Companies often reward their shareholders with dividend distributions. Of course, dividends are not just declared profits, but they also involve other tax consequences related to dividend distribution by companies. In India, both companies and shareholders must understand how dividend taxation works in order to comply with the law and effectively plan their tax strategies.
This blog will cover the taxation system on dividends, the recent amendment under the Income Tax Act, and its impact on shareholders, as well as the entire tax implications of dividend distribution by companies in India.
What is Dividend Distribution?
A dividend is the portion of profit that is distributed by a company to its shareholders; this distribution can be in cash, stock, or other assets. A company will always declare a dividend after taking care of its operational costs, statutory obligations, and needs for reinvestment.
For the purpose of taxation, it is important to consider what dividend distribution is because the company and shareholder will be subject to specific provisions of the Income Tax Act, 1961. The tax implications of dividend distribution by companies are based on whether the shareholder is resident or non-resident and whether the company is domestic or foreign.
Evolution of Dividend Taxation in India
Previously, companies were required to pay Dividend Distribution Tax (DDT) prior to making dividend payments to shareholders. However, with the Finance Act, 2020, DDT has now been abolished and the responsibility for the tax payments has shifted from the companies to the shareholders.
Dividends will now be taxed in the hands of the shareholders in accordance with the applicable income tax slab rates. This is a substantial change from past practice whereby companies paid tax until distribution, and dividends will now be taxed progressively as opposed to the flat rate of corporate tax– which caused controversy regarding tax planning.
Tax Consequences of Dividend Income to Shareholders
The tax consequences of dividend distributions made by companies to shareholders are best appreciated in the hands of shareholders.
For Resident Shareholders:
- Income arising from dividends will be subjected to tax under the head “Income from Other Sources.”
- Tax will be charged at the appropriate slab rates for the shareholder or entity.
- Where the aggregate dividends received exceed ₹5,000 in a particular financial year from any one particular company, the entity or company making the distribution must withhold Tax Deducted at Source (TDS) in the amount of 10%.
For Non-Resident Shareholders:
- Non-resident shareholders must pay a TDS on dividends paid out at 20%, along with an additional surcharge and cess.
- A non-resident has the option of claiming a lower TDS rate for dividends under double tax avoidance agreements (DTAAs), contingent on the submission of the proper documentation.
In light of this, an investor must take into account the applicable tax consequences on dividend payments when arranging their investment in the appropriate structure.
Tax Deducted at Source (TDS) on Dividends
Employees and Companies that are subject to TDS on dividends must deduct TDS prior to making the payment.
- Resident Shareholder: Shareholders residing in India are charged TDS at 10%, only if the share of dividend exceeds ₹5,000.
- Non-Resident Shareholder: Shareholders residing outside India are charged TDS at 20%, which is referred to the extent of DTAAs benefits.
Failure to deduct or remit TDS can lead to penalties, increasing the burden on Companies to act compliantly.
Expense Deductions to Earn Dividend Income
Section 57 of the Income Tax Act allows shareholders to deduct expenses incurred to earn dividend income, but only to the extent of the following;
- Interest expense capped at 20% of dividend income earned.
This specific provision places slightly less burden on the tax implications of dividend distributions by companies to shareholders with borrowed funds to invest in shares.
Advance Tax Liability on Dividends
Another significant consideration with respect to tax consequences on dividend distribution by corporations is the advance tax obligation. Shareholders are obligated to pay advance tax only if the estimate of their total tax liability, including dividend earnings in a financial year, exceeds ₹10,000.
Because corporations declare interim dividends in the year, shareholders are compelled to factor in dividend earnings in calculating their advance tax liability to avoid penalties on interest.
Dividend Income for Corporations Receiving Dividends
The dividend is taxable if a domestic corporation receives dividends from another domestic corporation, although, under Section 80M of the Income Tax Act, there is some relief through deductions.
Section 80M permits that any corporation may deduct the amount of the dividend distributed to shareholders within 1 month before the due date for filing the return. This helps to avoid the cascading effect of tax and balances the tax consequences on dividend distribution by corporations at different levels of corporate structure.
Compliance Obligations for Corporations
Corporations need to be diligent in their compliance with dividend distribution purposes. The tax consequences of dividend distribution by corporations will include:
- Withholding tax (deduct, deposit of TDS within the time line demand).
- TDS certification issued to shareholders.
- Filings of TDS returns that accurately total the dividend distribution for compliance with tax obligations.
Consequences of failure to determine compliance adequately result in penalties, interest exposure, and reputational risk to the corporation.
International Perspective on Dividend Taxation
Globally, the taxation of dividends is treated differently, with some countries taxing dividends at a flat rate and others allowing exemptions to promote investments. Since 2020, the chosen regime in India has taxed the shareholder directly, complying with global norms in taxation. For foreign investors, exchange and DTAA benefits will potentially reduce the overall tax implications of dividend distribution by companies, making it a relatively attractive investment location.
Conclusion
Post the removal of Dividend Distribution Tax in 2020, the tax implications of dividend distribution by companies have been significantly restructured. Shareholders now bear the burden of taxation, making it crucial for both companies and investors to understand the implications.
For Residents, the taxation of dividend income depends on the individual’s slab rates, whereas for non-residents, TDS and DTAA benefits play a significant role. For companies, there is a requirement to adhere to TDS provisions and reporting obligations to avoid penalties.
The revision to the tax framework enables equity and aligns with global standards. In this new regime, both companies and shareholders will need to continue seeking updates to manage dividend distribution tax implications and compliance more smoothly.
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