In India, we have a capricious tax law structure. Every year the legislature emanates amendments in the tax laws. These amendments are done to make the tax structure more enabling in nature. These amendments are brought in through the medium of Finance Acts every year. The Finance Act, 2020 which is one such latest amendment aims to attract Foreign Direct Investment (FDIs). This is a step towards progressive system of levying taxes. One of the major step to attract FDI in Finance Act, 2020 is the abolition of Dividend Distribution Tax (DDT). Abolition of DDT has resulted in amendments in various sections related to it. Some amendments will take effect from 1st April, 2021 whereas the rest have come to effect from 1st April, 2020. Accordingly, they will be applicable from Assessment Year 2019-20 and Assessment Year 2020-21 respectively.
The tax authorities have been at sixes and sevens, when it comes to DDT. DDT was first introduced in the year 1997, then abolished in the year 2002, then again brought back to life in the year 2003 and now finally Finance Act, 2020 has abolished DDT again.
What is the meaning of DDT and how DDT was applicable in India?
In the form of income, the shareholders of a company are given dividend, out of the profits of the company. Ideally, any income is taxed in the hands of the person who earns it. However, in India there was an exception in taxation of dividend income in the hands of the shareholders. Under Section 115-O of the Income Tax Act, 1961 (the Act), DDT was levied on companies paying dividend to the shareholders. Domestic companies had to pay DDT @15% on the gross amount of dividend distributed within 14 days of declaration of dividend. Moreover, interest was levied in case of non-payment within the prescribed time. Under section 10(34) of the Act, dividend in the hands of the shareholder was exempt from tax. However, dividend in excess of Rs. 10 lakhs were taxable @ 10% in the hands of the shareholder under section 115-BBDA of the Act.
Why was DDT abolished?
The Indian economy had slowed down and with forecasts of recession in the near future, Government adopted measures to gear up the economy. Budget, 2020 came as the savior which intended to promote FDI in order to boost the economy. However, DDT acted as a snag in the way to promote FDI. Therefore, DDT was abolished as a measure to accelerate the economy. It led to a situation of economic double taxation for foreign investors. As DDT was deducted by the company, regardless of the shareholder’s resident country further, the dividend income in the hands of the foreign shareholder was also taxed in shareholder’s resident country and no credit was available for such DDT. In order to remove the cascading effect, DDT was abolished and dividend income was made taxable in the hands of the shareholders only. This will promote FDI as overseas shareholders may either claim tax credit in their country or set-off the taxes paid between India and their country of residence, depending upon the laws of their country of residence.
Global Impact of abolition of DDT: With special reference to India-Singapore Avoidance of Double Taxation Agreement (DTA)
The abolition of tax paid by the dividend payer known as DDT has now made dividend taxable only in the hands of the dividend recipient. This step will lead to extensive tax saving and prevent double economic taxation. In DDT era, the company declaring dividends were obliged to pay tax at a total resultant rate of 20.56% inclusive of 15% DDT, 12% surcharge and 4% health and education cess. The same dividend was exempt in the hands of domestic and foreign shareholders. Thereby, becoming a vexation point for the foreign investors as income being exempt in their hands disabled them to apply the reduced rates under the Double Taxation Avoidance Agreement (DTAA) or to claim a tax credit in residence country. The net effect being that the same income was taxed thrice. Now, after 1st April, 2020, dividend income will be taxed from the pockets of the shareholders, under the head ‘income from other sources’, @ 10% for Indian shareholders and @ 20% for the foreign shareholders. The “additional” or “rich” taxes shall also stand annulled after abolition of DDT. The amendment shall have a prospective effect and be applicable on all dividends declared after 1st April, 2020.
It will have a positive impact on Indian economy as well as foreign shareholders. As now the foreign shareholders will be able to take the benefit of reduced tax rate specified in the DTAA between the two countries and will also be able to claim tax credit for the tax paid by them in their resident country. This will also ensure harmony between India tax law and universally accepted international practice thereby increasing the incoming and outgoing of investments.
India-Singapore DTAA has a special dividend tax rate boosting Indian shareholders to shift their base to Singapore as its domestic laws offer nil rate of dividend tax further, as per DTAA dividend income, will be taxed in the pockets of the shareholders in their resident country @ 10% (where the recipient company holds a minimum of 25% of the payer company) and @ 15% in all other situations. Full dividend tax exemption is also available subject to fulfillment of certain conditions under the Exemption for Foreign-sourced dividend scheme. Singapore being the economic hub with low rates and various tax reliefs makes it very attractive to establish subsidiary companies as there is complete taxation relief for resident holding companies receiving foreign sourced dividends from subsidiaries which have been taxed abroad at a rate of at least 15% and in case of India this condition is satisfied thereby establishing subsidiary company will reduce the Indian dividend withholding tax.
Earlier, foreign shareholders used to channel their investments into India through tax havens or through other countries having favorable DTAA. For instance, India-Singapore Treaty which provides favorable tax rates for dividend income. So foreign investors channeled their investment into India through Singapore. However, Indian tax authorities began to object against such practice. To prevent such practices, India also adopted the General Anti-Avoidance Rules (GAAR) with an aim to denounce all the transactions undertaken with the sole intent to dodge tax. The post DDT era makes it even more attractive for investors to establish India-Singapore holding companies to enjoy the tax exemptions. This also means there will be more instances of escaping taxes which GAAR might not have been able to curb.
In the meantime, OECD had released 15 Action Plans on Base Erosion and Profit Shifting (BEPS) which was to be implemented by way of Multi-Lateral Instrument (MLI). The object of MLI is to trace and prevent aggressive tax planning measures resulting in treaty abuse, dividend transfer arrangements, etc. The India-Singapore Tax Treaty with regard to the MLI became operational on 1st April, 2020. The life-saving amendment in the MLI with respect to curbing dodging of taxes was Article 7 of MLI which talks about Principal Purpose Test (PPT). These are stern rules which shall serve better in curbing dodging of taxes. According to Article 7, tax treaty benefit will be denied if the sole motive of such transactions or arrangement was to avail tax benefit which is against the object, spirit or purpose of the tax treaty. This empowers the tax authorities to determine the legal nature of the transaction by applying the ‘substance over form rule’. It has to be seen whether the main motive of investor to establish a subsidiary in Singapore was for tax abuse or not. The general objective of a treaty between two countries is to encourage trans-border investments however, if investors foreign to the two countries to a treaty, instead of investing directly in that country channel their investments through the country which has a beneficial tax treaty exemption, only to obtain tax benefit, then such investment cannot be considered in consonance with object, spirit and purpose of such tax treaty.
Abolition of DDT makes India an attractive place for investments as countries will be interested in investing directly and at the same time, MLI and GAAR provisions will ensure that such investments have an underlying commercial and strategic objective. Article 7 of MLI shall be triggered in the absence of any such objective.
Even before Covid-19 era, the government had forecasted recession. Abolition of DDT was a step to overcome such a situation. However, no one forecasted Covid-19 and the effect it will have on the economy. Abolition of DDT will promote FDI and improve the investment return. It has already been acknowledged as welcome step by foreign companies like Singapore. This steps also highlights that we are moving from a regressive to a progressive tax regime. It will ease the market situation making it more friendly to the foreign investors. Abolition of DDT and MLI coming into operation will do wonders to revive the economy from the set-back including the set-back arising from worldwide lockdown. Aatmanirbhar scheme recently adopted by the Government of India is just a cherry on the cake.
- The Finance Act, 2020.
- PPT- A Paradigm Shift for India-Singapore Tax Treaty?, Taxsutra, Jul 26, 2019, https://www.taxsutra.com/experts/column?sid=1155
- India Drops Dividend Distribution Tax; Singapore FDI now Favored, Corporate Services.com, Mar 03, 2020, https://www.corporateservices.com/india-dividend-distribution-tax-eliminated-2020/
- India ratifies OECD’s MLI- its impact on Singapore-India DTA, Corporate Services.com, Mar 14, 2020, https://www.corporateservices.com/oecd-mli-impact-on-singapore-india-dta/#:~:text=The%20MLI%20amends%20the%20Singapore,where%20treaty%20abuse%20is%20suspected.
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