The deduction for inter-corporate dividends for companies choosing the 22% tax rate, as authorized by the Income Tax Act of 1961, has been removed in the Income Tax Bill 2025.
Under Section 80M of the present income tax law, Indian companies are allowed to deduct dividends received from domestic or foreign companies, as well as business trusts, when these dividends are distributed to their shareholders. This provision, introduced by the Finance Act 2020, aims to prevent double taxation of dividends and avoid cascading taxation in multi-tier structures.
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“This will have far-reaching ramifications since there will be a cascading effect on taxation of dividends across multiple domestic companies which are subject to the 22 per cent tax rate. This appears to be an anomaly, which would need to be addressed before the Bill gets enacted,” Himanshu Parekh, Partner, Tax, KPMG in India, told Businessline.
What is inter-corporate dividend?
When a company receives dividends from another company in which it holds shares, these dividends are referred to as inter-corporate dividends. Inter-corporate dividends received from a domestic company before April 1, 2020, are exempt from tax.
If Company A has shares in Company B, any dividend paid by Company B to Company A is considered an inter-corporate dividend. After April 1, 2020, such inter-corporate dividends are exempt from tax and can be claimed as a deduction.
For example, if Company A receives a dividend income of Rs 100, it would typically be subject to a tax rate of 22% or 30%. However, if Company A distributes the full Rs 100 to its shareholders as dividends, it can claim a deduction, resulting in the company not having any taxable dividend income. Consequently, the dividend is taxed only at the shareholder level.
Section 80M
Section 80M provides a deduction for domestic companies that have declared and received dividends from other domestic companies in any previous year. The deductible amount is limited to the dividend distributed by the first-mentioned company before the due date for filing its return. This deduction is available to all domestic companies, regardless of their tax regime.
The introduction of Section 80M was part of a broader effort to shift the tax burden on dividend income from payers to recipients. The current technology infrastructure enables efficient tracking of dividend income, rendering the provisions related to Dividend Distribution Tax (DDT) obsolete. Additionally, the scope of deduction for dividend income has been expanded to cover all domestic companies, not just those in a holding-subsidiary relationship, thereby mitigating the issue of double taxation of dividend income.
Under Income Tax Bill 2025
According to the Bill, if Company A chooses the reduced corporate tax rate of 22%, it will be required to pay tax on the Rs 100 dividend since the deduction is not applicable. Shareholders would also be taxed on the same Rs 100, leading to double taxation. Nevertheless, companies that fall under the concessional 15% tax rate can still benefit from the dividend deduction provision.
“The exclusion could lead to multiple levels of taxation on dividends, making them less tax-efficient and necessitating restructuring before declaring dividends as those under a concessional tax regime cannot revert to the original tax regime,” said Vinita Krishnan, Executive Director at Khaitan & Co.