Tax Implications On Inter-Corporate Dividends

Dividend distribution is crucial in the corporate world for rewarding shareholders. Among them is inter-corporate dividends, i.e., dividends paid by one corporation to another; these have specific tax implications under Indian income tax laws. As the legislation of dividends taxation in the form of the Finance Act, 2020, and the amendments have changed, the taxation of dividends has undergone a monumental shift. This blog discusses the term inter-corporate dividends, taxation, and compliance that businesses in India have to follow.

What are Inter-Corporate Dividends?

An inter-corporate dividend is the dividend payment that one company receives from its investment in the shares of another company. Suppose Company A is a shareholder in Company B, and B pays the dividends, the portion paid to A is an inter-corporate dividend.

Such dividends occur regularly in group structures, holding subsidiaries and investment strategies, and it is therefore imperative that corporates are aware of their tax treatment.

Taxation of Dividends Before and After 2020

Pre-Finance Act, 2020 (Earlier Regime)

1. Dividends paid by domestic corporations until March 31, 2020, were taxed under Section 115-O of the Income Tax Act to Dividend Distribution Tax (DDT).
2. Shareholders (both individuals and companies) were tax-free in receiving the dividend, except when the dividend is more than Rs. 10 lakh to taxpayers of some categories.
3. Under Section 80M, companies were allowed to claim a deduction on inter-corporate dividends in order to avoid the tax rate on the same being taken two or more times.

Current Regime (Post Finance Act, 2020)

1. Since April 1, 2020, the DDT system has been eliminated.
2. Dividends are now taxable to the date of the holder, including corporate shareholders.
3. Business firms that get dividends should classify them as Income Other Sources or Business Income, depending on the kind of investment.
4. Section 80M was revisited to curb the instances of double taxation, and the section allowed deductions to firms on additional distribution of dividends.

Section 80M Inter-corporation Dividend Deduction

Section 80M of the Income Tax Act is important in the avoidance of cascading taxation of dividends on corporates.

Key Features of Section 80M:

1. A domestic company is allowed to deduct dividends paid by another domestic company, foreign company, or business trust.
2. The deduction is only available in case the company makes additional dividend distributions to its shareholders at least a month before the time when it is required to file the return.

The deduction is limited to the lower of:

1. Dividend received, or
2. Dividend distributed.

Example:

Assuming that Company X gets Rs. 50 lakh of dividends as dividends received on the stocks of Company Y, and that Company X also gives dividends to its stockholders to the tune of Rs. 40 lakh before the specified due date of filing of returns, Company X is entitled to a deduction of Rs. 40 lakh under Section 80M. The sum of Rs. 10 lakh will be liable to tax.

Tax Rates Applicable on Inter-Corporate Dividends

The rate of tax will be based on the classification of the receiving company on the dividend income:

1. Business income: In case shares are held as stock-in-trade, dividends are subject to business income tax and taxable at the regular corporate rates of 22 percent or 30 percent (with surcharge and surcharge etc., as applicable).
2. Other Sources of income: In case shares are kept in the form of investments, the dividend income is taxed under this head at the corporate tax rate that applies.

Also, in case a domestic company that pays dividends deducts TDS at 10% under the provision of Section 194, in the event of a payment that is more than Rs. 5,000, the deduction is made.

Foreign Dividends: Special consideration

Though this blog addresses inter-corporate dividends in India, it is important to mention that foreign companies also pay dividends that are taxable in India. Nonetheless, the firms can also claim relief in Double Taxation Avoidance Agreements (DTAA), provided that the dividend is taxed in a foreign country.

Company Requirements on Compliance

The following must be met when companies are transacting with inter-corporate dividends:

1. Dividend Disclosure: According to the accounting standards, dividend income has to be recorded as Other Income or Business Income.
2. TDS Obligations: The companies that pay dividends are to deduct TDS according to Section 194.
3. Advance Tax: Dividend is taxable and therefore to calculate the advance tax liability, companies who receive dividends must take dividend income into account.
4. Return Filing: The deductions made under Section 80M are only allowed in case the company pays dividends and makes the returns on time.

Impact on Corporate Groups

To conglomerates and group companies, inter-corporate dividends constitute a significant flow of income between subsidiaries, associates and holding companies. The reintroduction of Section 80M will make sure that the tax burden does not compound at each phase of dividend payment, hence making efficient distribution of capital in the corporate set-ups.

Practical Challenges

Despite the clarity of the framework, there are practical issues for the companies, including:

1. Dividend distribution prior to the dividend due date in order to claim the Section 80M deduction.
2. Recording dividends as business income or as another income.
3. The control of TDS credit discrepancies when there are several receipts of dividends.
4. Calculation of advance tax liability to prevent the interest of Sections 234B and 234C.

Conclusion

Inter-corporate dividends taxation regime in India has gradually transformed a DDT-based taxation regime to a shareholder-based taxation regime. The Section 80M deduction today offers a great relief to the companies when they are required to add the dividends as taxable income, but the cascading effect of the tax is then eliminated. To the corporate groups and investors, it is crucial to know these provisions so that they can do their planning and compliance in taxation.

To sum it up, inter-corporate dividends are liable to taxation as normal corporate tax, and liable to a deduction in accordance with Section 80M and must comply with the TDS, advance tax, and filing of income tax returns. The prudent payment of dividends during periods can assist firms in saving tax and enhancing their financial accountability.