Dividend Distribution Tax to be paid after grossing up of 'Dividend Distributed'

Section 115-O and 115R

Section 115-O was introduced by Finance Act, 1997 and materially altered the taxation of income distribution by companies. Prior to its introduction, entire amount of dividends (say Rs.1,000) paid by a company to its shareholders was taxed in the hands of the shareholders, and the Government collected tax on this entire amount from such shareholders.

Post introduction of section 115O, the dividend was treated as exempt in the hands of such shareholders and the company declaring such dividend was required to pay Dividend Distribution tax (DDT) on the amount of dividends actually paid. The objective behind this transition was to simplify the tax collection mechanism on income distribution, as the number of companies paying such dividend was much less as compared to the number of shareholders receiving such dividend. As an illustration, assuming a distributable surplus of Rs.1,000 the same was earlier split as follows:

Distributable Surplus:Rs.1,000

Dividend Declared: Rs.1,000/1.16995 = Rs.854.73

DDT Paid: Rs.854.73*16.995% =Rs.145.26

In other words, the effective tax rate recovered by the Government on distribution of income is 14.526% as opposed to stated rate of 16.995%. A similar position is also present for section 115R which deals with declaration of dividend by Mutual Funds.

In order to correct this anomaly, Finance Bill, 2014 proposes to gross up the basis for calculation of DDT, in as much, that the basis of calculation should be the gross distributable surplus. Thus, in the above mentioned illustration, the DDT shall be now calculated at Rs.1,000 (Aggregate of Dividend Distributed and DDT Paid, in existing position) rather than Rs.854.73 (only dividend distributed), resulting in DDT liability of Rs.169.95 and net distributable surplus of INR 830.05.

This shall result in increased tax outflow to the Government and reduced cash remittance in the hands of shareholders.

The effective tax rate of Dividend Distribution tax from 01-10-2014 shall be 19.994% on amount actually distributed as dividend to the shareholders. Alternatively, the DDT can be computed at present rate in force, i.e., 16.995%, on the distributable surplus to be used for distribution of dividend and to meet obligation for payment of dividend distribution tax.

Amendment Proposed

In section 115-O of the Income-tax Act, after the Explanation to sub-section (1A), the following sub-section shall be inserted with effect from the 1st day of October, 2014, namely:

"(1B) For the purposes of determining the tax on distributed profits payable in accordance with this section, any amount by way of dividends referred to in sub-section (1) as reduced by the amount referred to in sub-section (1A) [hereafter referred to as net distributed profits], shall be increased to such amount as would, after reduction of the tax on such increased amount at the rate specified in sub-section (1), be equal to the net distributed profits.".