Budget 2018 brought in a slew of amendments that expanded the ambit of taxation for the Revenue. While the most talked about amendment was the taxation of Long Term Capital Gains from Listed Equity Transactions, there still remains a few critical anti-abuse provisions that have managed to slip under the radar. Some of these provisions are, in fact, the amendments brought about to Deemed Dividend and Dividend Distribution Tax.

What is Deemed Dividend?

Dividend, in normal parlance, may be understood as a sum paid to or received by a shareholder in proportion to his shareholding in a company out of the total profit distributed. A more robust and specific definition, for the purposes of the Income Tax Act, has been defined u/s 2(22). The sub-clauses (a) to (e) of section 2 (22) of the Income-tax Act bring into the ambit of dividend certain distributions/ outflows which would otherwise not have been considered as dividend in the ordinary sense. This is known as ‘Deemed Dividend’. The following table represents a summary of the same:

What is Dividend Distribution Tax?

Dividend Distribution Tax (DDT) is a separate levy, independent from the regular Income Tax paid by the Company. Sec. 115-O obligates the Company to pay specified rate of tax on the distributed profits or dividends as defined u/s. 2(22) of the Income Tax Act.

Any dividend paid by the domestic company is taxable in the hands of such company u/s.  115-O and is exempt in the hands of the shareholder u/s. 10(34). However, as per Explanation to Chapter XII-D, “dividend” for the purpose of Chapter XII-D (which includes section 115-O) shall not include deemed dividend u/s. 2(22)(e). Therefore, Sec. 2(22)(e) was outside the ambit of Sec. 115-O. Any dividend u/s. 2(22)(e) was taxable in the hands of the shareholder at the applicable rate.

However, all this changes with the Finance Bill, 2018. In one among the 3 major changes to Sec. 115-O, dividends u/s. 2(22)(e) has been brought to tax under the section.

The first significant change in the budget is widening the definition of ‘Accumulated Profits’ u/s. 2(22).

Accumulated Profits Amendment u/s. 2(22) – Effective from 1^st April, 2018

A significant anti-abuse provision included in the Finance Bill, 2018, is the move to expand the definition of ‘accumulated profits’. Explanation 2A has now been added with a view to plug slippage of revenue which was done through tax abusive arrangements to avoid taxation u/s. 115-O.

A disheartening common trend always arose in the past when companies with large accumulated profits amalgamated with companies with large accumulated losses, thereby having a low balance of accumulated profits. This eventually gave companies the opportunity to reduce capital, through the Capital Reduction process, bypassing and circumventing the provisions of Sec 2(22)(d).

Now, where companies are amalgamated, the accumulated profits whether capitalized or not or loss as the case may be shall be increased by the accumulated profits, whether capitalized or not of the amalgamating company on the date of amalgamation. Thus, while calculating deemed dividend u/s. 2(22)(d) on a transaction of capital reduction, amalgamated companies shall have to even include the accumulated profits of the amalgamating company as on the date of amalgamation in order to determine the deemed dividend in the hands of the shareholder.

Dividend Distribution Tax now levied on Dividends u/s. 2(22)(e) - Effective from 1^st April, 2018

A significant move in taxation, likely to affect companies, is taxation of deemed dividends u/s. 2(22)(e). As explained earlier, Sec 2(22)(e) was outside the ambit of Sec. 115-O. Any dividend u/s. 2(22)(e) was taxable in the hands of the shareholder at the applicable marginal rate.

In a big move, the Hon’ble Finance Minister has announced in the Finance Bill, 2018 that dividends u/s. 2(22)(e) alone is set to be taxed at the rate of 30% on distribution (without grossing up). It is interesting to understand why such a special rate of tax is reserved for Sec. 2(22)(e). While one reason is to prevent camouflaging of dividends in the guise of loans and advances, there is thought to be a bigger reasoning behind the same. The move to tax the dividend in the hands of the company, rather than the shareholder, makes the task simpler for the Revenue and reduces the challenges faced by the Department in collection of dividend tax in the hands of the shareholders.

Several decisions of High Courts and Tribunals ruled in favour of the Assessee, when taxed in the shareholders hands. The rising litigation costs and difficulty in collection from the foreign residents, who received such dividends was increasingly high and this move to tax the dividend in the hands of the company will likely provide some relief to the Revenue.

In Bagmane Constructions (P) Ltd Vs Commissioner Of Income Tax [TS-785-HC-2014(KAR)-O], the Karnataka High Court held that 'advance' given by a closely held company to its sister concerns and substantial shareholder (assessees) does not fall within ambit of deemed dividend u/s. 2(22)(e).

In Pradip Kumar Malhotra Vs Commissioner Of Income Tax [TS-5498-HC-2011(CALCUTTA)-O], it was held that 'Loan or advance' for business considerations not a deemed dividend - ‘Deemed dividend' provisions u/s. 2(22)(e) applicable for ‘gratuitous advances’ and not where advance is given for business considerations.

Dividend Distribution Tax on Dividend to Equity Oriented Mutual Funds - Effective from 1^st April, 2018

As per Sec 115R, the specified mutual fund which distributes an amount to its unit holders will be chargeable to tax on such distributed income at the specified rate. However, the income which was distributed to the unit holder was exempt from tax under this section.

Now, the Finance Bill 2018 proposes that the aforesaid exemption be withdrawn and the income distributed to the unit holders of equity-oriented funds be taxed at the rate of 10% in the hands of the Mutual Fund distributing such income. The Govt. explains that the reason this amendment has been made is to provide a level playing field between growth oriented funds and debt funds in the wake of the amended capital gains tax regime wherein the unit holders of equity oriented funds shall be liable to long-term capital gains tax. This move is however likely to take a bite out of the dividends that reach the shareholders pockets.

Conclusion:

It is expected that these moves to bring to tax dividends and long term capital gains of equity shares are likely to impact investments in the short-term. It is also likely that foreign investments may feel discouraged to invest in India in the immediate wake of the Finance Bill. However, credence must be given to the fact that these are measures intended to stop abuse of loop-holes in the Act. Therefore, it is expected that in the medium term and long term, the amendments will put the Indian economy on a solid foundation; which will attract positive investment.