The FM proposed amendments to provisions of income tax and levy tax on dividend received in the hands of shareholders and unitholders. Domestic companies and MFs declaring any dividend shall not be required to pay any DDT.
By Jinesh Shah and Devarsh Patel
Finance Minister on Saturday announced a budget woven around 3 themes—Aspirational India, Economic development and Humane and compassionate society. The most important and expected amendment for corporate India was the abolition of the dividend distribution tax (DDT). Currently, companies are required to pay DDT on the dividend paid to its shareholders at the rate of 15% plus applicable surcharge and cess (effective tax rate for DDT is 20.56%) in addition to the tax payable by the company on its profits.
The FM proposed amendments to provisions of income tax and levy tax on dividend received in the hands of shareholders and unitholders. Domestic companies and MFs declaring any dividend shall not be required to pay any DDT. The incidence of tax would get shifted from companies/MFs distributing dividend to shareholders/unitholders receiving the dividend. Section 80M of the IT Act has been proposed to be reintroduced to provide a deduction of dividend received from domestic company on further distributions by the domestic company receiving the dividend. Amendments have also been proposed in the withholding provisions and all dividends have been brought under the ambit of withholding @10% for domestic shareholders and 20% or applicable treaty rate for non-resident.
FM in her speech said, changes have been proposed in order to “increase the attractiveness of the Indian equity market and to provide relief to a large class of investors”. Other reasons were “system of levying DDT results in increase in tax burden for investors and especially those who are liable to pay tax less than the rate of DDT if the dividend income is included in their income” and “non-availability of credit of DDT to most foreign investors in their home country results in reduction of rate of return on equity capital”.
Various Indian promoters have migrated their shareholding to a trust structure. Proposed amendment would negatively impact such promoters. Indian promoters receiving dividends from domestic companies will be taxed at maximum marginal rate of 42.74%—significantly higher than the current effective rate. Indian promoters would include individuals, HUFs and trust structures. On the other hand, non-resident investors would enjoy lower tax rate as available under tax treaties in force. Tax rate in tax efficient jurisdictions ranges from 5-15%. This discrimination between resident and non-resident investors, does not create a level playing field for on-shore and off-shore investors, and may discourage resident Indian investors. Adversely impacted Indian promoters holding shares through trusts need to reconsider and evaluate their shareholding structure.
Currently, Indian companies receiving dividend from specified foreign subsidiaries were subject to 15% tax and when such companies distribute dividend to shareholders, they were not required to pay DDT. Proposed amendment provides deduction of dividend received from domestic company only on further distributions. No similar deduction has been provided for dividend received from foreign subsidiaries. This would entail an additional tax outflow and a hit on profitability for domestic companies receiving dividend from foreign subsidiaries. One positive impact is that dividend set off would be available for dividend received from all domestic companies and, hence, requirement of having holding-subsidiary relationship shall no longer be required to avail such benefits. Domestic firms receiving dividend from domestic associates, JVs and other small investments would not be taxed if the same are distributed.
As per current regime, REITs/InVITs receiving dividend from investee company (subject to conditions) are exempted from DDT and unitholders of such REITs/InVITs are also not taxed. Effectively, there would have no tax leakage on dividend distribution. However, the budget has taken away exemption in the hands of unit holders of such REITs/InVITs, and they would be subject to tax. This would reduce effective yield in the hands of such unitholders. Currently, when the country needs long-term funds for infrastructure development, continuation of such exemption would have assisted in deepening the market. Investors typically prefer consistency in policy decisions when investing into long term projects.
Jinesh Shah is partner and Devarsh Patel director, M&A and Private Equity Tax, KPMG in India
(With inputs from Kunal Choradia, Assistant Manager, KPMG in India)