Dividend Distribution Tax (DDT) is one such concept of India taxation system that has been playing a significant role for several years, especially for the investors who earn money in the form of dividends either through companies or mutual funds. Dividend Distribution Tax was abolished recently in 2020 itself, but it is still a common search and discussion as it has played a pivotal role in determining taxation on dividends in India. Investors, taxpayers,s and finance geeks need to know how DDT worked and what took its place.
In this post, we discuss Dividend Distribution Tax in plain English, how DDT is calculated, the rationale behind abolishing i,t and how dividend income is taxed now.
What Is Dividend Distribution Tax?
DDT, or Dividend Distribution Tax, was a tax levied on companies or mutual funds when they paid dividends to their equity shareholders/unit holders. Rather than taxing the dividend in the hands of investors, the government collected corporate or mutual-fund taxes upon distribution.
Under this regime, dividends were ‘imputed’ up-front for tax, and the dividend income was mostly tax-free in their hands. That is what made the receipt of dividend income tax-free to investors, even though tax had been paid by the distributing entity.
Dividend Distribution Tax applied to:
- Domestic companies declaring dividends
- Mutual funds pay income to unitholders
How Dividend Distribution Tax Worked
When a company declared a dividend, it would first pay Dividend Distribution Tax to the government. Only after making this payment did it distribute the remainder of the dividend to shareholders.
For instance, if a company wanted its shareholders to get a dividend of ₹100, it had to suitably gross up the amount, bearing in mind the tax rate and pay DDT on such amount from its own kitty. This eroded the firms’ retained earnings and thentheir profitability.
Though this tax was not payable by the investors, it still had an indirect impact on them because a lot of companies used to reduce the payout since they had the additional cost of paying taxes onward.
Pre-Abolition Rates of Dividend Distribution Tax
The standard DDT rate is 15 percent before its abolition. Effective tax rate shot up by the grossing-up facility along with surcharge and health and education cess, though.
The effective DDT rate in most scenarios exceeded 20 percent. The tax rate was, in fact, higher for some deemed dividends under the Income Tax Act.
This made dividends a costly way for companies to distribute profits relative to other methods, like share buybacks.
Why was there Criticism of DDT?
Myriad criticisms were leveled against the Dividend Distribution Tax.
In the first place, it fell under double taxation. Profits of the companies got taxed first as corporate tax and then again when distributed as dividends using DDT.
Second, it was said to be unfair for the little guys. Because the DDT was charged at a flat rate, an investor in lower income tax slabs paid taxes indirectly at the same rate as high-income investors.
Third, the system lacked transparency. A lot of investors knew that dividends were received tax-free, and didn’t realise that actually the company in which they were investing had already suffered a tax charge on those profits.
These were finally addressed with a major reform of how dividends are taxed.
Abolition of Dividend Distribution Tax
The Indian government did away with the Dividend Distribution Tax with effect from 1 April 2020 in the Union Budget 2020. This was an important change in the tax treatment of dividend income in India.
After the abolition:
- As per Section 115-O(1), now companies and mutual funds do not have to pay DDT
- Dividends are assets in the hands of shareholders and are taxable there.
- They brought the old system of dividend tax back.
This reform harmonized India’s taxation system with the international system and was in keeping with best practices adhered to by most developed countries.
How Dividends Will Be Taxed After DDT Removal 1. DDT removed, dividend tax imposed: If upheld by the court Proceedings are initiated, and the order ofthe High Court is stayed again.
Getting dividends taxed at the marginal rate was one that paid.
The dividend income is categorized under “Income from Other Sources” for individual assessees. It is also added to the total income and taxed at the normal income tax slab rate.
For example:
- Those further down the tax scale are liable to pay lessÉutory on dividends.
- The slab rates for high-income individuals may be increased.
- This way, dividend income is taxed on the true income of the taxpayer.
- TDS on Dividend Income
With the removal of DDT, dividend tax was made subject to TDS.
TDS is deducted by companies and mutual funds before paying dividends to investors whenever the total dividend payment in a fiscal year exceeds a threshold.
The TDS as deducted can be seen in Form 26AS, and you can claim the same as credit at the time of filing the income tax return. In case where TDS is deducted in excess, the investor can claim the refund.
Impact on Mutual Fund Investors
Earlier, even mutual fund dividends were subject to Dividend Distribution Tax at the rate applicable based on the nature of the mutual fund, be it equity-oriented or debt-oriented.
Post abolition of DDT, mutual fund dividends are taxed in the hands of investors at their respective slab rates. This shift has enticed some investors to pursue a greater share of growth options, since returns are only taxed upon redemption and not annually.
This meant many investors switched from the dividend option tothe growth option because of tax efficiency.
Benefits of Abolishing Dividend Distribution Tax
There were some benefits of the removal of the Dividend Distribution Tax.
It cut the double taxation of corporate earnings.
- It brought greater transparency to the tax system for investors.
- It established a fair way to tax the rich and well-off.
- It prompted businesses to share profits more evenly.
- In its totality, this new system is fair and in tandem with global tax norms.
What Investors Need to Know
Investors should also take note of dividend income on shares and mutual funds now. It is mandatory to report all dividend income while filing the tax returns.
Tax planning is key, particularly for investors who will receive sizeable dividend payouts. Knowing your TDS credits and slab rates can prevent surprises at the time of tax return filing.
Conclusion
Dividend Distribution Tax was a linchpin of India’s dividend taxation system for several decades, and today it is history. Its elimination has allowed taxation of dividend income in the hands of investors, which allows a more transparent and equitable way to tax the system.
Although the dividend is no longer tax-free, small investors benefit, and the overall tax efficiency is increased by permitting taxation at ordinary income levels. Understanding of DDT, i.e., Dividend Distribution Tax, and current dividend taxation laws can help you to take informed decision forthe financial planning of taxpayers.
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