Tax on dividend is something which has got constant attention of the lawmakers. We have yet another amendment to deal with and this time it’s a mammoth one.

Background

Dividend is a part of the profits of a company that is paid to the people who own shares in it. A company earns profits, on which it pays tax. This tax paid profit can be distributed to the shareholders in the form of dividend; which can be termed as return on investment. Such dividend is considered as income of the shareholders. Such profits of the company which has already suffered tax, again suffers tax in the hands of the shareholders. This treatment is considered by many as amounting to double taxation. Such conclusion is strengthened when similarly placed structures i.e., firms and LLPs are evaluated. The tax paid profit of a firm/ LLP, when distributed amongst the partners, is not again subjected to tax in the hands of the partners, and the same is exempt u/s 10(2A) of the Act.

Many a times, people are not able to digest the act of the Government in giving incentives to the companies vis-à-vis other persons, in the form of beneficial tax rate. Such angst amongst the other classes of taxpayers, as to favourable treatment to the company may not be justified, as the tax paid profits of the company when distributed again suffers tax in the hands of the shareholders and that too at the normal rates.

History of tax on dividend in India since 1961

Tax on dividend has undergone many flip flops. It was sometimes taxed in the hands of the shareholders and sometimes in the hands of the company in the form of Dividend Distribution Tax (DDT). The journey of tax on dividend so far is brought out as under:

Period	System of tax
01.04.1961 till 31.05.1997	Tax in the hands of the shareholders
01.06.1997 till 31.03.2002	DDT regime
01.04.2002 till 31.03.2003	Tax in the hands of the shareholders
01.04.2003 till 31.03.2020	DDT regime
01.04.2020 onwards	Tax in the hands of the shareholders

When the first change was made from the classic system of taxation to DDT by Finance Act, 1997, the Circular No. 763 dated 18.02.1998, explained the logic behind such insertion. It stated that the purpose was to reduce the paper work and to reduce the effect of double taxation. It is interesting to note that, tax on dividend amounts to double taxation was first acknowledged by the Government in this Circular.

When the DDT regime was reversed by Finance Act, 2002, the Hon’ble Finance Minister Shri Yashwant Sinha, in his Budget Speech, reasoned that there is an inherent inequity in the present system, which allows persons in the high-income groups to be taxed at much lower rates than the rates applicable to them.

Immediately in the next Budget, the system was reversed to DDT system. The reason given for this restoration in the budget speech was to promote investment in the industrial sector, improve the debt and equity markets and to bring the small investors back to the equity markets by restoring their confidence. Thus, the logic changed with the change in the ministers.

At this juncture, it may be noted that such amount of DDT is considered as an additional income tax in the hands of the payer company. This is clear from the section itself. In fact, this is also held by the Apex Court in case of Godrej & Boyce Manufacturing Company Ltd. vs. DCIT [394 ITR 449(SC)]. In this case, the Court held that DDT cannot be construed as tax paid on behalf of the taxpayers, accordingly, section 14A was made applicable.

Subsequently, in 2016, the Government vide Finance Act, 2016, introduced a new section i.e., section 115BBDA, whereby a person (other than company and other few exceptions) is taxed on dividend received over ₹ 10 lakhs at the rate of 10%. The Hon’ble FM in his speech, stated that DDT applies uniformly to all investors irrespective of their income slabs. This is perceived to distort the fairness and progressive nature of taxes. Persons with relatively higher income can bear a higher tax cost and therefore, section 115BBDA was inserted.

Proposed amendment

After a long period of 17 years of jostling with DDT, the Budget for the year 2020-21 has proposed to bring back the classical system of tax i.e. tax on dividend in the hands of the shareholder. Resultantly, the following amendments are proposed:

Change in system of tax

1. Section 115-O shall apply to all dividends declared, distributed or paid by a company on or before 31.03.2020, after which, it shall cease to apply.

2. Similarly, section 115R shall apply to any amount of income distributed by the specified company or a Mutual Fund to its unit holders only up to 31.03.2020.

3. Section 10(34) and 10(35) which provided exemption to the shareholders and unit holders respectively, will cease to apply after 31.03.2020.

4. Further, section 115BBDA is amended to apply only on dividends declared, distributed or paid by a domestic company upto 31.03.2020.

TDS

5. TDS is now to be deducted u/s 194 on dividend at the rate of 10% and threshold is proposed to be increased from ₹ 2,500/- to ₹ 5,000/- for dividend paid other than in cash. Further, the present mode of payment, which is payment by an account payee cheque or warrant is to change to any mode.

6. TDS is also to be deducted on payment of dividend to non-residents u/s 195.

7. TDS is now to be deducted under a new section 194K by any person responsible for paying to a resident any income in respect of units of a Mutual Fund specified u/s 10 (23D) or units from the administrator of the specified undertaking or units from the specified company. Such TDS is to be deducted @ 10%. Threshold limit of ₹ 5,000/- is provided so that income below this amount does not suffer tax deduction.

8. TDS shall be applicable u/s 196A on payment to a non-resident, not being a company, or to a foreign company, of an income in respect of units of a Mutual Fund specified u/s 10 (23D) or from the specified company referred to in the Explanation to section 10(35) @ 20%. Further, the present mode of payment is to change to any mode.

9. Section 196C provides, inter alia, for TDS on income by way of interest or dividends in respect of bonds or GDRs payable to a non-resident, referred to in section 115AC @ 10%. The exclusion of dividend referred to in section 115O is removed. Further, the present mode of payment is to change to any mode.

10. Income in respect of securities referred to in 115AD(1)(a) payable to a Foreign Institutional Investors (FII) is subject to TDS u/s 196D @ 20%. The exclusion of dividend referred to in section 115O is removed. Further, the present mode of payment is to change to any mode.

Consequential amendments

11. Consequential amendments of removing reference to section 115-O in various sections like section 57, 115A, 115AC, 115ACA, 115AD and 115C of the Act, are also proposed.

12. Consequential amendment proposed in section 10(23D), as mutual fund no longer required to pay additional tax.

Business trust

13. In so far as a business trust is concerned, the dividend distributed by SPV to such trust was exempt u/s 10(23FC). This exemption has been continued. When the trust distributes such dividend income to the unit holders, it was exempt in the hands of the unit holders u/s 10(23FD). Such exemption on dividend income to the unit holders of the business trust is proposed to the withdrawn. This is by making suitable amendments in section 10(23FC), 10(23FD) and 115UA of the Act.

14. TDS is to be deducted by the business trust u/s 194LBA on dividend income paid to unit holder, @ 10% for resident. For Non-Resident, it would be 5% for interest and 10% for dividend.

Deduction u/s 57

15. Section 57 is proposed to be amended to allowed deduction of only interest expense from the dividend income, or income in respect of units of a Mutual Fund [specified u/s 10(23D)] or specified company [defined in the Explanation to section 10(35)]. Further, such deduction is also limited to the extent of 20% of such income included in the total income for that year, without deduction under this section.

Removal of cascading effect (Section 80M)

16. Section 115-O, provided a deduction of dividend received from a subsidiary company (more than 50% shareholding), while calculating DDT on dividend distributed by the holding company, thereby removing the cascading effect. To continue such beneficial treatment, section 80M is proposed. It states that where the gross total income of a domestic company in any previous year includes any income by way of dividends from any other domestic company, then in computing the total income of first company, a deduction of an amount of dividends received from other domestic company shall be allowed. However, such deduction shall be restricted to the amount of dividend distributed by the first mentioned domestic company on or before the date which is one month prior to the date for furnishing the return of income u/s 139(1). Deduction allowed once, shall not be allowed in any other year.

Rationale behind proposed amendment

Interestingly, the explanation given in this behalf is worth pondering. The Hon’ble Finance Minister, in her speech stated that the system of levying DDT results in increase in tax burden for investors and especially those who are liable to pay tax at less than the rate of DDT, if the dividend income is included in their income. Further, non-availability of credit of DDT to most of the foreign investors in their home country results in reduction of rate of return on equity capital for them. Therefore, to increase the attractiveness of the Indian Equity Market and to provide relief to a large class of investors, it is proposed to remove DDT and adopt the classical system of dividend taxation.

Explanatory Memorandum, in this regard, states that the incidence of tax on dividend is on the payer company/Mutual Fund and not on the recipient, where it should normally be. Moreover, it also states that the present provisions levy tax at a flat rate across the board irrespective of the marginal rate at which the recipient is otherwise taxed. The purpose behind reintroduction of DDT by the Finance Act, 2003, was to ease the collection of tax at a single point and to reduce the compliance burden. However, with the advent of technology and easy tracking system available, the justification for current system of taxation of dividend has outlived itself.

Thus, the main reason for bringing back classical system of tax on dividend is stated to be a regressive state of affair of having a common rate of tax for all shareholder in all slabs. However, it may be noted that for the same reason, section 115BBDA was inserted. This reason, therefore, doesn’t appear to be the main reason for change. The Government may be lured by the increased surcharge rate which is effective from AY 2020-21; though it has been announced that the removal of DDT will lead to estimated annual revenue forgone of ₹ 25,000 Crore.

Impact of the amendment

The positives of bringing back the classical system are:

i. The company shall no longer need to comply with section 115O and it no longer shall be treated as assessee in default. This risk increased when DDT was made applicable even on deemed dividend u/s 2(22)(e) of the Act by Finance Act, 2018.

ii. Amount to be distributed by the company will be more as even the tax amount will be distributed amongst the shareholders.

iii. Shareholders falling in lower slab rates or whose total income does not exceed the maximum amount chargeable to tax will benefit.

iv. Entities whose income is totally exempt like charitable trusts etc. will benefit

v. Person who incurs loss in a year, will be eligible to set off such loss against dividend income and avoid tax on such income.

vi. The foreign entities or non-residents will be able to take treaty benefits of beneficial rates as well as tax credits.

vii. Section 14A becomes inapplicable. Therefore, litigation will reduce to this effect.

viii. Foreign companies having branch in India will benefit by setting up subsidiary company in place of branch. If such new company is set up after section 115BAB becomes effective and it is into manufacturing activities, then its profit will be taxed @ 15% and when dividend is distributed, such dividend may be taxed at beneficial rate under the treaty which may be 10% or so. Thus, the effective rate of 44% on the branch in India will reduce substantially if company is set up in India. In such cases, the Department will try to prove that the Indian company is PE of the foreign company and thereby try to tax such profits at the higher rates.

The negatives are:

i. TDS compliance on the company will increase. I feel that this compliance will be more than the compliance u/s 115O. The company will be required to deduct TDS on payment of dividend to various shareholders. It has to file TDS return with PAN of thousands or lakhs of shareholders. Further, it will have to issue TDS certificates to such shareholders. There may arise issues as a result of TDS mismatch etc. due to the sheer volume.

ii. High Networth Individual (HNI) shareholders will face the music. The dividend income above ₹ 10 lakh was taxed at the rate of 10% u/s 115BBDA. Now, the same will be taxed at the highest rate applicable with surcharge. Further, there shall also be a requirement to pay advance tax, as TDS will be @ 10% only, while such income may be charged to tax at much higher rate.

Business Trusts

Business Trusts, REITs and INVITs are the biggest losers. This concept of business trust was introduced in the year 2016. At that time, the Hon’ble FM promised that the dividend by SPV to the trust and by the trust to its unit holder will not be taxed and that it will enjoy complete tax exemption. The reason behind such exemption was explained in Circular No. 3 of 2017. It was stated that, under SEBI regulations both the SPV and business trust are obligated to distribute 90% of their operating income to the investors, whereas in case of normal real estate company, there is no requirement of such annual distribution of dividends. As a result, these initiatives have not yet taken off. In order to rationalise the taxation regime for business trusts (REITs and Invits) and their investors, provisions of sections 10, 115-O, 115UA and 194LBA of the Act were amended to provide a special dispensation and exemption from levy of DDT.

With such promise, investments were made in such business trusts. However, suddenly, there is a change in policy decision to tax shareholder. As a result, within 3 years of such investment, the dividend income becomes taxable in the hands of the unit holder. With such policy change, the business trust structure will again become unviable, though the funds would have been blocked in the trusts already formed.

Deductions from dividend income

The litigation u/s 14A in respect of dividend income will come to rest. But one will not be better off as section 57 has been amended to restrict deduction allowable from dividend income or income in respect of units of a Mutual Fund or specified company. Only deduction of interest expense is to be allowed and such deduction is to be restricted to 20% of such income. This appears to be harsh. The fundamental concept of tax is to tax the real income of a person. Such real income is computed after deduction of expenses incurred. However, restricting deduction from dividend income doesn’t appeal much, especially when such tax is in the nature of double taxation as already explained earlier.

In a case, where no dividend income is received, no deduction will be allowed, though expenses would have been incurred. This goes against the principles laid down by the Apex Court in Badridas Daga vs. CIT [34 ITR 10(SC)]. Though, we have enjoyed the reverse scenario u/s 14A, where we happily argued, that in absence of any dividend income, disallowance should not be made u/s 14A of the Act.

Section 57(iii) states that deduction of any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income shall be allowed. Thus, one has to demonstrate that the expense has been incurred wholly and exclusively for the purpose of making or earning such income. This condition shall continue to apply even to interest expense under the proposed proviso. As a result, deduction of interest expense shall be allowed only if it is proved that such expense has been incurred wholly and exclusively for the purpose of making or earning dividend income.

Proviso to section 57 proposes to restrict deduction of interest expense to 20% of such income included in the total income for that year, without deduction under this section. A deduction u/s 80M has been provided to a domestic company in respect of amount of dividends received from other domestic company. An issue will arise as to whether, such limit of 20% is on the dividend income after deduction u/s 80M or before deduction
u/s 80M. In my view, it should be before deduction u/s 80M, as 80M forms part of Chapter VIA of the Act. Section 80A states that any deduction under this section is to be allowed only from the gross total income and such term is defined in section 80B(5) to mean total income computed in accordance with the provision of this Act, before making any deduction under Chapter VIA. Thus, application of section 80M is at a much later stage.

Section 80M

Deduction u/s 80M is to be allowed by the company claiming such deduction only from the dividend it distributes upto one month prior to the due date of filing return of income u/s 139(1). Thus, to claim deduction, all companies will endeavour to declare and distribute such dividend before such date, so as to get the deduction of dividend received in such year. Earlier, it was due date of filing of return of income. It is important to note that what is relevant is not declaration of dividend but distribution of such dividend.

Interestingly, such deduction is not allowed while computing MAT, which will give rise to tax consequences.

Non-Residents

Non-residents and foreign companies who are not eligible for treaty benefits, will have to pay tax on dividend income u/s 115A of the Act @ 20% plus surcharge and cess. Further, no deduction is to be allowed in computation of such income as per section 115A(3). Thus, not even the allowance of interest to the extent of 20% of the dividend income is permissible. Further, if the income of such person consist only of income referred to in clause (a) or clause (b) of section 115(1) and requisite tax has been deducted at source on such income, then such person shall not be required to file a return of income under this Act.

Similarly, the dividend income on GDRs which are purchased in foreign currency, shall be charged to tax @ 10% u/s 115AC of the Act. Further, no deduction is to be allowed u/s 57 in computation of such income. Also, no return to be filed if necessary TDS is deducted on such income and if the total income only consists of the income referred to in section 115AC. Similar amendments are also made in section 115ACA of the Act which deal with an individual being a resident and an employee of Indian company or its subsidiary engaged in specified knowledge based industry.

Dividend income of FIIs are to be taxed @ 20%. Further, no deduction is to be allowed u/s 57 in computation of such income.

Corresponding TDS implications are provided for in section 195, 196C and 196D of the Act.

Planning in case of companies having huge accumulated profits as on 31.03.2020.

From 1st April, 2020, the new regime will kick in. Companies having huge reserves and whose shareholders are those who are taxable in the highest slab of surcharge, may think of declaring interim dividend up to 31.03.2020 and pay applicable DDT on the same. Just to understand the difference of tax in two regimes a small table is prepared below:

Say, if a company wants to distributes dividend of ₹ 6 crores and all shareholder fall under the highest slab of surcharge. The applicable taxes under both the regimes will be as under:

DDT regime		New regime
Particulars	Amount/ Rate	Particulars	Amount/Rate
Dividend	6,00,00,000
DDT rate	17.47%
DDT amount	1,27,02,598
In the hands of shareholder		In the hands of shareholder
Dividend amount	6,00,00,000	Dividend amount	6,00,00,000
Tax rate u/s 115BBDA (if SC is 37%)	14.25%	Tax at normal rate	42.74%
Tax u/s 115BBDA	85,48,800/-
Total tax implication	2,12,51,398/-	Total tax implication	2,56,46,400/-
		Incremental tax	43,95,002/-

Thus, there is an increase in tax under the new regime. In such cases, the company may think of declaration of dividend prior to 31.03.2020.

Another option in such cases will be to buy back the shares, subject to the provisions of Companies Act, and pay tax u/s 115QA @ 23.3%.

Tax on Buy back

Section 115QA was inserted by Finance Act, 2013, w.e.f. 1.06.2013. Simultaneously, section 10(34A) was inserted. These new provisions, taxed the income arising on buyback of share in the hands of the company and exemption was given to the shareholders.

Purpose of such introduction is given in Circular No. 3/2014 – 24.01.2014. It is stated that unlisted companies, as part of tax avoidance scheme, resort to buy back of shares instead of payment of dividends in order to avoid payment of tax by way of DDT particularly where the capital gains arising to the shareholders are either not chargeable to tax or are taxable at a lower rate. Therefore, such section was inserted.

With the end of DDT, logically even section 115QA should go. However, as already explained above, in some cases where tax on dividend in the hands of the shareholders is falling in the highest rate, a company may decide to distribute reserves by way of buyback. Thus, it will be beneficial if such section stays.

Dividend from foreign company – section 115BBD

It may be noted that any dividend received by an Indian company from a foreign company in which such Indian company holds 26% or more of the share capital, shall be continued to be taxed @ 15% u/s 115BBD of the Act. A dividend on which was tax is paid u/s 115BBD is allowed to be set off against the dividend declared by an Indian company, while computing the amount of DDT payable u/s 115O of the Act. Such benefit, is now no longer available. Deduction u/s 80M is allowed only in respect of dividend received from any domestic company.

Thus, sea changes are proposed in respect of dividend taxation and I will have to tackle new sets of issues in the years to come. Considering the nature of the present government, one may even expect some more fireworks in the years to come. Nevertheless, tax practitioners have something new to apply their brains.