Is it mandatory to pay tax on a corporate dividend?

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How many times in a day do you think of a windfall gain against your well researched and planned investment in a known blue chip the moment its board rolls out the dividend plan? But even before your eyes open up across your face with wildest expectations, the term corporate dividend tax slams you back to the real world. Our life is enmeshed with taxes. Be it a commodity or for that matter our hard earned money, for which all of us toil from the day we earn our degrees, there’s no escape from tax.

Now, while life without tax may remain wishful thinking, why not mend bridges and try to understand why they are levied in the first place. It might give us a better perspective and give some perception on developing a workaround where our earnings go alongside the day’s tax regime without impacting our long term financial goals.

Let’s start with a misconceived term tax on much desired dividends.

Understanding Corporate Dividend:

A dividend is a distribution of profits by a corporation to its shareholders.

When a corporation earns a profit or surplus, it can disburse a percentage of the profit as a dividend to shareholders.

Source of dividend

A dividend could be sourced as below: –

  • Investment in a domestic company
  • Investment in a foreign company
  • Equity mutual funds and/or
  • Debt mutual funds

Corporate Dividend Tax

The taxability of dividends will depend upon whether the dividend receiver deals in securities either as a trader or as an investor. Dividend income from shareholdings for trading is taxable under the subject revenue from business or profession, if held as an investment, however, it is taxable under the subject income from other sources.

So, let’s understand the tax implication of the above-

Dividends declared by companies were subject to dividend distribution tax until 31.03.2020. With effect from April 1, 2020, dividend payout tax has been removed, and taxable in the shareholders' assessment. 

The basic exemption limit advantage is available for dividend income since the dividend amount is taxed in the individual taxpayer's assessment. As a result, dividends up to Rs.2.5 lakh are tax-free for the financial year 2020-21.

Under Section 2(22) of the Income-tax Act, the dividend may:

(a) Disperse accumulated profits to shareholders warranting asset sale, etc.;

(b) Handover debentures or deposit certificates to regular stockholders, as well as issue bonus shares to VIP shareholders;

(c) Profits from the company's liquidation are distributed to the company's shareholders;

(d) Accrued gains from the company's capital decrease to be shared with shareholders

(e) A loan or advance granted to a shareholder by a tight consortium out of its accumulated profits.

Streamlining Corporate Dividend Tax

You didn’t have to pay any tax on a dividend earned from a company based in India till the year ‘20-21.

However, in such cases, the domestic company is liable to pay a Dividend Distribution Tax (DDT) under section 115-O.

Further, the Finance Act’ 20 abolished the DDT and taxed dividends at the investor level, irrespective of the amount received at applicable income tax slab rates.

Tax rates on Dividend Income

Dividend tax rates vary based on the type of assessee getting the dividend and the method used to distribute it. The following table can help you grasp this.:-

 

Category of Assessee

Dividend nature

Rate of Tax

Resident

Dividend from domestic company

A normal rate of tax applicable to the assessee

NRI

Dividend on GDR of Indian co./PSU (purchased in foreign currency)

10%

NRI

Dividend on shares of Indian co.(purchased in foreign currency)

20%

NRI

Any other Dividend income

20%

FPI

Dividend on securities other than 115AB

20%

Investment Division of offshore banking unit

Dividend on securities other than 115AB

10%

To remember

Final dividends, including considered dividends, are taxable the very year in which they are declared, dispersed, or handed over by the corporation, whichever comes first. 

Interim dividends, on the other hand, are taxable when the amount of the dividend is categorically dispersed by the corporation upon receipt of claims. 

TDS on Dividend Income

Post 1st April’20, Tax Deducted at Source (TDS) was introduced to dividends. A base tax of 10% would be knocked off from the dividend if it exceeds Rs.5000 during that financial year.

However, no tax is cut back from any dividend paid or due to the Life Insurance Corporation of India (LIC), the General Insurance Corporation of India (GIC), or any other insurer if they own shares or have any rewarding interests. When a dividend is paid to a non-resident or a foreign corporation, however, the tax is withheld in line with the relevant DTAA under Section 195.

Double Taxation Relief

Lot of Indian investors also have portfolios of foreign stocks by investing directly in the markets of foreign countries. As a result, a disbursement from a foreign company is taxable in India; double taxation would occur if tax is being levied at the country of origin as well. To avoid this double taxation, India has an agreement with several countries where relief can be claimed per provisions of the Double Tax Avoidance Agreement (DTAA) as well as under Section 91 of the Income Tax Act.

Inter-corporate Dividend

The Government has added a new section 80M to the Act, which came into place in 2020-21, to prevent the major impact whenever a domestic firm gets a dividend from another domestic company. 

  • Receipt of dividend - domestic co.

Section 80M states that inter-corporate dividend shall be subtracted from the total income of the company, if the same is further distributed to shareholders one month before the due date of filing of return.

  • Receipt of dividend - foreign co.

A dividend received by a domestic company (having 26% or more equity shareholding) in a foreign company - is taxable at a rate of 15% plus Surcharge and Health and Education Cess under Section 115BBD. A domestic company having less than 26% equity shareholding is taxable at the normal tax rate.

How a domestic firm receives a dividend from a foreign corporation and distributes it to its shareholders, however, is still not clear.

An afterthought:

Taxation of dividends is often used as justification for retaining earnings, or for performing a stock buyback, in which the company buys back stock, thereby increasing the value of the stock left outstanding.

Upon payment, however, individual shareholders in many countries suffer from double taxation of those dividends:

  1. The company pays income tax to the government when it earns any income
  2. When the dividend is paid, the individual shareholder pays income tax on the dividend payment.

Frequently Asked Questions

What is the frequency of dividend payments?

The frequency with which a dividend can be paid is - daily, weekly, monthly, quarterly, half-yearly, or annual basis, relative to the company or mutual fund house paying the dividend.

Is corporate dividends tax deductible?

A dividend from a domestic firm during Assessment Year 2020-21 is non-taxable since it is exempt from tax under section 10(34) of the Act. The domestic corporation, however, is obligated to pay a Dividend Distribution Tax (DDT) under section 115-O in such instances.

However, the DDT was repealed by the Finance Act of 2020, reverting to the traditional method of taxes, whereby profits are taxed in the hands of the investors. As a result, the assessee must pay tax on dividend income.

Are dividends considered income?

Yes, dividends are considered an income under the Income Tax Act

What does DDT mean?

DDT, or Dividend Distribution Tax, is a tax that companies must pay on dividends they pay out. No Dividend Distribution Tax (DDT) with effect from FY 2020-to 21.

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