The government's vision of making India a $5-trillion economy by 2024-25 appears to be challenging. To achieve the target, the government recently reduced the corporate tax rates cut and partially withdrew the enhanced surcharge to attract more foreign investments and to provide more funds with companies for reinvestment.
Abolishment of dividend distribution tax (DDT) has been in the news lately. Tax experts think that DDT is one of the significant hurdles in enriching the Indian corporate economy and it should be replaced with a progressive system of taxation.
The Finance Act, 1997 introduced the concept of DDT to levy an additional tax on the domestic companies distributing profits to the shareholders. Before this, dividend income was taxable in the hands of the shareholders. Though the structure of DDT is methodical and premeditated, yet it has a few shortcomings for the investors and companies paying such tax.
Multiple tax collection from the same source of income keeps the investors at bay. The companies pay the dividend out of profit remaining after tax. Thus, companies first pay tax on the profits earned by it, and then they pay additional tax on the profit distributed as dividend. Lastly, tax is also paid by the domestic shareholders if the aggregate amount of dividend received by them exceeds Rs 10 lakh. As a result, DDT brings in the cascading effect of taxation.
In the current regime, the companies pay the dividend distribution tax at the flat rate, notwithstanding the tax rates applicable to the shareholder. Thus, a shareholder who is otherwise liable for lower tax rate is paying higher taxes in the form of DDT. On the other hand, a shareholder who is otherwise liable to pay tax at a higher rate is actually paying tax lower taxes. If the government decides to abolish DDT, the dividend income would be taxable in the hands of shareholders as per the slab rates applicable to them.
The idea behind bringing DDT was to tax dividend income at the company level so that there could be zero revenue loss. Even after abolishing the DDT, the government can ensure zero revenue loss if the deduction of tax from the amount of dividend is made mandatory without any threshold limit. Companies should be liable to pay TDS at the flat rate, and the remaining amount of tax can be collected from the shareholders. The government follows a similar approach on interest income on which tax is deducted under Section 194A.
Considering the current state of the economy, rationalisation of DDT is the need of the hour. This decision can infuse positive sentiments as companies will have more funds for reinvestment. Foreign companies will pay lesser taxes on the dividend as most of the double taxation treaties prescribe the tax rate of 10 per cent on dividend income. Further, the foreign companies will be able to claim the foreign tax credit of taxes so paid in India.
This move not only avoids the ongoing cascading effect on dividend distribution but would also give monetary benefits to both the shareholder and the Income Tax Department. If a company allocates the same distributable profit for declaration of dividend, the shareholders will now receive more dividend income. In other words, that portion of distributable profit which was utilized for payment of DDT (till financial year 2019-20) will now be distributed among shareholders. Thus, more dividend income shall be paid to the shareholders. Shareholders falling lower tax brackets pay lesser taxes on dividend income, whereas those in higher tax brackets lead to more revenue for the tax department. Let's understand how.
|Shareholder||Applicable tax rate||Financial Year 2019-20||Financial Year 2020-21||Net benefit/Loss|
|Dividend received after DDT @ 20.55%||Dividend Received*||Tax on dividend||Net inflow from dividend|
(*Assuming that the portion of distributable profit which was utilized for payment of DDT (till FY20) will be distributed among shareholders. Thus, more dividend income will be paid to the shareholders. If other conditions remain the same, the same shareholder would now get a dividend of Rs. 1,20,556 viz-a-viz Rs. 1,00,000.)
The task force constituted to draft new direct tax laws has also suggested the abolishment of dividend distribution tax (DDT) in its report which was submitted to the Finance Ministry in August 2019. It has been recommended that instead of levying DDT on companies, the tax should be levied in the hands of shareholders. The task force claims that this step will provide an enormous boost to foreign direct investment (FDI).
(Naveen Wadhwa is Deputy General Manager and Shivi Agarwal is Assistant Manager at Taxmann.com)
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