One of the major changes proposed by finance minister Nirmala Sitharaman in her second Union Budget relates to the taxation of dividends. The Budget has proposed to abolish the Dividend Distribution Tax (DDT), and moving to the classical system of taxing dividend in the hands of individuals.
Current situation: Currently, a domestic company is required to pay DDT at the rate of 15 per cent (plus applicable surcharge and health and education cess) on the dividends. Further, dividend income from a domestic company is tax-free up to Rs 10 lakh. Dividend in excess of Rs 10 lakh is taxed at the rate of 10 per cent in the hands of specified resident individual shareholders. It is also tax-free for non-resident individual shareholders.
The proposal: The Finance Bill of 2020 now proposes to tax dividend income in the hands of the shareholder and unit-holder respectively. Domestic companies or mutual funds will no longer be required to pay DDT, but will be required to withhold taxes at specified rates.
The rationale for the proposed amendment is that since foreign investors were unable to avail of credit on DDT in their home countries, it reduced the rate of return they were able to earn on equity capital. To increase the attractiveness of the Indian equity market and to provide relief to a large class of investors, the government has proposed to do away with DDT. With the advent of technology and easy tracking systems, the government has proposed to shift to the system of taxing dividend in the hands of shareholders or unit holders.
Dividend income arising from securities held as investment will be taxed and reported as income from other sources in the income-tax return form. Deduction of only interest expense incurred to earn that dividend income, to the extent of 20 per cent, of total dividend income can be claimed.
Further, the final dividend will be taxable in the year in which it is declared, distributed or paid by the company, whichever is earlier. However, interim dividend will be taxable in the year in which the amount of such dividend is unconditionally made available to the shareholder. In case of mutual fund units with dividend reinvestment option, dividends are not received as cash. Instead, the dividends are directly reinvested in the units. In such a scenario, even if the re-invested dividend is not received in cash, it will be taxed. This may create cash flow challenges. Further, even when dividend is unclaimed due to any reason, it will have to be offered to tax.
Tax rates: For resident individuals, the dividend income shall be chargeable to tax at their respective tax rate. However, dividend shall be taxable at a concessional tax rate of 10 per cent without providing for any deduction, if the resident individual is an employee of an Indian company or its subsidiary engaged in specified industries (like information technology, entertainment, pharmaceutical or bio-technology) and receives dividend from Global Depository Receipts (GDRs) issued by such a company under a specified Employees’ Stock Option Scheme, which are purchased by the employee in foreign currency as notified.
The dividend income, in the hands of a non-resident individual, will be taxable at the rate of 20 per cent without providing for deduction. However, where the dividend is received from GDRs of an Indian company or a public sector company purchased in foreign currency, the tax shall be charged at the rate of 10 per cent without providing for any deductions.
Non-residents can avail of DTAA: India has signed Double Tax Avoidance Agreements (tax treaties) with many countries to help taxpayers avoid paying double taxes on the same income. Lower rate of withholding tax can be availed under the tax treaties for non-resident individual investors. Such lower rate will be subject to satisfying conditions related to treaty eligibility.
The balance tax payable (net of withholding), if any, on dividend by individuals, can be deposited into the government treasury in the prescribed manner via advance tax or self-assessment tax within the specified due dates.
The Budget measures still must be approved by both Houses of Parliament and receive the assent of the President of India. Once approved, the provisions will apply from the India tax year 2020-2021 (April 1, 2020, to March 31, 2021), unless otherwise stated.
Plan your cash flows: After the abolition of DDT and with the introduction of a tax on dividend, the post-tax net return on investment for non-resident individuals may increase (due to availability of credit for tax on dividend in their home country). However, the tax outgo on dividend by resident individuals may increase, especially for high-income earners. Further, individual investors need to be vigilant in tracking dividend re-invested and plan their cash flow as there may be a tax outgo, even if there is no cash inflow.
Homi Mistry is partner and Reena Poddar is manager, Deloitte Haskins & Sells LLP