Reforms in Dividend Distribution Tax

Introduction:

A dividend refers to a distribution of incomes by a company to its shareholders. It is derived from the Latin word ‘Dividendum’, meaning to be a share. The allotment of dividends is made through the profits left after deduction of all overheads, provision of the company’s taxes, and transfer to capital/revenue reserve of the company. Decisions for the dividend distribution is a significant task for financial management. The Dividend Policies determine the percentage of net profits to be paid to the shareholders as dividends, and the remaining percent is reinvested in the company as their retained earnings.

Therefore, the dividend is that part of the company’s profits, which is to be allotted amongst the shareholders. It is considered as the return that the shareholders receive from their holdings in the company shares[1]. The Board of Directors considers the financial necessities of their company and calculates a reasonable profit for their shareholders before determining the methods of dividend distribution. It is then announced in the Annual General Meeting of the company for its approval, and then subsequently distributed as a dividend. Thus, dividend policies mean the policy relating to the calculation and distribution of profits as dividends.

It also implies that within the companies, only the Board of Directors has the power to introduce a method of dividend payments. The distribution of dividends also has an impact on the company’s prospective financial decisions. Dividend distribution is advantageous because the shareholders invest in the company’s capital to get high returns and maximize their wealth. The retained earnings are only the source for internal financing for future needs and expansion plans for that company. Hence, dividend policies regulate the distribution of profits between payments to shareholders and as part of the retained earnings.

Tax on Dividends

Till now we have understood that dividend policies are made to determine the distribution of a company’s earnings, resulting in a reciprocal bond between dividend and retained earnings. Dividend causes outflow of cash and a further reduction in the company’s current assets. Additionally, Dividend Distribution Tax (DDT) is a tax imposed on dividends allotted by companies to their shareholders. The DDT is a Tax Deductible at Source (TDS), hence, it is deducted at the time of its allocation. Under the law, DDT is charged at the hands of the companies along with their shareholders.

When a shareholder receives more than INR 10 lacs as a dividend, they have to incur an additional tax. As per the provisions of the Income Tax Act, 1961, the DDT is charged on the companies prior to their distribution of dividends. Any domestic company which is allocating dividends has to pay the DDT at the rate of 15 percent of the gross value. It depends on the governments of the day to make DDT schemes, to impose, and to remove them according to market requirements.

The DDT has to be given only to the government, within fourteen days of declaration of the dividend. If payment was not made within the stipulated time period, it has to be made with an accrued interest which is charged at the rate of 1 percent per month on the dividend. The DDT is paid separately, over and beyond the Income Tax liability of the company. The DDT postulate proposes that Corporate Tax on allotments and charges made on dividends are important to be considered while deciding a dividend policy. Particularly, the variations between tax levied on dividends, and that on the capital gains are to be considered as well.

If the dividend-in-hand of the shareholders is taxed higher than the capital gains of the company, investors must calculate the estimated earnings through an after-tax basis approach. This would result in share prices varying contrariwise with the company’s overheads. The rationale behind DDT offers an additional tax charged on dividends to make capital gains a less expensive way of refunding the wealth to shareholders[2].

Finance Act, 2020 and the Amendments

Till the Assessment Year 2020-21, if a shareholder receives their dividend from a domestic company, the DDT is discharged in the hands of the shareholder. Earlier, companies were obligated to pay the DDT. The Finance Act, 2020 has proposed the abolition of DDT for companies. Currently, the dividend taxes are charged in the hands of the shareholders or investors of the companies. The DDT is charged in the hands of the shareholders only when dividend distribution was declared on or after 4^th January 2020. The whole amount would become taxable in the hands of the shareholders, and they would be then liable to pay DDT. In simple words, the companies will not be obligated to pay DDT under any law.

Earlier, a domestic company would be liable to pay DDT at the rate of 15 percent on the gross amount of dividend under Section 115-O of the Income Tax Act, 1961. For the deemed dividends DDT is payable at the rate of 30 percent under Section 2(22)(e). Here, the dividend is discharged in the hands of the shareholder. The operative rate for DDT is at the rate of 17.65 percent on the sum of dividends. As per Section 115-O, the valid tax is at the rate of 15 percent. As per the Income Tax Act, 1961, DDT has to be paid within fourteen days of the latest events from the following:

• Declaration of dividend
• Distribution of dividend
• Payment of dividend

On the occasion of non-payment within the due date, interest is applicable at the rate of 1 percent for every subsequent month or part on the aggregate of the tax. The interest would be payable from the point beginning immediately after the latter date on which the tax was to be paid till the actual date of its payment. It is to be noted that the companies are not required to pay DDT on any dividends allotted on or after 4^th January 2020. Below are a few changes to the DDT scheme:

• The whole sum of the dividend is now taxable in the hands of the shareholders.
• The company deducts tax under Section 194 at the rate of 10 percent when the amount of the dividend is above INR 5K.
• Exemption under Section 10(34) is withheld for Assessment Year 2021-22.
• Section 115BBD will not be valid for the current Assessment Year.

Furthermore, through Section 115BBDA, the DDT is also not applicable on mutual funds as:

• For the Debt-oriented funds, DDT is at the rate of 25 percent and at the rate of 29.12 percent after including surcharge and cess.
• For the Equity-oriented funds, DDT is at the rate of 10 percent and at the rate of 11.64 percent after including surcharge and cess.

After the Finance Act, 2020, and its amendment, the dividend would now be taxable in the hands of the unit-holder. The dividend income is taxable as per the slab rates applied for them. This would be when the unit-holder opted for the dividend plan. No limit is set for payment of the dividend. If the company wants to distribute its profits to the shareholders, it can do so without any upper limits, according to its dividend distribution policy and profit assessment. The TDS is currently applicable at a rate of 5 percent for that dividend income which is greater than INR 5K in a financial year[3]. 

The dividend received on shares or mutual funds from a domestic company on or after 1st April 2020 is also taxable in the hands of the shareholders. TDS at a rate of 10 percent is applied to such dividend income. The dividend received by a foreign company is also taxable in the hands of the shareholders as Income from Other Sources under Income Tax Act, 1961. The tax rate would be applied as per the slab rate to such shareholders[4].

Conclusion

As a taxpayer, a person may not be sure about how to treat dividend income while filing a tax return. Finance Act 2020 has shifted the taxability on dividend income from the hands of the dividend declaring the company to the individual investors. The Finance Act, 2020 has changed the method of taxing dividends. The tax of 10 percent on dividend incomes of resident individuals, HUF, and more than INR 10 lacs has been withdrawn under Section 115BBDA.

The regular rate of TDS is fixed at 10 percent on dividend income paid in for more than INR 5K from a company or mutual funds of a company. As a relief measure during the COVID-19 pandemic, there has been a reduction in the TDS rate to 7.5 percent for allotment from 14^th May 2020 to 31^st March 2021. The tax deduction would be held as credit from the aggregate liability of the taxpayer while filing for the income tax returns.

For the non-residents, TDS is to be deducted at the rate of 20 percent, as opposed to the Double Taxation Avoidance Agreement (DTAA), if applicable. The non-residents are required to submit documentary proof (Form 10F), and other such documents to avail the benefits of the lower TDS scheme. In absence of the same, a higher TDS would be deducted at the time of filing the returns.

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References:

[1] What is Dividend Distribution Tax (DDT)? Business Standard, https://www.business-standard.com/about/what-is-dividend-distribution-tax-ddt (26^th Oct. 2021, 18:00 PM)

[2] Saroj Vats, Dividend Distribution policy: An Evaluative Study of Selected Manufacturing Sector in India, Shodhganga@INFLIBNET, https://shodhganga.inflibnet.ac.in/handle/10603/36390 (26^th Oct. 2021, 17:00 PM)

[3] Dividend Tax- Do I need to pay tax on dividend income? Cleartax, https://cleartax.in/s/how-dividends-taxable#:~:text=In%20India%2C%20a%20company%20which,is%20liable%20for%20the%20tax. (27^th Oct., 2021, 16:00 PM)

[4] Anjana Dhand, What is DDT? When is it levied and by whom? Scripbox, https://scripbox.com/tax/dividend-distribution-tax-ddt/#:~:text=surcharge%20and%20cess.-,Amendment%20made%20by%20Finance%20Act%202020%2D%20Abolition%20of%20DDT%20for,to%20pay%20dividend%20distribution%20tax. (27^th Oct., 2021, 18:00 PM)