ABOLITION OF DDT AND ITS IMPACT

[ARJUN JAIN]

ABOLITION OF DDT VIDE FINANCE ACT, 2020 AND ITS IMPACT

INTRODUCTION

In the year 1997, DDT was introduced by the government through section 115-O, which made the companies liable to pay tax on distribution of dividend. However, such dividend income was exempt in the hands of shareholders u/s 10(34). The DDT system was abolished in the year 2002 but such discontinuation did not sustain till long, as the DDT system, was in the very next year, brought back again vide Finance Act, 2003.

This resulted in various representations being made to the government as the companies would have to bear additional tax on distribution of its profits after tax to its shareholders, which caused undue hardship to say the least. Even the Task Force constituted by the Government to draw new direct tax laws had recommended the removal of DDT.

Vide the Finance Act, 2020 the government has finally heard the cries of these companies by re-introducing the conventional system of taxation of dividend. At the same time, we should not be forgetful of the reason behind introducing the DDT system. The administrative defunct and the long process against the simplistic procedure under the DDT definitely made things more smooth and transparent. 

It will be interesting to see whether DDT has become history or will the history repeat itself!?

IMPACT OF REMOVING DDT:

1. Analysis of omitted sections made vide Finance Act, 2020

The following sections have been amended vide the Finance Act, 2020 which will have a great impact. The same is discussed as under:

• Abolition of Section 115-O - Deals with the tax on the distribution of dividend, commonly known as “DDT”, which was to be paid by the company distributing its income by way of dividend to its shareholders. Earlier the DDT was taxed @20.56%, which has now been abolished and all the dividend income shall be taxed in the hands of the shareholders.

• Abolition of Section 115BBDA - Deals with the taxation of dividend income which shall be taxable in the hands of the shareholders if the dividend received is in excess of ₹ 10,00,000/- in a FY, which shall be taxed @10%. This section has now been abolished w.e.f. 01.04.2021 and all the dividend income shall be taxed in the hands of the shareholders.

• Abolition of Section 10(34) - Dealt with the exemption of the dividend income in the hands of the shareholders, which has now been scrapped off vide Finance Act, 2020. Any dividend received on or after 01.04.2020 will be taxed in the hands of the shareholder.

Subsequent to the changes in the taxation regime for dividend income, the dividend income shall be taxed only in the hands of the recipient as per the rate as follows:

•  In case of the resident individual shareholders: The dividend shall be taxed as per the applicable slab rates. This system of taxation is reflective of the progressive system of direct taxes. Therefore, from the perspective of an investor whose effective tax rate is below 20%, it would be beneficial; however, individuals who fall under highest bracket of 42.74% (30%+37%+4%) would be made to pay taxes on a significantly higher rate on the dividend income as compared to the DDT at 20.56%, under the current regime. Low income individual taxpayers, who earn up to INR 5 lakh per annum, also stand to gain since dividend shall be exempt in their hands as compared to tax cost of 20.56% borne by them indirectly through DDT. 

•  In case of resident corporate shareholders: The dividend shall be taxed as per the applicable tax rates, which would range from 25.17% (22%+12%+4%) to 34.94% (30%+12%+4%). In certain circumstances, this could result in higher taxability than the current DDT mechanism. However, note that dividend received from a foreign company would continue to be taxed at applicable rates in the hands of a domestic company and only dividend received from domestic company is sought to be allowed as a deduction.

•  In case of non-resident corporate shareholders: The Indian company shall be liable to withhold taxes at 21.84% (20%+5%+4%) on payment of dividend to a non-resident corporate shareholder. This rate could be lower if the benefit under the tax treaty is available to such shareholder. Earlier, non-availability of credit of DDT to most of the foreign investors in their home country results in reduction of rate of return on equity capital for them. The foreign shareholder will now get the credit of such withholding tax against tax payable in their home country as per the taxation laws in their home country. The proposed amendment might boost the sentiment of foreign investors. 

2. Analysis of consequential amendment made under the Act

As discussed above, the above deliberation omits section 115-O, and consequently section 10(34) and 115BBDA have also been omitted. Apart from them, a lot of amendments and insertions have been made under the Act. However, there are certain provisions which have been impacted due to abolition of DDT. The same require the attention of legislature.

Some of these provisions and the issues involved therein have been analyzed below:

• Amendment in section 115A: Section 115A has been amended to provide for tax @20% on the dividend income in the hands of non-resident shareholder. A NR shareholder can also apply the rate given in respective DTAA/TIEA applying the beneficial provision under section 90(2) of the Income Tax Act.

However, there is no specific rate for resident shareholders, and so they will have to pay tax at slab rate basis as provided under the Act. This may create more burden of tax on resident shareholders now, as their effective tax rate on dividend income may go up to 42.74% (due to enhanced surcharge of 37%) while the shareholder had to pay additional tax at the rate of 10% (effectively 14.25%) under section 115BBDA which together would amount to much lower than 42.74%. 

• Amendment in section 80M: section 80M deals with the relief given to the domestic companies (say “Co. A”) being the shareholders for another domestic company (say “Co. A”), if both Co. A as well as Co. B are distributing income by way of dividend to their shareholders.

The  Finance Act, 2020 has inserted a new section 80M to remove the cascading affect, as it existed before its removal by the Finance Act, 2003, with a change that set off will be allowed only for dividend distributed by the domestic company one month prior to the due date of filing of return, in place of due date of filing return earlier.

For instance, if a domestic company 'A' receives dividend of ₹ 5 crore from another domestic company 'B' and company 'A' distributes dividend of ₹ 2 crore within one month prior to the due date of filing of return, then company 'A' will get the credit of ₹ 2 crore and have to pay tax on remaining 3 crore. However, if company 'A' distributes dividend of ₹ 8 crore then it will get the credit of entire ₹ 5 crore and will not have to pay any tax on the dividend.

As mentioned above, the intent of this section was to remove the cascading effect. However, this section provides for deduction only in respect of dividend received from a domestic company. Therefore, a domestic company receiving dividend from a foreign company will not be eligible to get any credit u/s 80M but it would be eligible to claim relief under section 90/90A as per specific provision under the tax-treaty or under section 91 in case of no tax treaty. This will lead to extra compliance burden on such domestic company. Therefore, in order address such issue, the scope of section 80M may extended to dividend received from foreign company as well.

• Buy Back Tax under section 115QA: A new tax avoidance strategy by unlisted companies was resorted, in a way to buy back of shares instead of payment of dividends in order to avoid payment of tax by way of DDT where the capital gains would arise in the hands of the shareholders that too at a very lower rate. Such buy back was taxable in the hand of shareholders u/s 46A of the Income Tax Act. Finance Act, 2013 had inserted section 115QA which provided for taxation on buy back of shares by such unlisted companies @20% (effective rate of tax is 23.29%). Accordingly, income from this transaction is exempt in the hands of shareholder under section 10(34A). Later on, the Finance (No.2) Act, 2019 extended the scope of this section by including listed companies within its ambit.
• Amendment in section 194: Deals with the TDS on dividend, now applicable with a tax rate @10% on the dividend with the minimum threshold limit of ₹ 5,000/-.

Now, a domestic company which has resident shareholders may be willing to buy back its shares instead to distributing dividend in order to reduce overall tax burden. This can be explained with the help of following illustration:

    (Figures in crore)

	Particulars	Pre- DDT	Buy Back	Post-DDT
	Profit before tax (A)	100.00	100.00	100.00
	Corporate tax rate @34.94% (B)	34.94	34.94	34.94
	Profit after tax	65.06	65.06	65.06
	Dividend pay-out	100%	N/A	100%
	Profits distributed by way of dividend or Buy Back	65.06	65.06	65.06
	[email protected]% or Buy Back Tax under section [email protected]% (C)	13.38	15.15	N/A
	Dividend Received by profit distribution or Buy Back (D)	51.68	49.91	65.06
	Tax on receipt of dividend @14.25%/42.74% (E)	7.36	Exempt	27.81
	Net Tax outflow of company [(B+C)X100/A]	48.32%	50.09%	34.94%
	Net tax outflow of shareholder [(E/D)X100]	14.24%	Exempt	42.74%

(Reference of this table has been taken from an article named Dividend Distribution Tax (DDT) published on taxmann.)

From above illustration, it can be seen that the least amount of total outflow of tax is when the Buy Back option is utilized. However, this outcome is based upon certain assumptions such as a) that the company has not opted for taxation under special regime under section 115BA, 115BAA, 115BAB; b) that the turnover of the company in PY 2017-18 is above 400 crores; and c) that the DDT has been grossed before surcharge and entire profit of the company has been distributed.

Further, if a company goes for buy-back, it is sine qua non for it to comply with the provisions of the Companies Act, 2013 which vide section 68, amongst others, provides that certain conditions such as the value of shares being bought back shall not exceed 25% of the aggregate of paid-up capital and free reserves of the company; only fully paid up shares can be bought back; and that the debt equity ratio post buy back shall not exceed 2:1 etc.

Further also, such company will not be able to not make a further issue of the same kind of shares or other securities within a period of six months except by way of a bonus issue or in the discharge of subsisting obligations such as conversion of warrants, stock option schemes, sweat equity or conversion of preference shares or debentures into equity shares. Therefore, even when a company plans to go for buy back, it has to evaluate from another perspective as well.

• Secondary Adjustment under section 92CE: Section 92CE provides for 'Secondary Adjustment' in transfer pricing in case primary adjustment to transfer pricing is more than ₹ 1 crore. 'Secondary Adjustment' means actual receipt of the amount from the associate enterprise in question. The Finance Act, 2019 inserted a new sub-section, as section 92CE(2A) to provide an option to the taxpayer to pay additional tax @18% with the exemption from repatriation. Therefore, the intent behind this seems to recover the amount of DDT as the same amount would have been distributed as dividend had it been repatriated and the Government would have received DDT. Now since DDT has been abolished, the Government may consider abolishing the provision of this additional tax as well.

The move of the Government to abolish DDT is in furtherance of attracting foreign investors, in order to support and strengthen the slowed-down economy. However, the Government should also protect and keep in mind the interest of the stakeholders. They should not be made to face a higher tax burden. Therefore, the Government should come up with a special rate of tax for taxability of dividend in the hands of resident shareholders also.

• Amendment in Section 57: Subsequent to the amendments vide this Finance Act, 2020, changes have been made to restrict the interest expense to 20% of the dividend income. Limiting such deduction is against the basic principle of allow ability of the expenses incurred for earning income and the same would pave a harsh reality on the stakeholder and the same can prove to be a reason for the investments made by large shareholders having major reasons for incomes by way of dividends as income from holding the investments. The said amendment comes in effect from 01.04.2021.

CONCLUSION:

• It is a welcome change for corporates as they are now exempt from paying DDT and this could serve to be a game changer in terms of inviting investments. It is also to be noted that a domestic company receiving dividend from an Indian company would be free to deduct the same u/s 80D and this would go a long way in facilitating and improving business workings of group concerns. However, dividend received from foreign companies will not be eligible to get any credit u/s 80M but it would be eligible to claim relief under section 90/90A as per specific provision under the tax-treaty or under section 91 in case of no tax treaty. 
• There is no specific rate for taxing the dividend income for resident shareholders as discussed above. This could lead to the individual shareholder being relieved or burdened on the basis of the slab rate in which he would fall. 
• The limitation of allowance of interest expense max. upto 20% of the income will put a major impact on the bonafide nature of income and related expense being claimed as deduction.

SUGGESTIONS:

• This may lead to demotivation amongst the resident shareholders. So, it is proposed that the Government must come up with a special rate for taxation of dividend for resident shareholders as well.
• The compliance requirements u/s 80M pose a question on the face of the legislature with a frown and hope that the scope of section 80M may be extended to dividend received from foreign company as well.
• As per the limitation on the allowance of the interest expense on dividend income, it is proposed to amend the law to allow deduction in full, as being incurred for the purpose of earning income. Also, it may be proposed that where any interest expense is not allowed as deduction, such interest shall form part of cost of acquisition for the purpose of computing capital gains at the time of sale of such shares held as investment in the books of the shareholders