TAX IMPLICATIONS ON DIVIDEND DISTRIBUTION BY COMPANIES

Dividend can be understood as the distribution of the companies’ earnings to the shareholders of the company either in the form of cash or additional stock. It will be distributed to a particular class of shareholders on the basis of the determination made by the board of directors. When a company is paying dividend all its shareholders holding the stock of the company would basically possess the right to earn the same. This is a reward given to the investors for keeping trust in the company and entrusting their sensitive material which is money with the company and their venture for a good period of time. At times companies also retain a part of their profits or earnings for investing it back into the company for catalysing its growth or maybe retain the whole of such earnings.
It is the number of shares held by the shareholders which determine the amount of dividend earned by them. Say the dividend per share to be paid is INR 170 and you are holding 1000 shares in the company. Then your total dividend earning will be INR 170,000 i.e., 1000 shares*INR 170.
As per the Companies Act, we can say that the dividend payment by the company can be made from the following sources namely:

1. From the current year’s profit,
2. Previous years accumulated profits and,
3. Any amount which was given by the Central or the State Governments for paying dividends with respect to any guarantee given by the entity.

Taxability of Dividend in case of Domestic Companies and Shareholders

Dividend, as stipulated above, are nothing but a part of the income or earnings of the company which makes it apparent that such distribution will be taxable. But pertaining to the Assessment Year 2021-22 onwards, there will be a change in the taxability of dividends in the hands of the company as well as shareholders. Let’s understand it in different parts:

The obligation of domestic companies

After 01.04.2020, the domestic companies shall not be liable to pay DDT or Dividend Distribution Tax on the dividend which is distributed to the shareholders. But they should be deducting tax under section 194.
Section 194 states that, the dividend which is distributed, declared, or paid on or after, 01.04.2020, an Indian Company shall deduct tax at the rate of 10% when paid to the resident shareholders, only if the aggregate of such dividend distributed or paid during the financial year exceeds INR 5,000. But if the dividend is payable to the LIC (Life Insurance Corporation), GIC (General Insurance Corporation of India), or any other insurer, with respect to the shares held by them or the beneficial interest held by them, then no amount needs to be deducted as per section 194.
At the same time, if the dividend is payable to a non-resident or a foreign company then the tax shall be deducted under section 195 in accordance with the DTAA.

Tax Liability of Shareholders

Section 10(34) which provided an exemption to the shareholders with respect to payment of tax on dividend income, is withdrawn from Assessment Year 2020-21 onwards, which makes it clear that the same would now be taxable in the hands of the shareholders. It also makes it apparent that section 115BBDA, which is regarding the taxability of the dividend income in excess of INR 10 lakh is now kept out of the purview, as the entire dividend earned will now be taxable in the hands of the shareholders. Lastly, the taxability of the dividend earned would now depend on the residential status, earnings, or income pertaining to other heads of income and such other similar factors.

Tax Liability of Resident Shareholders

A person can either invest directly in the shares and securities or trade the same. If the income was earned by him through the trading activities, then the same would be taxable under the head income from business or profession. On the contrary, if it is earned via the assesse’s investment, then the same shall be taxable under the head income from other sources.
When the income under PGBP (Profits and Gains from Business or Profession) is computed, the same can be done in accordance with the regular accounting followed by the assessee which might be in mercantile or cash basis of accounting. But the basis of the charging of dividend income stated as per Section 8 would still be in place, and it states that the final dividend including the deemed dividend shall be taxable in the hands of the assessee in the year in which it was declared/distributed/paid by the company, whichever is earlier. Taking the case of interim dividend, we can say that it would be taxable only during the previous year during which the dividend was unconditionally made available to the shareholder by the respective company, i.e., on a receipt basis.
The assessee who is assessing the dividend income under the business income can deduct those expenses which were directly incurred by the assessee for earning such dividend income. An example of this would be the collection charges or interest on the loan.
At the same time, if the dividend income is taxable under the head income from other sources, the expense or deduction which can be claimed by the assessee will be limited to the interest expenditure to the maximum of 20% of the total dividend income earned by the assessee. It is to be noted that, under the head income from other sources, no other expenses shall be allowed to the assessee over and above the interest expenditure. This interest expenditure refers to the loan obtained by the assesse for the purpose of making investments that have generated this dividend income.

Tax rate on Dividend Income – Residents

The dividend income earned by an assessee shall be taxable as per the normal tax rates applicable to the assessee. But in case of a resident individual who is an employee of an Indian company or its subsidiary and is engaged in entertainment, pharmaceutical or biotechnology, or Information Technology, has earned or received any income in respect of the GDR’s (Global Depository Receipts) issued by such company, pertaining to the Employees Stock Option Scheme, then the same shall be taxable at 10% which is a concessional rate of tax specified by the Income Tax Act. But it has been specifically provided that the employee must have purchased the same in foreign currency denominations.

Taxability of Non-Resident Shareholders

For investing in India, non-residents generally choose the direct method as private equity investors or the Foreign Portfolio Investors (FPI). A non-resident can also become a promoter of an Indian Company. As the non-resident is holding the shares in the Indian Company in form of investment, we can easily state that the dividend earned should be taxable under the head income from other sources.
In the case of the FPIs, the shares or stocks held by them will be treated as capital assets and not stock-in-trade. Thus, the dividend income earned by them should be taxable under the head income from other sources as it clearly is an investment and not trading.

Tax Rate on Dividend Income – Non residents

The dividend income which is in the hands of the FPIs and the non-resident Indian Citizens, or basically the non-resident persons, should be taxed at the rate of 20% without providing for any other deductions under the Income Tax Act. But the dividend income in the hands of the investment division of an offshore banking unit shall be taxable at a rate of 10% as per the Income Tax Act.
Taking it a step further, we can say that the Income Tax Act also stipulates, that any dividend earned or received with respect to the GDRs of an Indian Company or Public Sector Companies i.e., PSUs which is purchased in foreign currency shall be charged at the rate of 10% without allowing any deductions.

Taxability under DTAA

DTAA is Double Taxation Avoidance Agreement, which enables the NRIs living abroad, earning income in India can avoid themselves from paying double taxation in the country of residence and country of source. In short this is a treaty signed within two countries such that the country is made attractive destination for making investments and at the same time get relief from paying double taxation.
Dividend income earned is generally taxable in the source country as well as the country of residence of the assessee. And the country of residence would provide the assessee with credit of taxes which was paid by the assessee in the source country. So, the assessee can get the dividend income, taxed in India as per the provisions of the Act or as per the relevant and applicable DTAA, on the basis of the one which is most beneficial for the assessee liable to pay the tax.
Taking reference to the DTAAs formed by India with other foreign countries, the dividend shall be taxable in the source country in the hands of the beneficial owner of shares at a rate that ranges from 5% to 15% of the gross amount of the dividend income earned.

Advance Tax Liability and Dividend Income

If any shortfall in the instalments of advance tax happens in case of an assessee due to the dividend income earning, or the failure to pay the same on time has arisen due to the dividend income, no interest under section 234C of the Income Tax Act shall be charged. But the same shall only be applicable if the assessee has paid full tax in the subsequent advance tax instalment.
It should be further noted that in case of deemed dividend under section 2(22)(e), which are nothing but the loans or advances extended by a company in which the public are not substantially interested or a closely held company, the benefit which was stated before, i.e., no interest under section 234C for non or late payment of advance tax be made available, to the following:

1. A shareholder who is the beneficial owner of shares, and holds a minimum of 10% of the voting rights. It may be noted that the shares so held should not be entitled to a fixed rate of dividend.
2. Any concern in which the shareholder of the company is a member or partner holding a substantial interest.
3. On behalf, or for the individual benefit of such shareholder, to the extent specified by law,
4. On behalf of a shareholder to the extent the company has accumulated profits,