The abolition of the Dividend Distribution Tax (DDT) in Budget 2020 is hailed as a big relief for corporates and non-resident shareholders.
There will be no disputes regarding disallowance of expenses in terms of Section 14A of Income Tax (I-T) Act read with Rule 8D of I-T Rules.
What is dividend and DDT?
Dividend is a return given by a company to its shareholders out of the profits earned by the company in a particular year.
Dividend constitutes income in the hands of the shareholders which ideally should be subject to income tax.
However, the Indian income tax laws provide for an exemption of the dividend income received from Indian companies by the investors.
DDT is levied on any domestic company which is declaring/distributing dividend and is paid at the rate on the gross amount of dividend.
What are the current regulations?
Section 14A provides that any expense concerning income not forming part of total income would not be allowed as deduction.
Presently, the dividend income is not taxable in the hands of shareholder and does not form part of total income.
Section 56 charges income tax on the dividend.
Section57 allows certain deductions while computing income from other sources.
All expenses incurred wholly and exclusively to earn income taxable under Section 56 are allowed as deduction.
What does the Budget 2020 propose?
It proposes a proviso to Section 57 that states that no deduction shall be allowed against dividend income other than interest expenses.
The deduction on account of interest will be restricted to 20% of the dividend income.
The cap of 20% is based on the amount of income earned and offered to tax in the previous year.
Hence, in case, no dividend income is earned in a year even though the assessee incurs interest expenditure or fee on investment managers, she cannot claim any deduction.
What are the other proposals?
Besides restricting the quantum of deduction in respect of interest, the amendments change the regime of taxation from being net to gross.
The intention cannot be to discourage investors from borrowing heavily to invest in shares or paint all dividend earned as a windfall, nor can there be a fear of an excessive claim of expenses.
Presently, expenses are allowed to be deducted as per Section 57, and it is nobody’s case that it has resulted in a massive leakage of revenue.
How income is taxed now?
Income may be interpreted in a wide manner to include receipts, windfalls and gifts.
When the income like profit is taxed, the mechanism provided to tax it would allow for a deduction of expenses.
Certain incomes like royalty, fee for technical service, etc, are subject to taxation on a gross basis.
In case of income from house property, there is a cap on deduction towards interest paid on borrowed capital.
The rationale is that the annual lettable value of a self-occupied property is deemed as nil.
Where the assessee claims that dividend is business income, it may be possible to claim all expenses regarding it.
However, the debate of whether dividend can ever constitute business income is already before the courts.
What would be the impact?
The abolition of DDT and reintroduction of tax on dividends in the hands of the shareholder has brought relief to non-resident investors.
However, this change is likely to increase the pain of resident shareholders, especially those falling in higher tax brackets.
