The Union Budget 2020-21, presented by Finance Minister Nirmala Sitharaman, has brought in some major changes for investors, including the treatment of Dividend Distribution Tax (DDT). The FM in her budget speech proposed to remove DDT and adopt the classical system wherein the dividend shall be taxed in the hands of the recipients at their applicable slab rates and companies will no longer be required to pay DDT. The dividend distribution tax (DDT) has been abolished at both the company and mutual fund levels. However, tax will be deducted at source (TDS) on such dividend incomes in excess of Rs 5,000 per annum at the rate of 10%.
Under the current tax regime (until March 31, 2020), Indian corporates have to pay tax at an effective rate of 20.56 per cent on their distributable profits directly to the government. Effectively, out of every 100 rupees in distributable profits, companies had to pay Rs 20.56 as tax, with only Rs 79.44 left for distribution to shareholders. On the individual front, earlier a taxpayer had to pay tax on dividend at 10% only in cases where dividend received from Indian companies was more than Rs 10 lakh and no tax was payable in case of dividends received from mutual funds.
The abolition of DDT enables companies to share their entire distributable profits with shareholders; however, its impact on dividend receivers is uneven. As per the Government, this policy change will benefit all taxpayers, and it is beneficial to companies, but will this move really benefit all the end-investors who receive dividends and who will now have to pay tax on them needs a closer scrutiny. The irony is explained by the fact that, while some categories of equity investors will get the benefit of lower taxes on their dividend income after the DDT abolition, others will end up paying through their nose.
Impact on resident dividend recipients:
The benefit of abolished DDT will depend on the tax-bracket that the individual investors fall into. For those who are currently under the 20 per cent tax-slab, the abolition of DDT will benefit them, since the effective DDT would’ve been higher and therefore they will pay a less taxes on dividend income.
Those residential individuals and trusts who fall under the highest slab of 30% with income more than Rs 5 crore have an effective tax rate of 42.7% (including surcharge and cess) would be the biggest losers in the proposed DDT regime. Earlier, the effective tax rate on their dividend income was 34.8% i.e. DDT at 20.6% plus income tax at 14.2% (tax at 10% plus surcharge and education cess).
On the other hand, resident individual taxpayers falling under the lowest slab who are subject to nil tax or at the effective tax rate of 10.4% (including cess) stand to gain the most from the new regime, with nil or lower tax outgo as earlier they had to forgo a 20.56% tax as DDT at company level whereas now they would be taxed at a lower rate.
Similarly, Indian firms and LLPs will also be liable to tax on the entire dividend income resulting in higher tax outflow under the new DDT regime. Under the earlier regime, they were subject to tax at an effective rate of 32.20% (DDT at 20.6% plus tax at 11.60% including surcharge and cess), whereas under the new regime they will have to forgo tax at the effective rate of 34.90%.
The resident corporate shareholders may also be at a loss under the new dividend tax. Under the earlier regime the company declaring dividend was required to pay DDT at 20.60% whereas under the proposed regime the corporate shareholder opting for the new concessional tax rate under section 115BAA of the Act will be liable to pay tax at 25.20% on the dividend income.
Impact on different stakeholders
As discussed earlier, retail shareholders with a total income up to Rs 10 lakh a year will benefit the most as they no longer need to suffer the flat 20.56 per cent imposition on their dividend receipts when their own slab rates are much lower. In addition domestic mutual funds/asset managers who enjoy pass-through status and pay no tax can pocket larger dividend incomes from their portfolios, as they will no longer suffer the indirect incidence of the DDT.
Foreign Portfolio Investors (FPIs) structured as corporates can now pay tax on dividends earned in India at either 20 per cent or lower rates, specified in tax treaties inked by their home countries. These rates can be as low as 5 per cent in some cases. Foreign companies that receive dividends from their Indian subsidiaries will also enjoy a regime similar to corporate FPIs. As an added sweetener, many of them can now claim credit for taxes paid on dividends received in India when assessed for corporate tax back home, this set-off wasn’t available with the DDT.
Those who will lose most under the new dividend tax regime are as mentioned below:
Individual shareholders who fall under higher than 20% tax bracket will shell out a higher effective tax on their dividends, instead of a flat 20.56 per cent under the DDT. For example, most of the promoters of big India companies who are likely to fall in the Rs 5 crore or higher income slab will have to pay up the 42.74 per cent effective tax on dividends.
Insurance companies and other corporate investors in stocks who do not enjoy a pass-through status like mutual funds, may see a dent to their incomes as they now have to pay tax on dividends at the corporate tax rate. However, there is some respite to these entities as Section 80 M benefits would be applicable to them that allows these companies to net out the dividends they distribute to their shareholders from the dividend income they receive while paying corporate tax.
NRI investors and FPIs structured as non-corporates will not reap the benefit of the 20 per cent tax rate on dividends enjoyed by other foreign investors, and may need to pay taxes at their slab rates.
To summarize, the new DDT regime is a mixed bag where there are both losers and gainers. However, by implementing the new DDT mechanism, the government has listened to the long-standing demands of the Foreign Portfolio Investors (FPI’s) who were disadvantaged due to their inability to avail the tax credit in their home countries. The effect of the new DDT regime would be net positive to a large pool of retail investors who do not have significant dividend income and fall under lower tax slabs.