BUDGET 2020 – DIVIDEND DISTRIBUTION TAX
Dividend distribution tax is a tax imposed by the Indian Government on Indian companies to the dividend paid to a company’s investors.
It was introduced in 2003 where all domestic companies were required to pay tax @ 12.5% on the dividends being distributed and such dividend was exempt in the hands of the taxpayer but then increased to 15% with effect from 1st April 2007. However, the budget for 2008-2009 proposes to remove the double taxation for the specific case of dividends received by a domestic holding company from a subsidiary that is in turn distributed to its shareholders. From 2016, the investors earning dividends above 10 lakhs per annum will have to pay an additional tax of 10%. Mutual fund companies also have to pay DDT. The rates are as under:
a) Debt oriented funds - DDT shall be 25%.
b) Equity-oriented funds - DDT shall be 10%.
In the Union Budget of India 2020 on 1st February, the Dividend Distribution Tax is removed by the government in the financial annual statement 2020. Consequently, dividends will be subject to tax in the hands of the shareholders at applicable tax rates.
IMPACT ON SHAREHOLDERS
At present, shareholders earning dividend income of Rs 10 lakh or more have to bear a tax of 10% on such income, plus the applicable surcharge and cess. The dividend, no matter the quantum, is tax-free in the hands of foreign shareholders. Under the Budget proposals, a rich shareholder will find that against a tax rate of 10% on dividend income, the dividend gets added to his taxable income and is taxed at the applicable slab rate. A person with a taxable income of between Rs 50 lakh and Rs 1 crore is subject to a tax rate of 34.32%.
It would encourage low-income earners to invest in the capital market as the person with total income up to Rs 5 lakh will not have to pay tax on dividend income as against 20.56 percent paid by them indirectly.
IMPACT ON COMPANIES
The abolition of dividend distribution tax will reduce the cost of doing business for high dividend-paying companies such as TCS, Hindustan Unilever, and ONGC. Now corporates will either pay more dividends to investors or will use that funds to diversify their business. India currently levies dividend distribution tax at an effective rate of 20.5% on companies declaring dividends. This is over and above the corporate tax that companies pay on their taxable profit. Removal of DDT will remove the burden of compliance on dividend-paying companies.
The list of major beneficiaries includes multinationals such as Nestle and Colgate, public sector firms such as Indian Oil, NTPC, BPCL, and Infosys.
ADVERSE IMPACT ON PROMOTERS
Removal of DDT would adversely affect promoter shareholders and holding companies. Promoter owners holding equity individually or in trusts may be adversely impacted, particularly when they are in the 43% tax bracket. Promoters shareholders, as owners of company they pay tax on profits and it gets taxed again on dividends received by them as investors.
IMPACT ON MUTUAL FUND
The proposed changes in Dividend Distribution Tax (DDT) and the new income tax system announced in the budget will not have any adverse impact on the mutual fund industry that showed resilience and maintained robust growth amid economic headwinds. Budget 2020 has proposed to make dividend income from mutual funds taxable in the hands of the recipient instead levying on companies and MFs, and withdrawn certain exemptions to get the benefit of lower tax slabs. Both DDT and new income tax proposals will not have any adverse impact on the mutual fund industry.
To summarize, the new DDT regime is a mixed bag where there are both losers and gainers. However, 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.