Union Budget 2020 India: The dividend distribution tax (DDT) has been a part of the income-tax statute for over 20 years. The primary objective behind introducing the DDT in 1997—and consequently exempting the shareholders—was to encourage investment in shares of domestic companies. Additionally, it resulted in huge administrative convenience for the government in as much as the tax on dividends could be recovered from a single source as against from several assessees.
When the DDT was introduced as an additional tax on domestic companies, one of the stated objectives was also to reward companies which invested in future growth by ploughing their retained earnings into fresh investments.
In other words, the DDT was intended to act as a deterrent to distribution of profits to the shareholders, and was capped at 10% of dividends declared. Fast forward to today, it appears that the objectives behind its introduction have been achieved, but at double the tax cost to domestic companies—from a moderate 10% in 1997 to 20.56% currently.
Since the DDT is applicable only to domestic companies, other entity forms such as limited liability partnerships gained popularity. Of course, the recent corporate tax rate cut has partly offset the advantage in favour of limited liability partnerships, but, nevertheless, the DDT remains a sore point for companies. This issue gets further aggravated with the introduction of 10% tax on individuals earning dividends over Rs 10 lakh.
According to certain estimates, the DDT collection for the government is approximately Rs 60,000 crore, which is just about 5% of the total income-tax collection. Therefore, it will be interesting to see if the government decides to abolish this tax, with a hope that similar collections could be done from the shareholders. Where the shareholders are Indian resident individuals, the taxability of dividends in their hands would depend upon factors such as slab rates and availability of loss to be set off against the dividend income. Likewise, where the shareholders are non-residents, the taxability of dividends would depend upon the tax rate prescribed under the dividend article of the relevant tax treaty.
Further, individual shareholders with incomes below the basic exemption limit will be obligated to file their tax returns to offer dividend income to tax. This may result in expansion of the tax base.
It appears that the principle of equity can also be restored if the DDT is abolished and, instead, the shareholders can be taxed on dividend income directly. To ensure the interest of the Revenue is protected, the tax deducted at source (TDS) on dividend can also be reintroduced. Since the rate of 20.56% is extremely high, taxing shareholders at a flat rate of 10% or 15% could be considered. This will not only encourage more distribution of profits by companies, but also increase the purchasing power in the hands of the shareholders.
Source : FEconomic Times