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Taxation of Dividends July 2020 2 TAXATION OF DIVIDENDS JULY 2020 2 TAXATION OF DIVIDENDS Table of contents 1. Background 3 2. Impact of new dividend tax regime on resident shareholders 4 3. Impact of new dividend tax regime on nonresident shareholders 5 4. Impact of new dividend tax regime on Business Trusts (REITs and InvITs) 6 Impact of new dividend tax regime on Investment Funds and Category III 5. 6 Alternative Investment Funds (AIFs) 6. Withholding tax (‘WHT’) on dividend pay-outs to resident shareholders 6 7. WHT on dividend pay-outs to non-resident shareholders 6 8. Availability of tax treaty benefits 8 9. Deduction for expenses incurred for earning dividend income 9 10 Issues for consideration 9 11. Other aspects 11 Annexure 1 - Impact of dividend taxation on Business Trusts (REITs and 12. 12 InvITs) Annexure 2 - Impact of dividend taxation on Investment Funds and 13. 13 Category III Alternative Investment Funds (AIFs) 14. Annexure 3 - List of dividend WHT rates of India’s various tax treaties 14 Annexure 4 - WHT rates on dividend pay-outs by an Indian company to 15. 16 several category of investors (residents and non-residents) 3 TAXATION OF DIVIDENDS Background Dividends constitute a significant stream of income the Hon’ble Finance Minister in her Budget Speech, for shareholders of companies. Double taxation the removal of DDT will lead to an estimated annual of income – first, in the hands of the companies revenue foregone of INR 25,000 crore. Higher and thereafter in the hands of the shareholders on personal and corporate tax collections on account of distribution as dividend is prevalent worldwide. The taxation of dividend in the hands of shareholders will manner in which dividend income is taxed in India compensate the loss on account of DDT. Whilst the has undergone several changes over the years. In former DDT regime had the advantage of ease of tax 1997, India introduced the Dividend Distribution Tax collection, it significantly increased the cost of doing (‘DDT’) regime wherein dividend income was exempt business in India; especially for foreign investors, as in the hands of the shareholders but the company there were issues on availing credit of DDT in their paying the dividend was required to pay DDT at home jurisdiction (given that DDT was a tax on the a flat rate (irrespective of the tax rate applicable company and not on the shareholders) and thereby to respective shareholders). Ease of tax collection leading to double taxation in many cases. The on dividends at a single point was a prime reason effective DDT rate of 20.56% was also significantly for such a move. However, this methodology was higher than the maximum rate at which India would considered regressive and inequitable, as dividend have had the right to collect tax under most of the is income in the hands of the shareholder and not in relevant tax treaties. Given the re-introduction of the hands of the company. In 2002, the incidence the classical system of taxing dividends coupled of dividend tax was shifted to the shareholders and with reduced corporate tax regimes introduced in again shifted back in the hands of the company in 2019, India certainly has emerged as an attractive 2003. destination for foreign investors. This should augur well in attracting companies seeking to diversify their India has now re-introduced the classical system of global supply chains due to COVID-19. taxing dividends in the hands of the shareholders as was prevalent in the past. The classical system In this publication, we have made an attempt to of taxing dividends will be effective from Financial summarise the key aspects of the newly introduced Year (‘FY’) 2020-21 and will apply to dividends dividend taxation, practical issues and potential distributed on or after 1 April 2020. As stated by solutions which merit consideration. 4 TAXATION OF DIVIDENDS A. Impact of new dividend tax regime on resident shareholders (i) Individuals and HUFs tax outflow, companies may consider migrating to the concessional tax regime or options could be explored Dividend income earned by resident shareholders to accelerate the utilisation of MAT credit. being individuals and HUFs will now be taxable in their hands at the slab rates applicable to them. Further, in order to remove the cascading effect of However, the maximum surcharge on dividends would taxation in a multi-tier holding structure, a rollover be restricted to 15%. Thus, the dividend income will benefit for dividend income is permitted. This is be taxable at a maximum effective rate of 35.88% for pictorially explained below: shareholders being individuals and HUFs whose total income exceeds INR 1 crore. (ii) Partnership firms and Limited liability A Co Partnerships (‘LLP’) DIVIDEND OF INR 800 Dividend income earned by partnership firms and LLPs from domestic companies will be taxable at an B Co effective tax rate of 31.2%. The effective rate in case DIVIDEND OF the total income of the firm/ LLP exceeds INR 1 crore INR 1000 would be 34.94% (inclusive of surcharge). X Co (iii) Domestic companies The dividend income received by a domestic company will be taxable at the following rates: In the example, X Co (which could be a domestic company or a foreign company) distributes INR 1000 Tax rate with incentives/ exemptions (applicable for companies which as dividend to B Co, which in turn distributes INR 34.94%2 have not opted for concessional tax 800 as dividend to A Co. In order to prevent the regime1) cascading effect of taxation of the same dividend income, the law permits a deduction5 of INR 800 in Tax rate without incentives/ exemptions (applicable for the computation of income of B Co provided B Co 25.17%3 companies which have opted for has upstreamed the dividend income to A Co at least concessional tax regime1) 1 month before the due date of filing its tax return of Tax rate without incentives/ the year in which the dividend was received. In such exemptions (applicable for a case, B Co will be taxed only on the net dividend companies who have opted for income of INR 200. It may be noted that such 29.12%4 concessional tax regime under old deduction is allowed irrespective of the percentage section 115BA) of shareholding in X Co and regardless of whether X Co is a domestic company or a foreign company. However, where X Co is a foreign company, the The dividend income, however, will also be subjected dividend income of INR 200 will be taxable in the to Minimum Alternate Tax (‘MAT’), at 17.47% only hands of B Co at a concessional tax rate of 17.47%6 for companies who have not opted for concessional under section 115BBD of the Income-tax Act, 1961 tax regime. If MAT poses a significant burden on the (‘Act’). 1Section 115BAA and Section 115BAB of the Act 2Provided total income is more than INR 10 crore. If the total income exceeds INR 1 crore but is less than INR 10 crore, the effective tax rate is 33.39%. If total income is below INR 1 crore, then the effective tax rate is 31.2%. 3For these companies, surcharge is levied at a flat rate of 10% irrespective of the total income 4Provided total income is more than INR 10 crore. If the total income exceeds INR 1 crore but is less than INR 10 crore, the effective tax rate is 27.82%. If total income is below INR 1 crore, then the effective tax rate is 26% 5 Section 80M of the Act 6However, this concessional tax rate if applicable provided B Co holds at least 26% of the paid-up equity share capital in X Co. Otherwise, the dividend income will be taxable in hands of B Co at 34.94% or 25.17% as the case may be depending on whether B Co has opted for a concessional tax regime or not. 5 TAXATION OF DIVIDENDS B. Impact of new dividend tax regime on non- resident shareholders (i) Foreign Portfolio Investors (‘FPIs’) z enable tax withholding at the tax rate prescribed in the tax treaty. As aforementioned, under the revised provisions, z enable FPIs to obtain lower withholding tax order the dividends received by foreign shareholders from from the Indian Revenue authorities. Such lower Indian portfolio companies post April 1, 2020 withholding tax order would enable the Indian would be liable to pay tax at the rate of 20% (plus portfolio companies to withhold taxes at the lower applicable surcharge and cess) and the Indian rate prescribed in the tax treaty. portfolio companies would be liable to withhold taxes at such rates. (ii) Non-resident shareholders (other than Typically, tax treaties entered into with India provide FPIs) a beneficial tax rate on dividend income, ranging As aforementioned, if the dividends are paid to non- 7 from 5% to 15%, subject to certain conditions . It is resident shareholders, tax is required to be deducted important to note that such beneficial tax rate is not at 20% (plus applicable surcharge and cess) subject to available at the time of withholding tax on dividend tax treaty benefits where a lower rate can be availed. income paid to FPIs. The FPIs based out of jurisdictions However, as discussed earlier, a careful analysis of with a beneficial tax rate on dividend income under the treaty provisions, test of beneficial ownership, the tax treaty with India will be eligible to claim such wordings of Most Favoured Nation (‘MFN’) clauses, beneficial tax rate at the time of filing their tax return changes due to Multilateral Instrument (‘MLI’), etc.
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