
Let us discuss whether scrapping of DDT is beneficial to the investors or not.
Genesis of DDT
So far, companies were required to pay DDT at 15%, but effective rate comes out to be 20.56% (on including surcharge and cess). It was introduced in 1997 at a 7.5% flat rate in an effort towards efficient tax collection, but the rate has increased over a period of time which has attracted criticism for unnecessarily burdening companies. People also argued that it amounts to double taxation, after paying a corporate tax at 25%, the effective tax rate, including DDT, for Indian firms worked out to be 48.5%.
As per the recent Budget announcements, all types of dividend income, i.e., whether dividend income from shares or mutual funds, will now be taxable in the hands of the investors. Accordingly, the dividend income which was so far tax-exempt in the hands of the investors, will now become fully taxable. This would mean that the taxable income of the individuals might go up. So, Budget 2020 has proposed to abolish DDT on dividends paid by the corporates and shift the tax burden completely onto the hands of the investors.
Earlier, an individual taxpayer was required to pay tax on dividend at 10% only in case dividend received is more than Rs 10 lakh and no tax was payable in case of dividends received from mutual funds. As per the Budget proposal, the recipient of dividend would be liable to pay income tax at applicable rates irrespective of the amount of dividend received.
Impact on investors
There are certain advantages and drawbacks associated with this new rule. From the company’s point of view, by removing DDT, the quantity of profit available for distribution would get significantly enhanced which the companies could plough back into their own business. Thus, generally it enhances the firm value. Second, by taxing dividend in the hands of the shareholder, double tax avoidance agreement would be triggered in case of a foreign equity investor and the rate of tax would be determined depending on his shareholding and residential status as per double taxation avoidance agreement. Further, this will benefit taxpayers who are in 10% tax bracket as net cash flow in their hands will go up whereas for taxpayers in 20% tax bracket it will be neutral. But, taxpayers in 30% tax bracket will end up paying more tax to exchequer.
The writer is a professor of finance & accounting, IIM Tiruchirappalli