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With the aim of reviving the Indian economy and kick-starting an investment cycle in India, Finance Minister Nirmala Sitharaman, in an unprecedented move, slashed the corporate tax rate to 15 per cent for new manufacturing companies and 22 per cent for other companies. Moving forward in this direction, Union Budget 2020 provides further impetus by abolishing dividend distribution tax (DDT). This bold move is likely to make India one of the most attractive destinations for foreign investments, though at an estimated cost of ₹25,000 crore to the exchequer.
Prior to June 1997, dividends were taxed in the hands of shareholders, like any other income. However, for ease of administration and collection of tax at a single point, taxation of dividend was shifted from shareholders to companies distributing dividends, with such dividends being exempt from tax in the hands of shareholders.
Having said the above, the investor fraternity had raised concerns about multi-level taxation. At the first level, dividends are distributed out of a company’s profits after taxation. At the second level, companies pay DDT on the distribution of these profits. With the super-rich tax levied on shareholders who earn dividends in excess of ₹10 lakh, there is triple-level taxation.
Moreover, foreign shareholders were subject to DDT at 20 per cent, which is typically higher than the dividend taxation rate provided in tax treaties, and these shareholders could not claim tax credit in their home country for the DDT paid by the Indian companies.
Much-needed relief
The abolishment of DDT offers much-needed relief to foreign shareholders, resulting in tax on dividends at lower rates as provided in the tax treaties, as well as enables them to claim tax credit in their home country. From the resident shareholder’s perspective, the super-rich tax is abolished, removing one additional layer of taxation on profits earned by the Indian company.
Taxation of dividends at the shareholder level has made investment in jurisdictions like Mauritius and Hong Kong attractive, with tax treaties providing a beneficial tax rate of 5 per cent on dividends. However, having substance in these jurisdictions continues to govern the availability of treaty benefits.
In the DDT regime, the cascading tax effect was mitigated for domestic as well as foreign dividends, subject to the prescribed shareholding threshold. To address the cascading tax effect of dividend taxation under the proposed regime, an Indian company is allowed tax deduction for dividends paid out of the dividend received from another Indian company without any shareholding threshold. Having said that, the cascading tax effect on foreign dividends remains unaddressed. This is likely to discourage Indian multinationals from repatriating profits from foreign subsidiaries into India.
Under the DDT regime, pooling investment vehicles like mutual funds used to suffer dual-level taxation: DDT paid by the company distributing dividends to mutual funds; and DDT payable by mutual funds on distribution to unit-holders. Under the proposed regime, there will be single-tier taxation in the hands of unit-holders. There is no tax leakage on distribution of dividend by the company to mutual funds.
REITs and InvITs
In the case of investment vehicles such as REITs and InvITs, while single-tier taxation continues, the proposed regime would result in cash-flow impact. In this case, an Indian company will be required to withhold tax on dividends distributed to REITs and InvITs. However, under the current scheme of taxation for REITs and InvITs, dividend income from Indian companies is not taxable. Hence, taxes withheld by Indian companies will have to be claimed as refund.
One of the key rationales for adopting the DDT regime was the increased compliance burden on companies. With technological advancement, although some of the compliance concerns can be addressed, administrative issues may persist. With dividend taxation shifted to the shareholder, companies will be required to withhold taxes from the dividends payable to shareholders.
In the case of resident shareholders, the tax withholding will be 10 per cent subject to certain de minimis . In the case of non-resident shareholders, dividends are taxable at 20 per cent subject to the beneficial tax rate under the tax treaty. However, in order to apply the beneficial tax rate under the tax treaty, the Indian company would be required to obtain the prescribed documentation under the law from the foreign shareholders, which could be a challenging task.
Under the proposed regime, while dividends are taxable in the hands of shareholders, the only deduction allowed would be interest expenses incurred for earning such dividends, subject to a cap of 20 per cent of the dividend income.
In a nutshell, this is a bold and positive step towards addressing the long-awaited demands of investors. Before the Budget proposals are enacted, removal of the cascading tax effect on foreign dividends received by Indian multinationals is anticipated. In any case, this step of rationalising taxation of dividends should help in regaining the confidence of foreign investors and getting the Indian economy back on track.
The writer is Partner and Leader, Corporate & International Tax, PwC India. The viewes are personal
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