Let us Explore the Changes in Dividend Taxation in India

Key Takeaways:

- Abolition of DDT and introduction of dividend taxation for investors

- Domestic companies must deduct tax at source on dividend payments

- Resident shareholders face taxation under “Income from Other Sources”

- Non-resident shareholders, including FPIs, face specific tax rates

- Inter-corporate dividends receive special treatment to avoid cascading taxation

- Advance tax liability provisions apply to dividend income

Detailed Narrative:

The Indian tax landscape for dividends has undergone a transformative change, marking a departure from the erstwhile Dividend Distribution Tax (DDT) regime. Under the new system, dividends are now taxable in the hands of the investors, aligning India with global practices.

For domestic companies, the obligation to pay DDT on dividend distributions has been abolished. However, a new responsibility has emerged – the deduction of tax at source. Indian companies must withhold 10% tax on dividends paid to resident shareholders if the aggregate dividend exceeds Rs.5,000 in a financial year. Specific provisions govern the tax deduction for non-resident shareholders, including Foreign Portfolio Investors (FPIs).

The taxability of dividends for resident shareholders is now governed by the “Income from Other Sources” head. Deductions are permitted for interest expenses incurred to earn the dividend income, capped at 20% of the total dividend. Furthermore, a concessional 10% tax rate applies to resident employees receiving dividends on Global Depository Receipts (GDRs) issued under an Employees’ Stock Option Scheme.

Non-resident shareholders, including FPIs and Non-Resident Indians (NRIs), face a flat 20% tax rate on dividend income, subject to the provisions of applicable Double Taxation Avoidance Agreements (DTAAs). Specific rates apply to dividends received on GDRs of Indian companies or Public Sector Units (PSUs) purchased in foreign currency.

To mitigate the cascading effect of taxation, the government has introduced Section 80M, allowing domestic companies to claim a deduction for inter-corporate dividends received from other domestic companies, provided the dividends are further distributed to shareholders within a specified timeframe.

The taxation of dividends received by domestic companies from foreign companies is subject to distinct provisions.

- If the domestic company holds 26% or more equity in the foreign company, the dividend is taxable at 15% on a gross basis.

- For shareholdings below 26%, the dividend is taxable at normal rates, with deductions allowed for associated expenses.

Notably, the Minimum Alternate Tax (MAT) provisions have been amended to ensure that foreign companies are not subject to MAT on dividend income taxed at a lower rate due to DTAAs.

To address potential tax avoidance strategies, India has adopted the Multilateral Instrument (MLI), which mandates a minimum 365-day shareholding period for foreign companies to benefit from reduced tax rates on dividends under DTAAs.

FAQs:

Q1: How does the new dividend taxation system impact resident individual investors?

A1: Resident individuals will now be taxed on dividend income under the “Income from Other Sources” head at their applicable tax rates. However, they can claim a deduction for interest expenses incurred to earn the dividend, subject to a 20% cap.

Q2: What are the implications for non-resident shareholders, including FPIs?A2: Non-resident shareholders, including FPIs and NRIs, face a flat 20% tax rate on dividend income, subject to the provisions of applicable DTAAs. Specific rates apply to dividends received on GDRs of Indian companies or PSUs purchased in foreign currency.

Q3: How does the new system address the cascading effect of taxation on inter-corporate dividends?

A3: The government has introduced Section 80M, allowing domestic companies to claim a deduction for inter-corporate dividends received from other domestic companies, provided the dividends are further distributed to shareholders within a specified timeframe.

Q4: What measures have been taken to prevent tax avoidance strategies by foreign companies?

A4: India has adopted the Multilateral Instrument (MLI), which mandates a minimum 365-day shareholding period for foreign companies to benefit from reduced tax rates on dividends under DTAAs.

Key Precedents:

1. Section 194:

This section governs the deduction of tax at source by domestic companies on dividend payments to resident shareholders. The tax rate is 10%, applicable if the aggregate dividend exceeds Rs. 5,000 in a financial year.

2. Section 195:

This section governs the deduction of tax at source by domestic companies on dividend payments to non-resident shareholders, including FPIs. The tax rate is determined by the provisions of the Finance Act or applicable DTAAs.

3. Section 115AC:

This section specifies a 10% tax rate for non-residents receiving dividends on GDRs of Indian companies or PSUs purchased in foreign currency.

4. Section 115AD:

This section specifies a 20% tax rate for FPIs receiving dividend income from securities, except for investment divisions of offshore banking units, which are taxed at 10%.

5. Section 115E:

This section specifies a 20% tax rate for Non-Resident Indians receiving dividend income from shares of Indian companies purchased in foreign currency.

6. Section 115A:

This section specifies a 20% tax rate for non-residents or foreign companies receiving dividend income in any other case.

7. Section 80M:

This newly introduced section allows domestic companies to claim a deduction for inter-corporate dividends received from other domestic companies, provided the dividends are further distributed to shareholders within a specified timeframe.

8. Section 115BBD:

This section governs the taxation of dividends received by domestic companies from foreign companies, with specific provisions based on the shareholding percentage.

9. Section 115JB:

This section has been amended to ensure that foreign companies are not subject to MAT on dividend income taxed at a lower rate due to DTAAs.

10. Multilateral Instrument (MLI):

This international instrument, adopted by India, mandates a minimum 365-day shareholding period for foreign companies to benefit from reduced tax rates on dividends under DTAAs, preventing tax avoidance strategies.