Dividend income has been subject to the various amendments over the course of years. The author, Mr. A. Sekar (Chartered Accountant), delves into the taxability of dividend received from a company and implications of proposed amendment by insertion of sub-section (4) to Section 115BBD. The author explains that vide Finance Act, 2020 the Dividend Distribution Tax was abolished and dividends are to be taxed in the hands of the investors. The Finance Bill, 2022 seeks to withdraw the concessional rate of 15% on taxation of dividend income from foreign entities under Section 115BBD, and the same shall be subject to tax at the applicable corporate tax rate including surcharge and cess. The author opines, "withdrawal of the concessional rate of tax at 15% as provided under the existing Section 115BBD would hamper the expansion of global companies, as the same would result in increased tax liability for Indian companies and compel some companies to move their headquarters." Further highlights that the same would, "impact companies across sectors with profitable foreign operations. It may drive up the tax cost of repatriation of the funds back to India unless the dividend so received are further distributed to its shareholders within the specified timelines." The author further remarks that, "This may have commercial implications on the overall structure for Indian Companies of start-up going global as well as encouraging spinning of their existing structures."

“Tax Treatment of Dividend Received from Company and the Implications of Budget 2022”

The taxation of dividends distributed by a company, in the hands of the recipient shareholders has been the subject matter of repeated amendments to the Income tax Act 1961. Up to Assessment Year 2020-21, if a shareholder gets dividend from a domestic company, then he shall not be liable to pay any tax on such dividend as it is exempt from tax under section 10(34) of the Act. However, in such cases, the domestic company is liable to pay a Dividend Distribution Tax (DDT) under section 115-O. The Finance Act, 2020 has abolished the DDT and move to the classical system of taxation wherein dividends are taxed in the hands of the investors.

Therefore, the provisions of Section 115-O shall not be applicable if the dividend is distributed on or after 01-04-2020. Thus, if the dividend is distributed on or after 01-04- 2020 the domestic companies shall not be liable to pay DDT and, consequently, shareholders shall be liable to pay tax on such dividend income. As dividend would now be taxable in the hands of the shareholder, various provisions of the Act have been revived such as allowability of expenses from dividend income, deductibility of tax from dividend income, treatment of inter-corporate dividend, etc.

In this part you can gain knowledge about taxability of dividend distributed by domestic companies on or after 01-4-2020.

Meaning of Dividend

Dividend usually refers to the distribution of profits by a company to its shareholders. However, in view of Section 2(22) of the Income-tax Act, the dividend shall also include the following:

(a) Distribution of accumulated profits to shareholders entailing release of the company's assets.

(b) Distribution of debentures or deposit certificates to shareholders out of the accumulated profits of the company and issue of bonus shares to preference shareholders out of accumulated profits.

(c) Distribution made to shareholders of the company on its liquidation out of accumulated profits.

(d) Distribution to shareholders out of accumulated profits on the reduction of capital by the company; and

(e) Loan or advance made by a closely held company to its shareholder out of accumulated profits.

Taxability of dividend received on or after 01-04-2020

The taxability of dividends in the hands of the company as well as shareholders from Assessment Year 2021-22 would be as under:

Obligation of the domestic companies

The domestic companies shall not be liable to pay DDT on dividend distributed to shareholders on or after 01-04-2020. However, domestic companies shall be liable to deduct tax under Section 194. As per the Section 194, which shall be applicable to dividend distributed, declared, or paid on or after 01-04-2020, an Indian company shall deduct tax at the rate of 10% from dividend distributed to the resident shareholders if the aggregate amount of dividend distributed or paid during the financial year to a shareholder exceeds Rs. 5,000. However, no tax shall be required to be deducted from the dividend paid or payable to Life Insurance Corporation of India (LIC), General Insurance Corporation of India (GIC) or any other insurer in respect of any shares owned by it or in which it has full beneficial interest. However, where the dividend is payable to a non-resident or a foreign company, the tax shall be deducted under Section 195 in accordance with relevant DTAA

Taxability in hands of shareholders

Section 10(34), which provides an exemption to the shareholders in respect of dividend income, is withdrawn from Assessment Year 2021-20. Thus, dividend received during the financial year 2020-21 and onwards shall now be taxable in the hands of the shareholders. Consequently, Section 115BBDA which provides for taxability of dividend in excess of Rs. 10 lakhshave no relevance as the entire amount of dividend shall be taxable in the hands of the shareholder. The taxability of dividend and tax rate thereon shall depend upon many factors like residential status of the shareholders, relevant head of income. In case of a non-resident shareholder, the provisions of Double Taxation Avoidance Agreements (DTAAs) and Multilateral Instrument (MLI) shall also come into play.

Taxable in the hands of resident shareholder

A person can deal in securities either as a trader or as an investor. The income earned by him from the trading activities is taxable under the head business income. Thus, if shares are held for trading purposes, then the dividend income shall be taxable under the head business or profession. Whereas, if shares are held as an investment, then income arising in nature of dividend shall be taxable under the head other sources. The income, taxable under the head PGBP, is computed in accordance with the method of accounting regularly followed by the assessee. For the purpose of computation of business income, a taxpayer can follow either mercantile system of accounting or cash basis of accounting. However, the method of accounting employed by the assessee does not affect the basis of charge of dividend income as Section 8 of the Act provides that final dividend including deemed dividend shall be taxable in the year in which it is declared, distributed, or paid by the company, whichever is earlier. Whereas interim dividend is taxable in the previous year in which the amount of such dividend is unconditionally made available by the company to the shareholder. In other words, interim dividend is chargeable to tax on receipt basis.

Deductions from dividend income

Where dividend is assessable to tax as business income, the assessee can claim the deductions of all those expenditures which have been incurred to earn that dividend income such as collection charges, interest on loan etc. Whereas if dividend is taxable under the head other sources, the assessee can claim deduction of only interest expenditure which has been incurred to earn that dividend income to the extent of 20% of total dividend income. No deduction shall be allowed for any other expenses including commission or remuneration paid to a banker or any other person for the purpose of realising such dividend.

Tax rate on dividend income

The dividend income shall be chargeable to tax at normal tax rates as applicable in case of an assessee except where a resident individual, being an employee of an Indian company or its subsidiary engaged in Information technology, entertainment, pharmaceutical or bio-technology industry, receives dividend in respect of GDRs issued by such company under an Employees' Stock Option Scheme. In such a case, dividend shall be taxable at concessional tax rate of 10% without providing for any deduction under the Income-tax Act. However, the GDRs should be purchased by the employee in foreign currency.

Inter-corporate dividend

 As the taxability of dividend is proposed to be shifted from companies to shareholders, the Government has introduced a new section 80M under the Act to remove the cascading effect where a domestic company receives a dividend from another domestic company. However, nothing has been prescribed where a domestic company receives dividend from a foreign company and further distribute the same to its shareholders. The taxability in such cases shall be as under:

Domestic co. receives dividend from another domestic co.

The provisions of section 80M removes the cascading effect by providing that inter-corporate dividend shall be reduced from total income of company receiving the dividend if same is further distributed to shareholders one month prior to the due date of filing of return. Domestic co. receives dividend from a foreign co.

Dividend received by a domestic company from a foreign company, in which such domestic company has 26% or more equity shareholding, is taxable at a rate of 15% plus Surcharge and Health and Education Cess under Section 115BBD. Such tax shall be computed on a gross basis without allowing deduction for any expenditure. Dividend received by a domestic company from a foreign company, in which equity shareholding of such domestic company is less than 26%, is taxable at normal tax rate. The domestic company can claim deduction for any expense incurred by it for the purposes of earning such dividend income.

Position Post Budget 2022

Clause 27 of the Finance Bill 2022 seeks to amend Section 115BBD of the Income tax Act 1961 The concessional rate of tax on dividends received by Indian Companies from foreign subsidiaries will be done away with from April 1, 2022, by virtue of this Clause 27, which has added a new sub-section (4) to Section 115BBD which reads as under:

“(4) The provisions of this section shall not apply to any assessment year beginning on or after 1^st April 2023.”

The effect of the insertion of sub-section (4) to Section 115BBD has been explained in the Memorandum explaining the provisions of the Bill as under:

“Withdrawal of concessional rate of taxation on dividend income under Section 115BBD:

Section 115BBD of the Act provides for a concessional rate of tax of 15% on dividend income received by an Indian company from a foreign company in which the said Indian company holds 26% or more in nominal value of equity shares (specified foreign company). This rate was aligned to the rate of tax provided under Section 115 O of the Act.

2. Finance Act 2020 abolished the dividend distribution tax provided in section 115O to, inter-alia, provide that dividend shall be taxed in the hands of the shareholder at applicable rate plus surcharge and cess.

3. In order to provide parity in the tax treatment in case of dividends received by Indian companies from specified foreign companies’ vis a vis dividend received from domestic companies, it is proposed to amend Section 115BBD of the Act to provide that the provisions of this section shall not apply to any assessment year beginning on or after 1st day of April 2023.

4. This amendment will take effect from 1^st April 2023 and will accordingly apply in relation to the assessment year 2023-24 and subsequent assessment years”

This means, dividend from foreign entities will be taxed at the applicable corporate tax rate. Corporate tax rates range from 15-30 percent plus surcharge and cess, depending on the type of the company. For instance, under Section 115BAA, domestic companies have an option to pay income tax at 22 percent plus surcharge and cess if they meet certain criteria. Income of new manufacturing domestic companies is taxed at 15 percent under Section 115BAB with a surcharge of 10percent.

The withdrawal of the concessional rate of tax at 15 percent as provided under the existing Section 115BBD would hamper the expansion of global companies, as the same would result in increased tax liability for Indian companies and compel some companies to move their headquarters. This also would impact companies across sectors with profitable foreign operations. It may drive up the tax cost of repatriation of the funds back to India unless the dividends so received are further distributed to its shareholders within the specified timelines. This may have commercial implications on the overall structure for Indian companies of start-up going global as well encourage spinning of their existing structures.