The Finance Bill 2022 proposes to remove the concessional tax rate of 15% plus applicable surcharge and cess under Section 115BBD of the Act, applicable on dividends received by Indian companies from specified foreign subsidiaries, with effect from Apr 1, 2023. The proposed amendment entails subjecting the dividend received by an Indian company from foreign companies to be taxed at normal rates applicable to corporates. The authors, Ms. Swetha Prasad A (Senior Manager, M2K Advisors LLP) and Ms. Varsha N (Associate M2K Advisors LLP), in their article, analyze the probable implications of the proposed amendment. The authors point out that vide Finance Act, 2020 the applicability of dividend distribution tax on dividend distributed by Indian Companies was removed and deduction under Section 80M of the Act was introduced. They observe that "Section 80M of the IT Act provides that where the gross total income of a domestic company includes dividend income from any domestic / foreign company, a deduction to the extent of dividend distributed by the Indian Company to its shareholders shall be available. In order to avail deduction under 80M, the domestic company has to distribute the dividend one month prior to the date of furnishing the return of income under Section 139(1) of the IT Act for the relevant year. Thus companies claiming Section 80M deduction would not be impacted by the amendment to the extent of dividends distributed to their shareholders before the said due date." The authors highlight that "Given that Section 115BBD is proposed to be inoperative from AY 2023-24, if the foreign sourced dividend is taxable under business income, eligible expenses can be claimed as a deduction and if it is taxable under income from other sources, interest expenditure up to 20% of such dividend income can be claimed as a deduction. The authors explain that the ambiguity on whether Section 80M deduction is an “allowance” and whether it can be claimed if dividend income is taxed under Section 115BBD would no longer exist."

Withdrawal of concessional rate of tax on foreign sourced dividends

1. Introduction 

Currently, dividends received by Indian companies from specified foreign subsidiaries are subject to a concessional tax rate of 15% plus applicable surcharge and cess under Section 115BBD of the Income Tax Act, 1961 (“IT Act”).  The Finance Bill 2022 proposes to remove the concessional tax rate with effect from AY 2023-24 (FY 2022-23).

Consequently, any dividend received by an Indian company from foreign companies would be subject to tax at normal rates applicable to corporates at 15%, 22%, 25% or 30% as applicable (applicable surcharge and cess has to be added).

Finance Act, 2020 had removed the applicability of dividend distribution tax on dividend distributed Indian Companies, and as part of removing the cascading effect on distribution between entities having multi-tier structure, it had introduced a deduction under Section 80M of the IT Act.

Section 80M of the IT Act provides that where the gross total income of a domestic company includes dividend income from any domestic / foreign company, a deduction to the extent of dividend distributed by the Indian Company to its shareholders shall be available. In order to avail deduction under 80M, the domestic company has to be distribute the dividend before one month prior to the date of furnishing the return of income under Section 139(1) of the IT Act for the relevant year.  Section 80M deduction is applicable against domestic sourced and foreign sourced dividends. Therefore, companies claiming Section 80M deduction would not be impacted by the amendment to the extent of dividends distributed to their shareholders before the said due date.

It is also to be noted that Section 90 of the IT Act provides that an Indian Company can claim the foreign tax credit as per the Double Taxation Avoidance Agreement (‘DTAA’) or the provisions of the IT Act whichever is beneficial to it.  This is also supported by the Foreign Tax Credit (‘FTC’) Rules (Rule 128 of the Income-tax Rules 1962) issued by the Central Board of Direct Taxes (‘CBDT’), providing the manner of computing the credit and the documents required for the same. 

Certain DTAAs such as India – Singapore DTAA also provides for Underlying Tax Credit (i.e., credit for the taxes paid in Singapore on the profits out of which dividend is paid) and Tax Sparing Credit (i.e., credit in respect of taxes that would have been paid in the source country had there been no exemption or concession under the domestic law of the source country) while paying the taxes in India. 

2. Analysis

Given the above background, the impact of the amendment in Section 115BBD of the IT Act vide Finance Bill 2022 is explained in the below table under three scenarios on an approximate basis where dividend is distributed by F Co (a 100% subsidiary of I Co):

** Excluding surcharge and cess

From the above table, it is evident that the tax cost of dividend income from foreign subsidiaries would increase unless the dividend income is further up streamed to the shareholders within the specified timelines.  To such companies, the amendment would be tax neutral.  However, suppose the domestic company proposes to retain the dividend income in its hands, the Indian company may resort to receiving the dividend prior to 31^st March 2022 to reduce the tax cost.

Section 115BBD also provides that no deduction in respect of any expenditure or allowance would be allowed against the dividend income.  Given that Section 115BBD is proposed to be inoperative from AY 2023-24, if the foreign sourced dividend is taxable under business income, eligible expenses can be claimed as a deduction and if it is taxable under income from other sources, interest expenditure up to 20% of such dividend income can be claimed as a deduction.  The ambiguity on whether Section 80M deduction is an “allowance” and whether it can be claimed if dividend income is taxed under Section 115BBD would also no longer exist.

In case foreign taxes are paid on such dividends, it will be interesting to see whether such foreign taxes can be allowed against the dividend income. For dividend, section 57(i) specifically provides that reasonable commission or remuneration paid to a banker or any person for realizing dividend is allowable. Section 57(iii) provides that expenditure laid out or expended wholly and exclusively for the purpose of making or earning an income; therefore, whether foreign taxes paid will be regarded as ‘expenditure wholly incurred’ to earn dividend income or is it an application of income is to be tested before claiming deductions.

3. Section 80M – Deduction against gross total income or dividend income?

Section 80M of the IT Act provides as follows:

Where the gross total income of a domestic company in any previous year includes any income by way of dividends from any other domestic company or a foreign company or a business trust, there shall, in accordance with and subject to the provisions of this section, be allowed in computing the total income of such domestic company, a deduction of an amount equal to so much of the amount of income by way of dividends received from such other domestic company or foreign company or business trust as does not exceed the amount of dividend distributed by it on or before the due date.

On a plain reading of Section 80M, there arises a question whether Section 80M deduction is against “gross total income” or “dividend income”.  For example, in a case where foreign dividend income is offered to tax @15% under 115BBD and such tax is fully discharged through availing foreign tax credit, whether 80M deduction can also be claimed against any other income forming part of gross total income or 80M has to be claimed only against that part of dividend income forming part of gross total income?

In this regard, reference can be made to the language provided in the following sections:

• Section 80A(1) of the IT Act provides that deductions specified in Sections 80C to Section 80U (includes Section 80M) shall be allowed from gross total income of an assessee.

(1) In computing the total income of an assessee, there shall be allowed from his gross total income, in accordance with and subject to the provisions of this Chapter, the deductions specified in sections 80C to 80U. 

•  Section 80AB of the IT Act provides that deductions are to be made against the specific nature of income, which specifically omitted Section 80M.

Where any deduction is required to be made or allowed under any section (**) included in this Chapter under the heading “C.—Deductions in respect of certain incomes” in respect of any income of the nature specified in that section which is included in the gross total income of the assessee, then, notwithstanding anything contained in that section, for the purpose of computing the deduction under that section, the amount of income of that nature as computed in accordance with the provisions of this Act (before making any deduction under this Chapter) shall alone be deemed to be the amount of income of that nature which is derived or received by the assessee and which is included in his gross total income.

(**) Words “except Section 80M” omitted by Finance Act 1997 

•  Wherever, the Act requires the deduction to be granted against the specific stream of income, it has expressly provided so. For E.g. Reference could be made to Section 80HH, 80HHA etc., where the deduction under the section shall be available only against “such profits and gains” whereas under Section 80-IA, there is no such express language provided.

•  It is interesting to note that the erstwhile 80Mintroduced in Finance Act 1967 (omitted in Finance Act 1997) contained the term “from such dividend income’ and the relevant extract is provided below:

1) Where the gross total income of an assessee being a company includes any income by way of dividends received by it from a domestic company, there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction from such income by way of dividends of an amount equal to…

•  The Hon’ble Supreme Court in the case of Reliance Energy Limited [TS-307-SC-2021] also held that deduction under Section 80-IA of the IT Act cannot be pressed into service by reading a limitation of the deduction only to “business income”, The Court upheld that deduction under 80-IA should be deducted from gross total income and not limited profits and gains form business or profession

Given the above arguments, a view can be taken that Section 80M deduction can be availed against “gross total income”.  However, this is not tested before the judiciary and hence litigation in this regard cannot be ruled out.