A person invests in a company for various reasons like gaining control of the company, getting share in the profits of the company, an investment vehicle, gain from the increasing price of company’s shares, etc. Investors/ shareholders, being owners of the company, are entitled to a share of company’s profits when distributed i.e. dividends. Historically, dividends when paid were taxed in the hands of the shareholder. However, in the year 1997, the government exempted taxing dividends in the hands of shareholders, replacing it with Dividend Distribution Tax (DDT), which was payable by the company on the dividends declared. In order to tax the super-rich, in 2017, the Indian Government introduced a tax on the dividends in the hands of shareholders, earning annual dividend income in excess of INR 10 lakhs. Recently, the Finance Act, 2020 abolished DDT and reintroduced a classical system of taxing the same in the hands of the shareholders. Certain considerations on account of the change are discussed hereunder:
What Has Changed?
- With the abolishment of DDT, dividend will now be taxed in the hands of the investor / shareholder, irrespective of the dividend’s quantum (i.e. INR 1 million limit has become redundant).
- Provisions to curb dividend stripping, a mechanism whereby the loss to the extent of dividend income (being exempt) was not allowed to be carry forward, will no longer apply.
- The company distributing the dividend is required to deduct tax at source (TDS), if the amount of the dividend paid to a shareholder exceeds INR 5,000 per shareholder/ investor. The tax withholding rate being 10% (recipient being Indian resident) / 20% (recipient being non-resident).
- Deduction available under section 80M of the Income Tax Act, 1961 (IT Act), in respect of Dividend income, is subject to satisfying prescribed conditions
- Restriction placed on deduction of expenses incurred for earning dividend income.
Transitional Relief Provided
On literal interpretation of the amendments proposed by the Finance Bill, 2020, it appeared that the dividend declared by companies before 31 March 2020, could attract double taxation. In the event a company declares dividend before 31 March 2020 and the same was received by the shareholders on or after 01 April 2020, such dividend could have been subjected to double taxation both in the hands of the company (as DDT) and in the hands to shareholders.
In order to address this concern and provide transitional relief, the Finance Act, 2020, has clarified that dividend received by shareholders on or after 01 April 2020, shall not be included in the income of the shareholder, if tax has already been paid on such dividends by way of DDT. Thus, where the DDT is paid by the company (in respect of dividend declared before 31 March 2020), even though dividends are received by the shareholder on or after 01 April 2020, such dividend will not be taxed in the hands of the shareholders.
Considerations For Shareholders
(1) Would dividend income qualify as business income or income from other sources?
Deduction of expenditure from any income would depend upon classification under appropriate heads of income. As income from dividends was exempt, no expenditure deduction was permissible, hence determining the relevant head of income was irrelevant. However, with dividend now taxable in the hands of a shareholder, identifying the relevant head of income assumes significance. Income from dividend may fall under either:
- Profits and Gains from Business or Profession; or
- Income from Other Sources
While the list of expenses that can be claimed against business income is vast, when it comes to income from other sources, section 57 of the IT Act restricts the deduction to interest expenditure not exceeding 20% of the dividend income.
Considering this, one needs to evaluate the proper head under which the dividend needs to be offered to tax. Based on judicial precedents, following could be key factors (not exhaustive) to assist determining the relevant head:
- Purpose/objective of investing in shares (investment or speculation)
- Asset category classification (investment or stock in trade)
- Accounting treatment (valuation, impairment, etc)
- Tax treatment in past
- Period of holding of shares
- Quantum of transaction
- Intention behind acquiring the shares
- Frequency of trade
(2) Would deduction be allowed for expense incurred to earn dividend income?
As per section 14A of the IT Act, expenses incurred for earning exempt income are not tax deductible. Rule 8D of the Income Tax Rules, 1961 (IT Rules) prescribes the mode of computing the disallowance. Section 14A of the IT Act is one of the most litigious sections and there is a plethora of judicial pronouncements on the subject. Shareholders are seeking lower or no disallowance under contention that there are no expenses incurred for earning dividend income, whereas the revenue officers have been maintaining otherwise.
With change in the tax regime, it may appear that the controversy may be put to rest, however, the contentions raised by shareholders in the past (especially where the shareholders contended that no expense is incurred towards earning dividend income) could be used against them for denying the deduction of expenditure incurred to earn dividend income. It will thus be relevant for the shareholder to revisit the position taken by them in the past, in respect of expenses incurred towards earning of dividend income.
(3) Would interest be levied on default in payment of advance tax on dividend income?
A taxpayer is required to estimate his annual tax liability and discharge the same by way of quarterly advance tax payments in prescribed proportion. Section 234C of the IT Act provides for interest upon default/delay in quarterly payment of advance tax instalment. The rigours of the section are relaxed in case of income under the head Capital Gains i.e. if appropriate tax on capital gains is paid in subsequent quarter, interest under section 234C of the IT Act would not apply. A similar relaxation was also provided to dividend income in excess of INR 1 million, when the same was brought to tax since 2017. However, no amendment was made to the section by Finance Act, 2020 to provide a similar relaxation for dividend income. Having said this, considering the fact that it may be difficult for a shareholder to estimate his annual dividend income, on a plain reading of the relaxation prescribed in section 234C of the IT Act, a shareholder may seek relaxation under the said provision. It is yet to be seen whether the tax department agrees to such reading of the provisions of section 234C of the IT Act. Even in such cases, it will be in the interest of the shareholders to track their dividend income and pay the relevant advance tax in the subsequent quarter.
Considerations For The Company
(1) Is PAN / AADHAR of the shareholder required where investment in shares was made before the same were made mandatory?
Recently, PAN/ AADHAR has been made mandatory for making investments, by a resident in shares of a company. However, for investments made years back, there are instances where the companies may not be having PAN / AADHAR of the resident shareholder. Even though the prescribed rate of TDS on dividend is 10% for resident shareholders, the company would be required to deduct tax at 20% in absence of PAN/ AADHAR of a resident shareholder.
(2) Deduction under section 80M of the IT Act
Companies declaring dividend out of the dividend received by it, were allowed a deduction from the DDT liability. However, with DDT abolished and dividend being taxed in the hands of the shareholder, in order to avoid double taxation on cascading of inter-corporate dividends, the Finance Act, 2020 has introduced section 80M to the IT Act. Accordingly, lower of the following amounts would be deductible from dividend income:
- Dividend income received from another company during the fiscal year; or
- Dividend distributed by the company on or before one month from the due date of furnishing the tax return for the relevant fiscal year.
This provision does not encapsulate a situation where the dividend is earned during a fiscal year, but where the dividend is distributed in subsequent year(s) beyond the due date of filing the tax return.
A question would also arise, where deduction of interest expenditure under section 57 of the IT Act is to be computed at 20% of dividend income, should the same be computed on gross dividend income or net dividend income (after reducing dividend declared). A clarification on this subject from the Government would help avoid unwarranted litigation.
Considerations For Foreign Investors
(1) Whether non-resident shareholder receiving dividend income is required to file a tax return in India?
As per section 139(1) of the IT Act, every company or firm, or any other person, if his total income under the IT Act during the fiscal year exceeded the amount which is not chargeable to income-tax, is required to file a tax return in India. However, section 115A (5) of the IT Act grants exemption to a non-resident from filing India tax return, if the following conditions are satisfied:
- The total income in respect of which the taxpayer is taxable during the fiscal year consisted only of specified income (dividend being one of them); and
- Appropriate tax has been withheld from such income
Thus, if the above-mentioned conditions are satisfied, a non-resident shareholder earning divided income would not be required to file tax return in India.
(2) Would a non-resident shareholder be entitled to credit for TDS on dividend income?
Earlier, as DDT was in the nature of tax on distribution, there was a question whether credit would be available for DDT against the tax on such dividend in the shareholder’s country of residence. With abolition of DDT and introduction of tax/ withholding on dividend payment, a foreign investor will now be able to take credit for the tax deducted in accordance with the Double Tax Avoidance Agreements that India may have with the shareholder’s country of residence. However, foreign investors would also need to take cognisance of the recently implemented multilateral instruments, as it could have far-reaching effects on the taxability of dividends in India.
The change brings a mixed bag for taxpayers (whether shareholder or company). However, a taxpayer needs to consider the above and other aspects for determining the overall tax impact and tax positions to be considered.
Note: Every reference to tax provisions in respect of a company, equally applies to Mutual Funds
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