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The budget of 2020 spurred the debate over taxations and raised several conundrums as to whether it could rescue the downtrodden economy of the country. Among several issues, one of the prime fiscal discourses which stole the limelight was the removal of Dividend Distribution Tax (DDT) and reverting back to classical system of dividend taxation. In praesenti, DDT stands at 15%, with the effective rate coming out to be 20.56%, on inclusion of surcharge and cess.
The latest budget to be implemented from 1st April, 2020 has abolished the DDT and shifted the burden wholly from the companies to their investors; the dividend amount received by a shareholder will be added to the personal income and the overall amount would be subjected income tax slab. It is speculated that it would benefit and attract foreign investors and also would benefit persons those are in the lower tax slabs along with imposing an annual burden of 25,000 Crore on the government too.
What is the issue of double taxation?
The genesis of DDT and double taxation in the Indian Economy can be traced back to the ‘dream budget’ of 1997 placed by the former FM P Chidambaram, imposing a flat tax rate of 7.5% to be paid by the companies on the profit dividends which the company distributes among its shareholders. As a result of it, the issue of double taxation was faced both by the companies and its shareholders, as for company needed to pay DDT and Corporate Tax and the shareholders had to pay DDT and 10% tax if the amount exceeded 10 lakhs, leading to double taxation.
Problems caused by it
The system of DDT leads to several problems as the resultant tax on the company and its shareholders, in aggregate, falls as an avalanche. The problem faced by companies, is that, at first, it pays a 25% Corporate Tax and further, it again pays the tax on DDT which takes the wholesome levy to 48.5%, leading to double taxation.
Similarly, a shareholder is also doubly taxed as firstly, the rule of DDT taxes the dividend when it is in the hands of companies and secondly, if the amount of dividend which is received by a shareholder exceeds Rs. 10 Lakhs, the excess amount is further subjected to a tax rate of 10% under section 155BBDA of Income Tax Act, 1961 and hence double taxation attracted. The problem of double taxation is also a bane for foreign investors, as the credit of DDT could not be borne by foreign company in their home countries and they too were doubly taxed.
Its effect on business
It is a fact that foreign investments are instrumental in development of economy of every nation. However, DDT is one of such levies which acted as a deterrent for foreign investments and businesses in India as it has a direct effect on the cost of business. As a result of DDT, the burden is upon the corporates, which increases the cost of business and the cascading effect is on the shareholders as the dividend paid is after subtraction of the DDT amount and hence no matter where the recipient shareholder stands on the tax slab, everyone bears the same burden.
DDT also acts as a deterrent to corporate equity financed investments; those are heavily taxed as compared to the same type of businesses carried by corporations, partnerships and sole proprietorship. The ultimate effect the DDT puts on business is that, it keeps companies bereft of the fund which it would other re-invest.
Significance of this relief
It is averred by the Finance Minister that the significance of the relief begotten by the abolishment of DDT will be accrued to those person who comes under the lower tax slab of income tax. This is because abolishment of DDT would add the income from dividends directly to their overall personal income and taxed accordingly. Similarly, the IT department will be benefitted as those fall in the higher tax brackets of income charged accordingly on their overall income.
The significance of this relief could trickle down to the downtrodden Indian economy, as now when there is no DDT, foreign investors can claim tax credit in their respective countries for every tax they pay in India and this will surely attract more foreign investments and bolster the fiscal oppression.
According to the Finance Minister, it is also contended that the abolishment of DDT would encourage investors to take a dig into debt mutual funds product because the rate, similar to DDT for distribution of income vide debt, was at 25% for single person and Hindu Undivided Family while 38% for rest which, on inclusion of surcharges and cess, went up to 38.33% and 49.92% respectively. Hence, removal of DDT would increase investments in debt mutual funds as individuals would pay much less in aggregate income tax in comparison to what they paid under the DDT system.
Public reaction to it
A duplexed public reaction can be gathered post annulment of DDT. Person belonging to the lower tax slabs hope to reap the benefits, while those who invested in mutual funds (MF) are in a dilemma. Pre-abolishment, dividends out of MF was subjected to a DDT of 11.64% however post-abolishment, though there will be no DDT, the government imposed TDS at a rate on 10% which is to be deducted from if the MF dividend exceeds Rs. 5,000. Hence, a bitter reaction is expected from who belong to the tax slab of lower than 10% and it is suggested by analyst that individuals investing in MFs should shift to growth oriented plans.
Similarly, High Net-worth Individuals (HNIs) too would be dissatisfied as they would pay tax in the effective income amount more than the DDTs. Alongside, promoters those who own highest stake-holdings in a company cannot digest the annulment of DDT as they primarily fall within the highest tax bracket of 30% income tax slab as a result of which, if previously they had to pay approx. 20% tax on the dividend amount, now since the amount would get added to their income, that is, their aggregate income which is subjected to a tax rate of 42.7% after inclusion of other charges leading to a burden far more than the DDT. It may also act as a double taxation for them as after already paying a corporate tax, their income amount will be subjected to another levy.
The above analysis would lead to the perception that annulment of DDT cannot be viewed as an isolative move but a strategic one. Its inception point can be found in September, 2019 when the government made a cut in the corporate tax rate foregoing 1.45 Lakh Crore with a latent objective of delving more money on the hands of corporates. Now this step would result into an otiose venture if an ultimate cascading effect could not be imposed and the extra money which is retained in the hands of corporates are used in dividends pay-outs.
Hence, abolishment of DDT would trigger the use of such monies on capital expenditure and business expansion where the contribution to GDP could be 4-5 times more than the foregone amount. Thus, it can be seen as a calculative step to not only to lessen the burden put on the shoulders of lower tax slab assesses but also a move that could help the economy in the long run, at the same time conceding the fact that it may militate against some classes of people both wealthy and indigent.
Author: Ishan Mazumder from West Bengal National Law University of Juridical Sciences (WBNUJS), Kolkata.
Editor: Ismat Hena from Faculty of Law, Jamia Millia Islamia.