Taxation of Dividends received after April 1 2020
Dividends is considered to be a significant stream of income for shareholder of a company. The manner in which dividend income is taxed in India has undergone several changes over the years. Earlier the dividend income in India was taxed under Dividend Distribution Tax (‘DDT’) regime wherein dividend income was not taxed in the hands of the shareholders but the company paying the dividend was required to pay DDT at a flat rate. This was a preferred method as tax collection on dividends was at a single point was a prime reason for such a move. However, this methodology was considered regressive and inequitable by many, as dividend is income in the hands of the shareholder and not in the hands of the company and the shareholders at individual level would be taxed at different rates.
India has now introduced the system of taxing dividends in the hands of the shareholders. It will be effective from Financial Year (‘FY’) 2020-21 and will apply to dividends distributed on or after 1 April 2020. As stated the Budget Speech, the removal of DDT will lead to an estimated annual revenue foregone of INR 25,000 crore. Higher personal and corporate tax collections on account of taxation of dividend in the hands of shareholders will compensate the loss on account of DDT. As mentioned earlier the former DDT regime had the advantage of ease of tax collection, it significantly increased the cost of doing business in India; especially for foreign investors, as there were issues on availing credit of DDT in their home jurisdiction as the DDT was a tax on the company and not on the shareholders and thereby leading to double taxation in many cases.
The effective DDT rate of 20.56% was also significantly higher than the maximum rate at which India would have had the right to collect tax under most of the relevant tax treaties. With the introduction system of taxing dividends coupled with reduced corporate tax regimes introduced in 2019, India certainly has emerged as an attractive destination for foreign investors. In this blog post we would be discussing the impact of Dividend tax regime
Impact of new dividend tax regime on resident shareholders
(A) Individuals and HUFs
The dividend income will be taxed at slab rates however maximum surcharge on dividends would be restricted to 15%. Thus, the dividend income will be taxable at a maximum effective rate of 35.88% for shareholders being individuals and HUFs whose total income exceeds INR 1 crore.
(B) Partnership firms and Limited liability Partnerships (‘LLP’)
Dividend income earned by partnership firms and LLPs from domestic companies will be taxable at an effective tax rate of 31.2%. .In case the income exceeds INR 1 crore the effective rate would workout to be 34.94% (inclusive of surcharge).
(C) Domestic companies
The dividend income received by a domestic company will be taxable at the following rates:
The dividend income, however, will also be subjected to Minimum Alternate Tax (‘MAT’), at 17.47% only for companies who have not opted for concessional tax regime. If MAT poses a significant burden on the tax outflow, companies may consider migrating to the concessional tax regime or options could be explored to accelerate the utilization of MAT credit.
Further, in order to remove the cascading effect of taxation in a multi-tier holding structure, a rollover benefit for dividend income is permitted. Example XYZ Co distributes Rs. 100 as dividend to LMN Co, which in turn distributes Rs. 90 as dividend to ABC Co. In order to prevent the cascading effect of taxation of the same dividend income, the law permits a deduction of Rs. 90 in the computation of income of LMN Co provided LMN Co has up-streamed the dividend income to ABC Co at least 1 month before the due date of filing its tax return of the year in which the dividend was received. In such a case, LMN Co will be taxed only on the net dividend income of Rs. 10. It may be noted that such deduction is allowed irrespective of the percentage of shareholding in XYZ Co and regardless of whether X Co is a foreign company or a domestic company . However, where XYZ Co is a foreign company, the dividend income of INR 10 will be taxable in the hands of LMN Co at a concessional tax rate of 17.47% under section 115BBD of the Income-tax Act, 1961
(However, this concessional tax rate if applicable provided B Co holds at least 26% of the paid-up equity share capital in XYZ Co. Otherwise, the dividend income will be taxable in hands of LMN Co at 34.94% or 25.17% as the case may be depending on whether LMN Co has opted for a concessional tax regime or not.)
Impact of new dividend tax regime on nonresident shareholders
(A) Foreign Portfolio Investors (‘FPIs’)
As mentioned earlier that under the revised provisions, the dividends received by foreign shareholders from Indian companies after April 1, 2020 would be liable to pay tax at the rate of 20% (plus applicable surcharge and cess) and the Indian companies would be liable to deduct tax at source at such rates. Tax treaties entered into with India provide a beneficial tax rate on dividend income, ranging from 5% to 15%, subject to conditions. However such beneficial tax rate is not available at the time of withholding tax on dividend income paid to FPIs. The FPIs based out of jurisdictions with a beneficial tax rate on dividend income under the tax treaty with India will be eligible to claim such beneficial tax rate at the time of filing their tax return and claim a refund of excess tax withheld subject to the fulfilment of certain conditions, mainly eligibility to claim treaty benefits, being the beneficial owner of the dividend income. Thus this would in turn affect their cashflows as the Indian companies would continue to deduct tax at source at the rate of 20% plus applicable surcharge and cess even though the FPI being eligible to a beneficial tax rate under the relevant tax treaty.
(B) Non-resident shareholders (other than FPIs)
If the dividends are paid to nonresident shareholders, tax is required to be deducted at 20% (plus applicable surcharge and cess) subject to tax treaty benefits where a lower rate can be availed. However, a careful analysis of the treaty provisions, test of beneficial ownership, wordings of Most Favoured Nation (‘MFN’) clauses, changes due to Multilateral Instrument (‘MLI’), etc. is important in order to determine the treaty eligibility before applying a lower withholding tax rate on dividend pay-outs to non-residents. Dividend pay-outs to non-residents with whom India does not have a tax treaty or if the treaty eligibility appears to be doubtful will be liable for to deduct tax at 20% (plus applicable surcharge and cess). The credit for taxes withheld will be available overseas in accordance with their applicable tax credit rules. In some cases the withholding tax may become cost if the dividend income is exempt and hence not taxable in the country of residence of the non-resident shareholders.