The Finance Act 2020 has shifted back to the classical system of taxing dividend within the hands of shareholders or unit holders from 01 April 2020, and abolished dividend distribution tax (DDT), wherein the incidence was once on the company.
With this amendment, the subsequent corresponding changes are made to scale back the tax burden on shareholders:
- As per the amended section 57 of the tax Act, 1961 (‘Act’), expense incurred for the aim of earning the dividend income would be allowed as a deduction up to a maximum of 20% of such income.
- Section 80M of the Act has been introduced in order to remove the cascading impact of tax on dividend income for company shareholders. Domestic holding corporations receiving dividend income from subsidiaries will be allowed to set off such amounts from their total taxable income. This set off shall not exceed the amount of dividend similarly disbursed by using it up to one month prior to the due date of submitting of return.
Further, by making dividend taxable within the hands of shareholders, the Finance Act 2020 has rendered section 14A of the Act inapplicable in computing such dividend income.
Taxability in the hands of resident shareholders
Individual – For an individual shareholder, dividend shall be taxable as per the relevant slab rates. Moreover, the govt has abolished additional tax of 10 Percentage on dividend earnings in more than Rs 10 lakh per annum for resident non-corporate taxpayers (section 115BBDA of the Act).
Companies – For corporate shareholders, dividend shall be taxable as per the effective tax rates, which might range from 25.17% to 34.94% (including surcharge and cess).
Taxability in the hands of non-resident shareholders
Indian organizations shall be liable to withhold taxes at the price of 20% on payment of dividend to a non-resident shareholder, as per the provisions of the Act. Non-resident shareholders can claim advantage of the lower tax price under the relevant tax treaty, provided they’re ‘beneficial owners’ of the dividend income. Various tax treaties grant for a decrease withholding tax rate, normally ranging from 5% to 15%.
The term ‘beneficial owner’ has been neither described in tax treaties nor in the domestic tax laws, and the determination of the equal is a reality-based exercise. The OECD commentary suggests certain criteria for ascertaining recommended ownership. The criteria, such as agent, nominee, conduit enterprise acting as a fiduciary etc., can’t be viewed as ‘beneficial owner’ or organization must not be bound by contractual/ legal obligation to ignore on dividends received from another person.
Various Indian judicial precedents have also laid down sure concepts to determine ‘beneficial ownership’, such as the principle that a taxpayer make impartial selections investment, expenditure, etc. or must ride unrestricted acceptable to use the income, etc.
Further, the impact of Multilateral Instruments (‘MLI’) wants to be evaluated. MLI came into force in India from 01 October 2019, and the provisions of MLI have been effective on the Indian tax treaties from 01 April 2020. Article 8 of the MLI, which offers with dividends, gives that the concessional price of tax on dividend in case of beneficial ownership will be reachable only in a case where the shares are held through the shareholder for at least 365 days.
In addition to ‘beneficial ownership’ and MLI, the Most Favoured Nation (‘MFN’) clauses of tax treaties additionally want to be looked into. MFN clauses forge a link between taxation agreements by ensuring that the parties to one treaty furnish each different with treatment no much less beneficial than the treatment they provide below unique treaties in areas included by the clause.
Separately, non-resident shareholders should also get credit of withholding tax towards tax payable in their domestic country, concern to local regulations.
Compliance burden for non-resident shareholder
- Non-resident shareholders applying the lower withholding price as per tax treaty are liable to publish all requisite files which consists of TRC, Form 10F, beneficial possession confirmation, etc.
- Requirement to file return of income in India, if the non-resident shareholder desires to declare the benefit of lower price as per tax treaty. For filing such return, a non-resident shareholder has to achieve a PAN in India.
- Requirement to file Accountant’s Report in Form 3CEB desires to be evaluated, as there is a view that dividend is an appropriation of profits, and not specifically a transaction between 2 parties.
The abolition of DDT may additionally improve the attractiveness of Indian markets to foreign investors and domestic small retail investors, from a dividend yield perspective.
Prior to the Finance Act, 2020, DDT was only relevant to home companies; hence, entrepreneurs desired setting up companies / LLPs instead of companies. However, post reduction of corporate tax prices for home companies and abolition of DDT, entrepreneurs may lean toward the enterprise format.