The present corporate tax rate in India and dividend distribution tax (DDT) together account for around 46%—50% of the effective tax rate for domestic companies. With the recent amendment to US tax laws, resulting in the reduction of corporate tax from 35% to 21%, India may be under greater pressure to reduce the tax burden on corporates. This will also fuel the expectations of relief in the form of abolishment of DDT and restoration of the classical system of taxing dividends in the hands of the shareholder rather than the distributing company.
Currently, dividend distributed by Indian companies is subject to DDT in the hands of the distributing company. The effective rate of DDT is around 20.36% of the distributed income. Such DDT-suffered dividend income is exempt in the hands of the shareholders. In addition, dividend in excess of INR10 lakh is now taxable in the hands of the shareholders at 10%. To recollect, Finance Act 2016 had introduced the 10% levy, also called the “super rich levy,” on shareholders earning dividend income in excess of INR10 lakh, to provide a level playing field for all shareholders.
In India, DDT was introduced by Finance Act 1997. Prior to that, India had the classical system of taxation wherein dividend was taxable in the hands of the shareholder and the company distributing dividends was liable to withhold taxes on dividend. DDT was briefly abolished in 2002 to align with the traditional approach that it is the shareholder’s income, which led to a furor among shareholders/investors. However, this proposal was short-lived and was reversed by Finance Act 2003, with India reverting to the DDT system of taxation of dividend. Since then, DDT provisions have been rationalized by the Government, including the provision of rollover benefit where relaxation is given to the cascading effect of dividend payment in a multi-tier structure.
Despite rationalization measures, the DDT system is not free from ambiguities and practical challenges. Primarily, no credit or refund can be claimed by shareholders/investor companies under this taxation, which increases the group cost. The cascading relief is conditional, thereby leading to some unfavorable situations, for example, where the investment holding companies hold less than half of the nominal equity share capital. Further, the dividend received from foreign subsidiaries is taxable at a lower rate of 15%, subject to certain conditions.
The present Government’s professed intent is to make India an investment destination. However, the DDT levy, in addition to the high corporate tax rate, makes doing business in India a relatively expensive proposition from a tax perspective.
On the contrary, globally, most countries do not levy a tax on the distributing company; instead, shareholders are taxed on the dividend income. Some countries also levy withholding tax on the dividends distributed to shareholders. China has recently proposed to defer the levy of withholding tax on dividends that are reinvested in China in a specified manner. This has been done with an intention to attract foreign investments in China. Interestingly, the US also had a provision for exempting dividends reinvested in the country.
With the recent US tax reforms reducing the headline tax rate, India will have to think of ways to boost foreign investments in the country similar to how countries such as China are trying to revive their economy from slumber.
With elections around the corner, it might be interesting to see how the present Indian Government will respond to the expectations from the 2018 Budget.
The author of the blog is Aastha Jain, Director, Tax – Knowledge & Solutions, EY India
The blog is co-authored by Pooja Chhajer, Manager, Tax – Knowledge & Solutions, EY India
 The US tax reforms bill was signed into law by the US president on 22 December 2017. (Source: EY Global Tax alert dated 22 December 2017 titled “Report on recent US international tax developments – 22 December 2017”).
 Refer EY Global Alert “China announces withholding tax deferral treatment on direct reinvestment” dated 12 January 2018.