6 minute read 8 Jun 2020
Dividend Distribution Tax

Dividend’s tryst with taxation

EY India
By EY India

Multidisciplinary professional services organization

6 minute read 8 Jun 2020
Related topics Tax Tax planning
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Dividend Distribution Tax (DDT) has fomented a debate regarding its desirability since its introduction in 1997, gathering more heat with the steadily increasing rate.

There have been frequent revisions and the introduction of new tax rates for almost a year. Reduction in corporate income tax and personal income tax rates has been a welcome change. The new corporate income tax rate at 25.17% (or 17.16% for new manufacturing companies), is well within a competitive range of the global/OECD average of ~23%.

Dividend Distribution Tax (DDT) for taxation of dividends has fomented debate regarding its desirability since its introduction in 1997, gathering more heat with the steadily increasing rate. With the proposal to remove the DDT and revert to the classical system, the government has answered another persistent demand of the industry.

In the table below, we attempt to capture the impact of this change from DDT to the classical system at the shareholder level (with certain assumptions on basis):

DDT and classical system of taxing
*INR 10 lakhs exemption not considered for non-corporate resident shareholders. Further, rollover benefit under section 115-O considered
**Assumed to be 10% for non-resident shareholders basis majority of India’s tax treaties, highest level of tax for resident individuals and assuming no distribution of dividends by resident Company. However, in case dividends are distributed by resident Company, deduction shall be available u/s 80M.

While the redistributive principals of taxation are met with the removal of DDT, the potential effective tax for the resident individual taxpayer now peaks at 35.88%. When adjusted for the 25.17% effective corporate tax by the dividend paying company the effective tax rate is ~52%. This behooves a question whether such level of taxation is fair for the risk taker/wealth creator amongst the Indian resident, who is so very important for the well-being and growth of the society. The issue is accentuated as it creates a potential bias in favor of non-resident, who has access to lower rates under the Double Taxation Avoidance Agreements (DTAA).

Double taxation of dividends has engaged tax policy over the years. Globally, economies while staying within the principles of classical system of dividend taxation have found some middle ground to address the issue of double taxation of dividends.

Types of dividend tax4

  • Classical system

    Broad description: Dividend income is taxed at the shareholder level in the same way as other types of capital income (e.g., interest income)

    Examples: Austria, Belgium, Czech, Germany, Iceland, Ireland, Israel, Italy, Lithuania, Netherlands, Slovak Republic, Slovenia, Spain, Sweden

  • Modified classical system

    Broad description: Dividend income taxed at preferential rates (for example, compared to interest income) at the shareholder level

    Examples: Denmark, Greece, Japan, Poland, Portugal, Switzerland, US

  • Full imputation

    Broad description: Dividend tax credit at shareholder level for underlying corporate profits tax

    Examples: Australia, Canada, Chile, Mexico, New Zealand

  • Partial imputation

    Broad description: Dividend tax credit at shareholder level for part of underlying corporate profits tax

    Examples: Korea, UK

  • Partial inclusion

    Broad description: Part of received dividends is included as taxable income at the shareholder level

    Examples: Finland, France, Luxembourg, Turkey

  • Exemption

    Broad description: No other tax than the tax on corporate profits

    Examples: Singapore, HK, Mauritius

  • Corporate deduction

    Broad description: Corporate level deduction, fully or partly, in respect of dividend paid

    Examples: Latvia

The Budget proposes a classical system of tax while allowing a maximum 20% of dividend income as deduction of interest paid for making investment. However, the effective rate for the capital risk taker remains significantly tilted in favor of the non-resident. Such disparities have, in the past, influenced behavior like flight of risk capital. Rebalancing the classical system taxation, with a possibly modified preferential rate or a system of imputation, would ensure neutrality of treatment. Having said that, the proposal to allow tax deduction on upstreaming of foreign dividends to the shareholders is a welcome move.

A related question that emerges is regarding the relevance of Buyback Tax (BBT) which was introduced vide the Finance Act, 2013. BBT was introduced to eliminate the arbitrage between DDT and capital exemption under certain DTAAs.  With the DTAAs having been amended through the Multi-Lateral Instrument (MLI), it may be worthwhile reverting buyback to capital appreciation and tax thereon as capital gains.  BBT in its present form still creates opportunities for arbitrage vis-à-vis dividend taxation in certain instances.

The impact reversion to the classical system of dividend taxation on the fledgling but a promising market for REITs and InvITs is quite interesting. The REIT and InvIT have opened avenues for capital raise to fund the infrastructure needs of the economy, including very large public sector enterprises who are looking at monetizing their infrastructure/ real estate portfolios. In the current regime, DDT is relieved at the Special Purpose Vehicle (SPV) and the unitholder level. Under the classical system the dividend is taxable at the unitholder level if SPV opts for new concessional corporate tax rate of 25.17%5. Where the concessional rate is not opted by the SPV, dividends remain exempt for the unitholders. In a manner this change could be retrospective in its effect on existing REITs and InvITs. Furthermore, the taxability at the unitholder level would impact yields, making the investment attractive/ unattractive for the investor community.

Reversion to the classical system of dividend taxation is a positive message on tax policy. It paves the way for a universally consistent system of dividend taxation, avoiding tax credit leakages. If some of the measures mentioned above are adopted, it would enhance its neutrality and positive impact.

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    1. As per the provisions of Finance Bill 2020 passed by the Parliament
    2. Base rate 10% + Surcharge 37% + Cess 4%
    3. Base rate 30% + Surcharge 15% + Cess 4%
    4. Source - Details obtained from country tax guides / public sources/ OECD databases
    5. Base rate 22% + Surcharge 10% + Cess 4%

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(This article is authored by Jayesh Sanghvi, Tax Partner, EY India).

Summary

Reversion to the classical system of dividend taxation is a positive message on tax policy. It paves the way for a universally consistent system of dividend taxation, avoiding tax credit leakages.

About this article

EY India
By EY India

Multidisciplinary professional services organization

Related topics Tax Tax planning
Upvote