Dividend Distribution Tax (DDT) regime is applicable only to Indian companies. The shareholders of such companies are exempt from tax on dividend received from such companies, with the tax at the rate of 15 per cent plus surcharge and education cess having been paid by such companies.

If an Indian resident receives dividend from a foreign company, such dividend will be added to his income and become taxable at the applicable marginal rate of taxation. Many Indian promoters have set up companies abroad in which their Indian investment companies have sizeable stakes. These promoters have been indulging in a bit of self-abnegation by contriving not to receive dividend from such foreign companies if only to escape taxation which would be a hefty 30 per cent plus. The fact that they have lobbied hard for an enabling regime shows that they want to use their sizeable dividend income for their Indian activities.

The Revised draft of the Direct Taxes Code unveiled a plan to zero in on the passive income from controlled foreign companies. Finding that their Indian promoters are refusing to declare and receive dividend from such companies, the revised draft read the riot act to them - dividend capable of being declared but which has not been declared would be deemed to be the dividend income of the Indian promoters and taxed accordingly. The threat seems to have worked.

Budget proposal

It is believed that the industrialists prevailed upon the government and scuttled the incipient move to tax the passive income from controlled foreign companies for a quid pro quo. And the quid pro quo is what the Finance Bill, 2011 proposes — a 15 per cent flat tax plus surcharge on the gross dividend income received by Indian companies from foreign companies in which the former have a minimum 50 per cent equity stake.

The new law on the subject would have done well to remove an ambiguity that seems to have crept in. Does 50 per cent stake in the foreign company by an Indian company mean direct holding or also through conduits? It is common for a clutch of investment companies coming under a group to invest abroad and together they may account for a minimum 50 per cent stake. Would such investments pass muster under the new law? If, on the other hand, the law insists on direct investment by an Indian company, then the group companies should anoint one among themselves for making foreign investments lest the sizeable tax relief is lost.

Other ponderables

It seems the Indian companies may not be able to get away with a 15 per cent basic tax after all on the dividend income from foreign companiesThey have the MAT regime to contend with. The current MAT rate is 18.5 per cent. Accordingly wherever MAT becomes payable, the dividend income from foreign companies built into the book profits would suffer tax not at 15 per cent, but at 18.5 per cent. Yet, the concession is nothing to scoff at.

The dividend received by an Indian company from its foreign subsidiary will form the part of the base for calculating DDT because as per Section 115-O DDT is not payable on dividend received by a parent from its subsidiary if the subsidiary has paid DDT. A foreign subsidiary obviously would not have paid DDT. In the event, the tax outgo on dividend received from foreign subsidiaries could be much more than 15 per cent plus or 18.5 per cent plus.

Given a DDT rate of 15 per cent plus, the final tax outgo would be anything between 30 per cent plus and 33.5 per cent plus. Under the original proposal, , the tax outgo would have been 30 per cent+15 per cent i.e. corporate tax plus DDT ignoring surcharge and education cess.

The Indian promoters should do well not to invest abroad on their own, but only through a conduit of a company. For, personal investment would still attract tax at the applicable marginal rate, and not at the proposed flat rate of 15 per cent.

Parity in tax treatment

Now, the tax rate on dividend is 15 per cent whether declared by an Indian company or by a foreign subsidiary. The Indian parent company will have to shell out DDT on dividend received from its foreign subsidiary as well. The double dose of tax on dividend avoided by Indian parent-Indian subsidiary duo cannot be avoided by the Indian parent-foreign subsidiary duo.

(The author is a Delhi-based chartered accountant.)