Grossing up of Dividend and Income Distribution Tax

Dividend and Income Distribution Tax

Section 115-O of the Act provides that a domestic company shall be liable for payment of additional tax at the rate of 15 per cent. on any amount declared, distributed or paid by way of dividends to its shareholders. This tax on  distributed profits is final tax in respect of the amount declared, distributed or paid as dividends and no credit in respect of it can be claimed by the company
or the shareholder.
Section 115 R of the Act similarly provides for levy of additional income-tax in respect of income distributed by the mutual funds to its investors at the rates provided.

Prior to introduction of dividend distribution tax (DDT), the dividends were taxable in the hands of the shareholder. The gross amount of dividend representing the distributable surplus was taxable, and the tax on this amount was paid by the shareholder at the applicable rate which varied from 0 to 30%. However, after the introduction of the DDT, a lower rate of 15% is currently
applicable but this rate is being applied on the amount paid as dividend after reduction of distribution tax by the company.

Therefore, the tax is computed with reference to the net amount. Similar case is there when income is distributed by mutual funds. Due to difference in the base of the income distributed or the dividend on which the distribution tax is calculated, the effective tax rate is lower than the rate provided in the respective sections.

In order to ensure that tax is levied on proper base, the amount of distributable income and the dividends which are actually received by the unit holder of mutual fund or shareholders of the domestic company need to be grossed up for the purpose of computing the additional tax.

Therefore, it is proposed to amend section 115-O in order to provide that for the purposes of determining the tax on distributed profits payable in accordance with the section 115-O, any amount by way of dividends referred to in sub-section (1) of the said section, as reduced by the amount referred to in sub-section (1A) [referred to as net distributed profits], shall be increased to such amount as would, after reduction of the tax on such increased amount at the rate specified in sub-section (1), be equal to the net distributed profits.

Thus, where the amount of dividend paid or distributed by a company is Rs. 85, then DDT under the amended provision would be calculated as follows:
Dividend amount distributed = Rs. 85
Increase by Rs. 15 [i.e. (85*0.15)/(1-0.15)]
Increased amount = Rs. 100
DDT @ 15% of Rs. 100 = Rs. 15
Tax payable u/s 115-O is Rs. 15
Dividend distributed to shareholders = Rs. 85

Similarly, it is proposed to amend section 115R to provide that for the purposes of determining the additional income-tax payable in accordance with sub-section (2) of the said section, the amount of distributed income shall be increased to such amount as would, after reduction of the additional income-tax on such increased amount at the rate specified in sub-section (2), be equal to the amount of income distributed by the Mutual Fund.

These amendments will take effect from 1st October, 2014.

DTC woes continues

We also bring to you latest news from Tax in India. Below is the article published in one of the News Tabloid in India.

The Direct Taxes Code (DTC) is, by now, a well-known concept to India Inc and the tax professional fraternity as it has been a matter of discussion and debate for almost six years now. The finance ministry released the revised draft—the Direct Taxes Code, 2013—for public discussion and comments in the first week of this month. DTC 2013, set to replace the half-a-century-old Income-Tax Act, has been in the news since 2009; but the latest draft came weeks before the ongoing general election, raising the prospect of the document being junked when a new finance minister takes charge next month.

In the revised draft, focus is on raising more revenue from high-net-worth residents, while leaving the slab rates unchanged for others. DTC 2013 proposes an additional levy of 10% tax on the recipient of dividend if the dividend income exceeds Rs 1 crore. Such dividend would fall under the income category of ‘special source’ and no deduction of expenditure would be allowed to be set-off against such income. This means, while non-residents are proposed to be kept out of this net so as not to further dampen the FDI environment, residents are covered.

At present, any domestic company after paying 30% corporate tax on its business profits is required to pay 15% dividend distribution tax (DDT) if it wants to distribute dividends to its shareholders. Further, once DDT is paid by the domestic company, such dividend remains tax exempt in the hands of the shareholders. However, the proposed additional tax will be paid by the resident shareholders and will be over and above the 15% paid by the distributing company. Here, if the recipient of such dividend is a company, then whether 10% rate would apply or would it be subject to MAT at the rate of 20% is also not clarified in DTC 2013.

At present, the credit of DDT is not available to the shareholder except in a case wherein the company receiving dividend from its subsidiary (in which it holds more than 50% equity shares) declares dividend to its ultimate shareholders. Here, it is to be kept in mind that DDT was introduced as a measure for easier collection of tax. So, it is clear that DDT at the rate of 15% is nothing but the taxes paid by the company for its shareholders. Thus, rather than over-taxing a select set of investors with such additional tax and discouraging them from investing, the idea should be to expand the tax base by bringing the tax evaders in the tax net and collect more revenues.

The income tax department, justifying the levy of additional tax, has stated in a note released with the draft DTC 2013 that “under the Income-Tax Act as well as in the DTC Bill, 2010, the DDT is to be levied at the rate of 15%. This favours high-net-worth taxpayers who pay only a fraction of their earnings as tax on their investments in the capital market.”

Exempting long-term capital gains arising from the sale of listed securities and dividend in the hands of the shareholders was clearly a boost to the Indian stock market. The idea behind such exemption is to create an investor-friendly environment in the market where investors invest the excess funds for the long-term, giving a much-required impetus to the markets. The current proposal of an additional 10% tax may lead to an aggravation of negative sentiments as the investors would view this tax as a penalty for investing excess funds in companies. This means that capital-deprived companies will resort to raising funds by way of debt, which will increase their finance costs and lead to lower profitability and, thereby, lower tax collections for the government.

Keeping in mind the capital-starved state of our country and the negative investment sentiment prevalent among the foreign investors due to the GAAR provisions and ambiguity around taxability on indirect transfer of assets, the government should avoid introducing provisions that will make the resident investors also turn their back towards making investments, while the need of the hour is to create a sound capital base.

Hiren Bhatt, director, KPMG in India, contributed to this article
The author is co-head of tax, KPMG in India. Views are personal
The above article was published in The Hindu