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Role of Dividend Tax in Achieving the Essence of the Budget

P.R. Sethuraman 
on 28 December 2020

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The author has in his article dated 26/12/2017) on Pre Budget Pitch 2017 has suggested various changes to achieve the essence (core) of the real purpose of the Budget. One among them is the introduction of dividend Tax for the reason mentioned below.

"Mr. Chidambaram in his earlier tenure as finance minister has made dividends in the hands of the receiver as tax free making a mockery of level playing traits of direct taxation but, has substituted with a dividend tax under the guise of double taxation. Why the company is to bear for the shareholders? That money may help in paying more dividends or plowed back to facilitate liquidity. What is the consequence? These rich shareholders, primarily promoters holding a lion's share of shares are the undue beneficiaries. In one of the subsequent budgets, it was addressed in a limited way - receivers of dividend beyond RS. 10 lakhs are also taxed at 10%. In the 2017 budget, promoters holding through the private trust are also brought under the net, if the dividend crosses RS. 10 lakhs- a welcome move for level playing but we have to wait to see how they circumvent. What's the way out? Revert back to the old regime. Remove the dividend tax in the hands of the company. Why the company has to bear the dividend Tax? Give tax exemption for dividend in the hands of the receiver for a specified amount- say, a lakh or around and beyond that will be taxed at the applicable rate to the individuals. With an Aadhar card and PAN card link, it would not be difficult to trace in today's internet world. Though it may be difficult to go for this approach in the context of an ensuing election, the suggestion may be revisited for level playing."

What is emphasized in the article quoted above is "Give tax exemption for dividend in the hands of the receiver for a specified amount- say, a lakh or around and beyond that will be taxed at the applicable rate to the individuals".

Role of Dividend Tax in Achieving the Essence of the Budget

Role of 'The Finance Act 2020'

But, 'The Finance Act 2020' has abolished the DDT and moved to the traditional system of taxation wherein dividends are taxed in the hands of the investors.

As a result, the provisions of Section 115-O shall not be applicable if the dividend is distributed on or after 01-04-2020. Consequently, the domestic companies are not liable to pay Dividend DistributionTax- a pet child of Chidambaram, the then Finance Minister but, shareholders shall be liable to pay tax on such dividend income. Since the dividend is now taxable in the hands of the shareholder, several provisions of the Act have been revived such as the permissibility of expenses from dividend income, deductibility of tax from dividend income, treatment of inter-corporate dividend, etc.

Meaning of Dividend

Dividend is usually a part of the profit that the company shares with its shareholders. Dividend usually refers to the distribution of profits by a company to its shareholders.

According to Section 2(22) of the Income-tax Act, the dividend shall also include the following:

(a) Distribution of accumulated profits to shareholders entailing release of the company's assets;

(b) Distribution of debentures or deposit certificates to shareholders out of the accumulated profits of the company and issue of bonus shares to preference shareholders out of accumulated profits;

(c) Distribution made to shareholders of the company on its liquidation out of accumulated profits;

(d) Distribution to shareholders out of accumulated profits on the reduction of capital by the company; and

(e) Loan or advance made by a closely held company to its shareholder out of accumulated profits.

Taxability in hands of shareholders

Section 10(34) that provided an exemption to the shareholders in respect of dividend income is obviously given the go-by, a virtual send off from Assessment Year 2021-20. As a result, dividend received during the financial year 2020-21 and receivable ahead shall now be taxable in the hands of the shareholders. In view of that, Section 115BBDA which provides for taxability of dividend in excess of RS.10 lakh has no application as the entire amount of dividend shall be taxable in the hands of the shareholder.

The taxability of dividend and tax rate thereon shall depend upon many factors like the residential status of the shareholders, relevant head of income. In the case of a non­-resident shareholder, the provisions of Double Taxation Avoidance Agreements (DTAAs) and Multilateral Instrument (MLI) shall also come into play.

How dividend is taxable in the hands of resident shareholders?

A person can deal in securities in 2 ways

1) As a Trader: Profits and Gains of Business or Profession (PGBP)

The income earned by him from the trading activities is taxable under the head business income.

Trading Income

The income, taxable under the head PGBP, is computed in accordance with the method of accounting regularly followed by the assessee. For the purpose of computation of business income, a taxpayer can follow either the mercantile system of accounting or a cash basis of accounting. However, the method of accounting employed by the assessee does not affect the basis of the charge of dividend income as Section 8 of the Act provides that final dividend including deemed dividend shall be taxable in the year in which it is declared, distributed, or paid by the company, whichever is earlier.

Whereas, interim dividend is taxable in the previous year in which the amount of such dividend is unconditionally made available by the company to the shareholder. In other words, an interim dividend is chargeable to tax on a receipt basis.

Where the dividend is assessable to tax as business income, the assessee can claim the deductions of all those expenditures which have been incurred to earn that dividend income such as collection charges, interest on loan, etc.

Income from other sources

Investment Income shall be taxable ipso facto under the head 'other sources'.

a) If the dividend is taxable under the head of other sources, the assessee can claim a deduction of only interest expenditure which has been incurred to earn that dividend income to the extent of 20% of total dividend income. No deduction shall be allowed for any other expenses including commission or remuneration paid to a banker or any other person for the purpose of realizing such dividend.

b) Tax rates on dividend income were obtained under Stock Option Scheme as specifically spelled out under the GDR Scheme and purchased under foreign currency.

The dividend income shall be chargeable to tax at normal tax rates as applicable in case of an assessee except where a resident individual, being an employee of an Indian company or its subsidiary engaged in Information technology, entertainment, pharmaceutical or biotechnology industry, receives a dividend in respect of GDRs issued by such company under an Employees' Stock Option Scheme and the GDRs purchased by the employee in foreign currency.

In such a case, the dividend shall be taxable at a concessional tax rate of 10% without providing for any deduction under the Income-tax Act. However, the GDRs should be purchased by the employee in foreign currency.

c) Taxability in case of non-resident shareholders including FPIs:

A non-resident generally invests in India either directly as private equity investors or as Foreign Portfolio Investors (FPIs). A non-resident person can also be a promoter of an Indian Company. A non-resident person generally holds shares of an Indian company as an Investment and, therefore, any income derived by way of dividend is taxable under the head of other sources except where such income is attributable to the Permanent Establishment of such non-resident in India.

As regards FPIs, securities held by them are always treated as a capital asset and not as stock-in-trade. Thus, in the case of FPIs also, the dividend income shall always be taxable under the head of other sources.

The dividend income, in the hands of a non-resident person (including FPIs and non-­resident Indian citizens (NRIs)), is taxable at the rate of 20% without providing for deduction under any provisions of the Income-tax Act. However, where the dividend is received in respect of GDRs of an Indian Company or Public Sector Company (PSU) purchased in foreign currency, the tax shall be charged at the rate of 10% without providing for any deductions. The relevant sections under which tax is charged are as under:

Section

Assessee

Particulars

Tax Rate

Section 115AC

Non-resident

Dividend on GDRs of an Indian Company or Public Sector Company (PSU) purchased in foreign currency

10%

Section 115AD

FPI

Dividend income from securities (other than income from units of specified mutual fund or units of UTI purchased in foreign currency)

20%

Section 115E

Non-resident Indian

Dividend income from shares of an Indian company purchased in foreign currency.

20%

Section 115A

Non-resident or foreign co.

Dividend income in any other case

220%

TDS on dividend income

a) FOR RESIDENT SHAREHOLDERS:

When PAN is available in the records of the Company: Tax deduction rate on Dividend - 7.5% *

When valid PAN is not available in the records of the Company: Tax deduction rate on Dividend- 20%

**The tax rate has been reduced from 10% to 7.5% with effect from 14 May 2020 until 31 March 2021 vide CBDT Press release dated 13 May 2020.

Vary from time to time as may be prescribed by the statute/authorities.

b) FOR NON-RESIDENT SHAREHOLDERS:

Particular/Category

Tax Deduction Rate

Foreign Institutional Investors (FIIs) / Foreign Portfolio Investors (FPIs)

20% (plus applicable surcharge and cess)

Other Non-resident shareholders

20% (plus applicable surcharge and cess)

The lower rate prescribed under the tax treaty applies to the non-resident shareholder (other than investments made under FPI/FII route)

Rate as per the applicable Tax Treaty

Submission of Lower/NIL withholding tax deduction certificate issued by Income Tax Department u/s 197 of Income Tax Act, 1961

The rate specified in the certificate

**Application of beneficial Tax Treaty Rate shall depend upon the completeness of the documents submitted by the Non- Resident shareholder and satisfactory review by the Company.

In a nutshell in Tabular Form: TDS.

The withholding tax rate on dividend distributed or paid to a non-resident shareholder can be explained with the help of the following table:

Section
(chargeability
of income)

Section
(withholding
of tax)

Nature of Income

Rate of TDS
(Payee is any
other non-
resident)

Rate of TDS
(Payee is a
foreign
company)

Section 115AC

Section 196C

Dividend on GDRs of an Indian Company or Public Sector Company (PSU) purchased in foreign currency

10%

10%

Section 115AD

Section 196D

Dividend income of FPIs from securities

20%

20%

Section 115E

Section 195

Dividend income of non-resident Indian from shares of an Indian company purchased in foreign currency.

20%*

-

Section 115A

Section 195

Dividend income of a non-resident in any other case

30%*

440%*

*If the withholding tax rate as per DTAA is lower than the rate prescribed under the Finance Act then tax shall be deducted at the rate prescribed under DTAA

It may be noted "Application of beneficial Tax Treaty Rate shall depend upon the completeness of the documents submitted by the Non- Resident shareholder and satisfactory review by the Company".

 

**If the withholding tax rate as per DTAA is lower than the rate prescribed under the Finance Act then tax shall be deducted at the rate prescribed under DTAA.

Taxability under DTAA

Dividend income is generally chargeable to tax in the source country as well as the country of residence of the assessee and, consequently, country of residence provides a credit of taxes paid by the assessee in the source country. Thus, the dividend income shall be taxable in India as per provisions of the Act or as per relevant DTAA, whichever is more beneficial.

As per most of the DTAAs India has entered into with foreign countries, the dividend is taxable in the source country in the hands of the beneficial owner of shares at the rate ranging from 5% to 15% of the gross amount of the dividends.

In DTAA with countries like Canada, Denmark, Singapore, the dividend tax rate is further reduced where the dividend is payable to a company that holds a specific percentage (generally 25%) of shares of the company paying the dividend. However, no minimum time limit has been prescribed in these DTAAs for which such shareholding should be maintained by the recipient company. Therefore, MNCs were often found misusing the provisions by increasing their shareholding in the company declaring immediately before the declaration of the dividend, and offloading the same after getting the dividend. India does not face this situation as dividend income is exempt from tax in the hands of the shareholders. However, after the proposed amendment, India too will face the risk of tax avoidance by the foreign company by artificially increasing the holding in the dividend declarant domestic company.

India is a signatory to the Multilateral Convention (MLI) which shall implement the measures recommended by the OECD to prevent Base Erosion and Profit Shifting. MLI is a binding international legal instrument that is envisaged with a view to swiftly implement the measures recommended by OECD to prevent Base Erosion and Profit Shifting in existing bilateral tax treaties in force. With respect to dividend income, Article 8 (Dividend Transfer Transactions) of MLI provides for a minimum period of 365 days for which a shareholder, receiving dividend income, has to maintain its shareholding in the company paying the dividend to get the benefit of the reduced tax rate on the dividend.

Inter-corporate dividend

As the taxability of dividend is proposed to be shifted from companies to shareholders, the Government has introduced a new section 80M under the Act to remove the cascading effect where a domestic company receives a dividend from another domestic company. However, nothing has been prescribed where a domestic company receives a dividend from a foreign company and further distribute the same to its shareholders. The taxability in such cases shall be as under:

Domestic co. receives a dividend from another domestic co.

The provisions of section 80M remove the cascading effect by providing that interoperate dividend shall be reduced from total income of company receiving the dividend if same is further distributed to shareholders one month prior to the due date of filing of return.

Domestic co. receives a dividend from a foreign co.

Dividend received by a domestic company from a foreign company, in which such domestic company has 26% or more equity shareholding, is taxable at a rate of 15% plus Surcharge and Health and Education Cess under Section 115BBD. Such tax shall be computed on a gross basis without allowing a deduction for any expenditure.

Dividend received by a domestic company from a foreign company, in which equity shareholding of such domestic company is less than 26%, is taxable at the normal tax rate. The domestic company can claim a deduction for any expense incurred by it for the purposes of earning such dividend income.

Exemption from deduction of TDS on dividends-

Following is a list of dividends on which TDS is not required to be deducted as per section 194 -

1. Dividend paid to an individual where the aggregate amount of dividend, paid by the company to the individual, during the financial year does not exceed INR 2,500, and such dividend is paid by an account payee cheque.

2. Dividend paid to the Life Insurance Corporation of India in respect of shares owned by it or has a full beneficial interest.

 

3. Dividend paid to the General Insurance Corporation of India in respect of shares owned by it or has a full beneficial interest.

4. Dividend paid to any other insurer in respect of shares owned by it or have full beneficial interest.

5. Dividend covered by provisions of section 115-o.

6. Declaration has been filed either in Form 15G or Form 15H.

Frequently Asked Questions (FAQ) -

Conclusion:

Though dividend taxable in the hands of the shareholders is a welcome feature, in 'the concept of capacity to pay', it would have been ideal to extend the tax exemption for dividend in the hands of the receiver for a specified amount at least for senior citizens above 80 years - say, a lakh or around and beyond that will be taxed at the applicable rate to the individuals" if his assessable income is less than RS.15,000, especially when their children have settled far away, even in foreign countries.

The author honestly hopes it will not fall on deaf ears but reach out to the Central Govt. more so to the Finance Ministry.

Does a TDS rate cut reduce your income tax liability?

Taxpayers whose gross annual income is below the basic exemption limit of RS. 2, 50,000 and senior citizens whose tax payable is nil can claim dividend income without TDS. Senior citizens should submit Form 15H to the company or mutual fund declaring the dividend. Other taxpayers who are below 60 years of age should submit Form 15G to claim exemption from TDS.

I invite suggestions for any to amend/ change/ to modify and revise this article based on the latest counsel and practical experience so that I will try to incorporate.

RBI Direction: In April 2020 in view of the heightened uncertainty caused by COVID-19 and the desirability of banks conserving capital to retain their capacity to support the economy and absorb losses, decided that all banks shall not make any further dividend pay-outs from the profits pertaining to the financial year ended March 31, 2020, until further instructions.


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