The clamour for removal of dividend distribution tax (DDT) is getting louder as the Union Budget comes closer. The industry has been asking for removal of DDT ever since the government levied 10% tax on investors receiving dividends of more than Rs 10 lakh a year in 2016.
According to tax experts, dividend distribution tax not only leads to cascading taxation but also acts as an impediment for non-resident investors, who cannot claim credit for the same in their home jurisdictions.
India currently levies a dividend distribution tax at an effective rate of 20.56% on the company declaring dividends. This is over and above the corporate tax that companies pay on their taxable profit. Apart from this, resident non-corporate taxpayers (Individuals, Hindu Undivided Families or a firm) need to pay 10% tax on dividends in excess of Rs 10 lakh a year. Hence, the effective tax rate becomes much higher.
Why was DDT introduced?
Dividend Distribution Tax was introduced in 1997. Before that dividends in the hands of the shareholders were taxed. However, collections were lower because of unreported income, shareholders reporting lower income than the taxable limit, etc. This led to a large portion of the dividend not getting taxed.
"DDT was meant to be a more efficient manner of collection of tax and therefore it was taxed in the hand of the company and dividend net of tax was paid to the shareholders. Dividends in the hand of shareholders were then made tax-free. As a result, the year in which it (DDT) was introduced, the collection of tax from dividend went up substantially," says Riaz Thigna, Riaz Thingna Director, Grant Thornton Advisory Private Ltd.
However, in 2016, the government again introduced tax in the hands of shareholders leading to duplication of taxes.
Why should DDT be removed?
It will benefit small as well as non-resident taxpayers.
Ashok Shah, Partner, NA Shah Associates LLP, says, "The government should abolish dividend distribution tax as this will benefit small tax payer as their effective rate of tax is much lower than DDT rate of 20.56%." He further says that non-resident shareholders will be able to claim tax credit in their home jurisdiction.
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Naveen Aggarwal, partner, Tax, KPMG in India, says the DDT at an effective rate of 20.56% for a foreign investor becomes an additional cost as this is often not creditable in their home jurisdiction.
"Given the criticality of foreign investments, the government should consider shifting from the current DDT to the withholding tax model, with respect to shareholder profit distribution. This approach would help shift the tax burden on dividends from corporates to shareholders, thereby reducing the cost of doing business. Add to this, the tax on dividends, under the withholding tax model will be governed by the tax treaty and will become creditable in the shareholders' jurisdiction," says Aggarwal.
Ashok Shah of NA Shah Associates says that withdrawal of the DDT will remove the cascading impact of taxation. Therefore, he suggests the government should tax dividend in the hands of the shareholders at a concessional rate of 15-20%.
Revenue concerns may play spoilsports
While there is much anticipation in the industry of a likely removal of DDT, but given the continuous revenue concerns, the government might give this proposal a miss.
The government collected around Rs 41,000 crore each in 2016-17 and 2017-18. If reverting back to taxing dividends in the hands of shareholders lead to a sharp drop in dividend distribution tax collection, it may further weaken the government's finances from next financial year onwards. Already, it has taken a hit of Rs 1.45 lakh crore due to cut in corporate tax rate from 30% to 22%.