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TAXATION OF DIVIDENDS: ANALYSIS OF UNION BUDGET IN DIRECT TAXES (2020-21) UNDER THE FINANCE ACT, 2020 (By-Somya Kumari)
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TAXATION OF
DIVIDENDS: ANALYSIS OF UNION BUDGET IN DIRECT TAXES (2020-21) UNDER THE FINANCE
ACT, 2020
Authored
By-Somya Kumari
Abstract
According to the
Black’s Law Dictionary, dividend refers “to distribution of
profits/rewards earned by a company/ corporation to its shareholders”.[1] When
a company makes a profit or has a surplus, it can distribute a portion of that
earnings to shareholders as a dividend. However, if money that isn't allocated
or distributed is re-invested in the company (called retained earnings).[2] As
for a company, a dividend plays very important source of revenue for
shareholders. In India, taxation of dividend income has undergone several
changes over the years. For the first time in 1997, Indian introduced the
Dividend Distribution Tax (‘DDT’) which exempted dividend income in the
hands of shareholder but obliged the corporation to pay a fixed rate of DDT.[3]
However, this move was considered regressive and inequitable, so in 2002, the
burden of dividend tax was shifted to the shareholders but that again shifted
back in the hands of company in 2003. Now, the Finance Act, 2020[4]
abolished DDT and brought back the classical system of dividend tax income in
the hands of shareholders.[5]
The paper is divided into three parts.
Part I deals
with the main analysis of new amended divided taxes regime under the Finance
Act, 2020[6]
including the impact on the investor for mutual funds as well as MAT on
dividend income of foreign company. Part II takes an illustration of impact of
dividend taxes on non-resident shareholders through the new amended Finance
Act, 2020[7].
Part III concludes the remark.
Part-I
Before delving
into the main paper, I will discuss new dividend regulations and analyzed the
new changes introduced by the Ministry of Finance in Union Budget 2020-21
through one case law i.e., Deputy CIT vs Total Oil India 2021[8].
Analysis Of
New Amendment In Dividend Taxation Regime Under Finance Act 2020
Now, firstly, I
will highlight the budget amendment done for direct taxes that is particularly
DDT regime which has been abolished and India has re-established the
classical system of dividend tax in the hands of shareholders, which was
prevalent in past.
In 2020, the
Hon’ble Finance Minister Nirmala Sitharaman in her budget speech adopted this
classical system of dividend tax which will be effective from financial year
(‘FY’) 2020-21 and will apply to dividends distributed on and after 1 April
2020.[9]
Further, it is clear that the removal of DDT will result in a loss of INR
25,000 crore in annual revenue, in order to do so, the DDT loss would be
compensated by the shareholders through their higher personal and corporate tax
collections on account of dividend tax. In the former DDT regime, the company
used to pay dividend tax @20.56% and as for shareholders, the dividend
income was exempted.[10]
The classical
system of dividend tax is a huge advantage for making tax collection easier and
therefore, it considerably improved cost of doing business in India was
especially for foreign investors. As, there were some issues regarding foreign
investors for double taxation because DDT was tax on company not on
shareholders and there were difficulties with getting DDT tax in their home
jurisdiction.[11] For
this, in 2019, re-establishment of classical system of dividend tax with
reduced corporate tax brought India an attractive place for foreign investors.[12]
Since the DDT regime abolished, companies will be able to properly distribute
dividends across the group without incurring DDT costs. This would be
especially beneficial to publicly traded corporations, since they will be able
to collect dividends from
joint ventures,
subsidiaries, and associates and distribute them to ultimate shareholders
without paying DDT costs. Even in unlisted industries, dividends from joint
ventures, subsidiaries, and associates may be received with a one-time tax
expense and held at the receiving business level. This amendment brought a
significant move for foreign investors who do not presently benefit from the
DDT tax credit in their home jurisdictions will gain from this modification.
Also, such foreign investors can now claim credit from withheld taxes only
through the availability of the benefit of the tax treaty.
This would also
impact on the investor as for taxes reasons, mutual funds that invest less than
65 percent of their corpus in equity are referred to as non-equity funds, such
as debt funds. Investors who seek recurring income from the dividends of
equity-oriented funds have to reevaluate their approach. They would receive a
lower in-hand return as a result of the taxes on returns. The investor's hands,
nevertheless, are still free of taxation on the payout. The DDT will be taken
out by the fund house before any dividend distributions. As other schemes are
tax-free, dividend plans won't be advantageous for LTCG below Rs. 1 lakh.
Despite the additional tax, investors hoping for a steady income can still
invest. Dividend schemes would regularly consume your earned gains if your
purpose is to create wealth. Additionally, the benefit of compounding is lost
when the dividend is paid, defeating the very goal of wealth development. Due
to their excellent returns, equity-oriented funds continue to rule despite the
new tax laws. Simply wait a little before making any hasty decisions.
MAT on
divided income of a foreign company: Only when a foreign firm is a
resident of a nation with whom India has a DTAA and conducts business via a PE
located in India are MAT provisions applicable on such company. However, it
shouldn't be subject to the presumed taxation provisions of Sections 44B, 44BB,
44BBA, or 44BBB. Certain adjustments are made to the foreign company's earnings
once it has been decided that it must pay MAT.
However, if they
are credited (or debited) in the profit and loss account and the corresponding
income is taxable at a rate lower than the rate of MAT, the following incomes
(and costs claimed in respect of them) are added back to (or removed from) the
net profit: (a) Capital gain from securities; (b) Interest; (c) Royalty; (d)
FTS.
As a result, a
foreign corporation is exempt from paying MAT on the aforementioned earnings.
The Finance Bill, 2021 has amended Section 115JB to provide that dividend
income and expenses claimed in respect thereof shall be added back or reduced
from the net profit if such income is taxed at a lower rate than MAT due to
DTAA, taking into account the taxability of dividend in the hands of the
foreign company
Critical:
Though, new
amendment should provide the corporate sector more freedom in treasury
management and capital mobility within the company because most of the time
shareholders makes contribution to company, so it should be at the cost of a
larger tax burden on shareholders. In the event of a dividend received by an
Indian firm or business from a foreign corporation, cascading relief is not
accessible. This appears to be a "miss" in the new proposal, given an
Indian business can deduct dividends from a foreign subsidiary company under
the present DDT system. Dividends received from overseas corporations are
likewise subject to the same rules.
Impact Of
New Dividend Tax Regime Under The Finance Act, 2020[13]
1.
Resident Shareholders:
A.
Individuals and HUFs: For Resident Shareholders
being individuals and HUFs, dividend income earned by them shall be taxable as
per the applicable tax slab rates. In addition to this, the maximum surcharge
applied on dividend tax is limited to 15%. Therefore, it will be taxed at a
maximum effective rate of 35.88 percent for individuals and HUFs with a total
income of more than INR 1 crore.[14]
B.
Partnership firms and limited Liability Partnerships
(‘LLP’): the dividend income shall be taxable at an effective rate of 31.2%
and in case of total income exceeds INR 1 crore, then it would be taxable at
34.94% inclusive of surcharge.[15]
C.
Domestic Companies: the dividend income is taxed
as per effective tax rates, which is range from 25.17% to 34.94%. if a company
chooses concessional tax regime, then shall be subjected to Minimum Alternate
Tax (’MAT’) at 17.47%.[16]
2.
Non- Resident Shareholders
A.
Foreign Portfolio Investors (‘FPIs’): the dividend tax for non-resident
shareholders has undergone several changes over the years and finally, in Union
Budget 2020-21, the dividend income earned by Foreign Shareholders (only
applicable to those income earned from Indian portfolio companies) shall be
taxable at the rate of 20% inclusive of both surcharge and cess, and as for
Indian portfolio companies will subject to liability to withhold taxes at such
rates.[17]
In case for tax treaties, the beneficial tax rate on dividend income would be
ranging from 5% to 15% subject to certain conditions in Section 80G of the
Income tax Act 1961[18]
(Donations). However, it is important to keep in mind that such a beneficial
tax rate isn't accessible when withholding tax is applied on dividend income
paid to FPIs. The dividend income under tax treaty formed between Indian and
FPIs would be able to claim that beneficial tax rate when submitting their tax
return and demand a refund of excess tax withheld if certain requirements are
met.[19]
Therefore, despite FPIs being eligible for a beneficial tax rate under the
applicable tax treaty, it is necessary for the FPIs would have to assess the
impact on their cash flows because Indian portfolio companies would continue to
limit their withhold taxes @20% inclusive of surcharge and cess (this has
been recognized the tax rate prescribed in the domestic tax laws).[20]
For this, FPIs might potentially contact the Indian government to request
appropriate changes to the country's domestic tax legislation in order to[21]:
Ø
FPIs will be able to get a reduced withholding
tax order from the Indian Revenue Department. The Indian portfolio firms would
be permitted to withhold taxes at the lower rate provided in the tax treaty
under such a lower withholding tax order.[23]
PART II
Now, I will
discuss the case where after introduction of Finance Act 2020[24],
dispute rose regarding protection given to shareholders in foreign jurisdiction
related to dividend income- tax treaty specific provision (DDT was exempted for
shareholder until 31st March 2020) in the hands of non-resident
shareholders.
Deputy
Commissioner Of Income Tax Mumbai Vs. Total Oil India (P.) Ltd.[25]
2021
Fact:
Dividend income
was exempt from taxes in the hands of non-resident shareholders until March 31,
2020, when the company was required to pay additional corporation tax in the
form of DDT at an effective and flat rate of 21% (regardless of the
shareholder's tax rate). Now, as of April 1, 2020, the Ministry of Finance has
removed the DDT regime, and dividend income of shareholders would be taxable,
as stated in the Union Budget 2020-21. Though, prior to the year, the policy
goal of introducing DDT was to guarantee that administrative simplicity was
achieved by using a single point of tax collection. The issue of applicability
or relevance of beneficial tax rates under tax treaties was always in dispute
or doubt since the Indian companies pays the DDT and not the non-resident
shareholders (divided tax was exempted). This issue of applicability was
brought for consideration before the Delhi Bench of Tribunal in the year 2019,
however, the court rules in favour of taxpayer and held that the DDT rate
should be capped (restricted) by the rate established for dividend income under
the tax treaty. The Delhi bench of the Tribunal's decision was later followed
by the Tribunal's Kolkata bench in a decision. In this case, the disputed year
was 2015-16 in which the taxpayer had distributed dividends to its
shareholders, some of them whom were French residents. During the ongoing
appellate processes before the Tribunal, the Taxpayer submitted an additional
cross-objection, arguing that the DDT rate should not exceed the rate set in
the India-France tax treaty.
The Mumbai Bench
of Tribunal also referred the issue in which Special bench took for
consideration. The issue framed was:
“Whether the
protection guaranteed by the tax treaties under s.90 of the IT Act 1961[26](Removal
of doubts), in respect of dividend income tax in their home or source
jurisdiction, can be extended, even in the absence of a specific treaty
provision to that effect, to the DDT under s.115-O (DDT-Profit of domestic
companies) in the hands of a domestic company?”[27]
Analysis Of
Tribunal Order And Comment:
The Tribunal's
Mumbai bench approved the Taxpayer's cross-objection and then voiced doubts
(s.90 of the IT Act) about the accuracy of the conclusions reached by the
Tribunal's co-ordinate benches. I will just discuss the important following key
reasons ruled by the tribunal on why it doubted the correctness of those
earlier decisions:
So, coming to
the first issue was whether, because the Assessee-resident of India ('Company')
paid taxes in India in respect of its own liability, such taxation in India
could not be covered or impacted by a tax treaty provision unless the linked
tax treaty contained a special provision allowing treaty protection to be
extended. It was held that DDT is solely taxable on the company and not
shareholders, henceforth, treaty protection for resident company is not
available in the absence of a specific provision. The Tribunal also ruled that
the DDT should be viewed as dividend paying company’s tax liability that is
completely discharged by such company. In this regard, the Tribunal relied on
the SC ruling in Godrej & Boyce Manufacturing Company Limited v. DCIT[28]
where the Court has said that DDT cannot be equated to a dividend tax paid on
behalf of the beneficiary shareholder. It also added that in a circumstance
where an India-resident company is viewed to be paying tax in India in respect
of its own liability, such taxation in India cannot be protected or impacted by
a tax treaty provision (including non-residents) unless the tax treaty contains
a specific provision.
If such tax
treaty provisions clearly allow for treaty applicability to dividend taxes, the
Tribunal reasoned that whenever the contracting states to a tax treaty wanted
to extend the treaty's protection to DDT, it has been specifically stated in
the treaty itself. For this, the Tribunal referenced the India-Hungary
DTAA (Tax Treaty)[29],
which protocol said that tax on distributed profits of an Indian resident
corporation paying dividends should be deemed to be taxed in the hands of
shareholders, and
that such tax
shall not exceed 10% of the gross amount of dividend.[30]
That is a main clause in the protocol, which is basically gives an integral
component of the treaty, and the protocol to a treaty is just as obligatory as
the main treaty's terms. Also, the tribunal ruled that even if the tax treaty
provision is not accessible in other tax treaties, the DDT rate should not be
limited by the applicable tax treaty provision. Regardless of how beneficial
such provisions in other tax treaties are, they cannot be deduced from a pretty
aggressively creative process of tax treaty interpretation. Tax treaties are
engagements between treaty partner countries, and they must be read as they
are, not as they would have been if they had been drafted otherwise.[31]
Furthermore, the
Tribunal ruled that there shall be no tax credit for shareholders because such
tax treaties do not allow shareholders to claim tax credits for DDT paid by the
corporation in which their shares are owned or held.[32] The
DDT, the Tribunal reasoned, cannot be compared or equated with a tax paid by or
on behalf of a shareholder in this situation. When it comes to DDT, this
taxability is completely tax-neutral for foreign resident shareholders, and the
treaty protection can only benefit the domestic corporation. The sought-after
treaty protection goes much beyond the aim of tax treaties.[33]
The tribunal
also applied foreign jurisprudence on taxes like DDT while citing the ruling of
the South African High Court in Volkswagen of SA (Pty) Ltd v Commissioner of
SA Revenue Service[34].
In this case, it involved a tax similar to the DDT known as secondary tax on
companies (STC) which was used to pay on the distribution of dividends. The HC
ruled that “STC is a tax on a company declaring dividends and not on
dividends”. Further, the tribunal observed that while the opinions of a foreign
judicial body are not binding on any Indian legal body but they deserve to be
considered in a fair and open-minded way.
PART III
Conclusion
From the above
paper analysis, I would like to conclude that dividend income should be taxable
to both the company and shareholders in an equitable manner. The new changes in
Finance Act, 2020 brought several doubts and difficulties especially for foreign
jurisdiction – tax treaty provision, so for that, India should adopt an ideal
agreement to resolve these difficulties. There are several cases which has been
adopted in a such way where the shareholders must pay the DDT only when treaty
obliged, if not, then shareholders must compensate to such losses incurred by
company for their double taxation. Furthermore, looking at the new amendment,
it should have given corporate more freedom in treasury management and capital
mobility rather than shareholders, so that it would reduce the tax burden on
company. The top business may strive to honor this opinion by maintaining a
strong dividend payment track record. Dividends boost a company's image and
help keep investors on board. Dividends are also favored by shareholders since,
in many countries, they provide tax-free income for them.
Article Information
TAXATION OF DIVIDENDS: ANALYSIS OF UNION BUDGET IN DIRECT TAXES (2020-21) UNDER THE FINANCE ACT, 2020 (By-Somya Kumari)
Author Name: Somya Kumari
Title: TAXATION OF DIVIDENDS: ANALYSIS OF UNION BUDGET IN DIRECT TAXES (2020-21) UNDER THE FINANCE ACT, 2020
Email Id: somya218038@nujs.edu
- Journal IJLRA
- ISSN 2582-6433
- Published 2022/07/05
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