Impact of Removal of Dividend Distribution Tax (DDT)

Dividend Distribution Tax Removed in Budget 2020

Introduction

In this article, we will analyse the impact of removal of Dividend Distribution Tax (DDT) on different segments in detail. In Union Budget 2020, government has abolished the Dividend Distribution Tax. Now dividends will be taxed in the hands of the recipients. According to government, this move will lead to a revenue forgone of Rs. 25,000 Cr.

Impact of Removal of Dividend Distribution Tax

Dividend Distribution Tax

• India currently levies Dividend Distribution Tax at an effective tax rate of 20.5% (including surcharge and cess) on companies declaring dividends. This is over and above the corporate tax that companies pay on their taxable profit.
• As per the old tax regime, companies had to pay taxes in two stages :
  • First is the 30% on Profit Before Tax (PBT)
  • Second is the DDT of 20% on the dividend paid from Net Profit
• Thus, companies had to suffer double taxation.
• With the corporate tax cut in Sep 2019 and abolition of DDT in this budget, cascading effect will be removed and domestic companies as well as MNCs will be highly benefited.

Impact of Removal of Dividend Distribution Tax on Different Segments

1. High Dividend Paying Companies

• Removal of DDT will remove the burden of compliance on dividend paying companies and reduce the cost of doing business for such high dividend paying companies.
• The list of major beneficiaries includes PSU companies such as IOCL, NTPC, BPCL, Power Grid Corporation
• Other Private high dividend paying companies such as TCS, Infosys, ITC, Vedanta and HDFC Bank etc.

2. Retail Investors & HNIs

The impact of removal of DDT is positive as well as negative for some investors while for some it is neutral.

• Retail Investors in Lower Tax Bracket (<20%)
  • Removal of DDT is positive for investors in the lower tax bracket (< 20%) as they will pay lower tax according to their tax slabs.
• Retail Investors in 20% Tax Bracket
  • For taxpayers in the 20% tax bracket, things remain unchanged. Earlier, companies paid the DDT of 20% so the dividends received were tax free in the hands of investor.
  • Now, the investors in the given tax bracket will have to pay tax of 20% on the dividends received. So, the effect of DDT is neutral for these investors.
• Retail Investors in Higher Tax Bracket (>20%)
  • Impact will be negative for the investors in higher tax brackets (>20%), HNIs (High Net Worth Individuals) and company promoters which are in highest tax brackets.
• Mutual fund investors opted for dividend plans will also be affected as they have pay tax on the dividend received. So, it would be better mutual fund investors to switch to Growth plans from Dividend plans.

3. Promoters

• Removal of DDT will badly impact the Promoters of Indian corporates.
• At present, investors in the country need not pay any tax on income from dividends from domestic companies for up to Rs.10 lakh. However, they are taxed 10% for dividend income beyond Rs.10 lakh.
• After the abolition of DDT, the recipient of dividend will have to pay according to their respective income-tax tax slabs which is as high as 43%.
• Thus, the Promoter owners holding equity individually or in trusts may be adversely impacted, particularly when they are in the 43% tax bracket.
• This may change the dividend culture of high dividend paying Indian corporates with higher promoters stake.
• It may result into paying off lower dividends among their shareholders. Higher portion of their profits could be set aside as retained earnings. Higher retained earnings could be used for capital expenditure and business expansions. It will increase the business activities in turn and can generate new employment opportunities.

4. Foreign Investors :

• For foreign investors, there will be no impact on countries which have Double Tax Avoidance Treaty with India (US & Canada)
• Whereas it will be beneficial for investors who live in Tax haven countries.

5. MNC / Foreign Holding Companies :

• Multinational companies such as Nestle, Colgate, HUL, Maruti Suzuki India Ltd will be among the biggest beneficiaries as they couldn’t claim credit in their home jurisdictions for DDT paid by their Indian subsidiaries.
• Dividends distributed by an Indian subsidiary of a multinational company were entailed a dividend distribution tax (DDT) of more than 20% in India. So the dividend that the holding MNC company would receive would have already suffered substantial tax in India indirectly.
• Such foreign company would normally be required to pay tax on the dividend income so received in its home jurisdiction. DDT is a tax in the Indian company and the foreign company not paying taxes directly on such dividend income in India. So, these MNCs would not be able to claim foreign tax credit in its home jurisdiction.
• This resulted in a double whammy for these MNC holding companies as they suffered double taxation at a group level.
• Abolition of DDT will encourage foreign holding companies to invest in India without having to worry about innovative structures to repatriate profits from India

Conclusion

• Overall, the removal of DDT would benefit companies in the long run. Since quantum of liquidity ie. retained earnings available with them would be significantly higher. Higher retained earnings used for capital expenditure and business expansion will indirectly create a multiplier impact on India’s GDP.
• It will also increase the in hand profits of PSU companies and thus the government indirectly.
• Removal of DDT will encourage foreign holding companies to invest in India without having to worry about double taxation. Thus they can repatriate profits from India. Thus, it is a welcome step for future FDI investments in India.
• This will increase the capital investment and improve the attractiveness of Indian market.