Union Budget 2024: Will government tweak double taxation on dividend earnings this time? 

The taxation of dividends can lead to double taxation since companies pay taxes on their profits before distributing them to shareholders. The Finance Act 2020 shifted the taxability on dividend income from the hands of the dividend-declaring company to the individual investors.

When individuals decide to invest in a company's equity, they typically do so with two primary objectives in mind: capital appreciation and dividends. Capital appreciation, which refers to the increase in the value of the investment over time, is subject to taxation under the category of Income from Capital Gains.

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On the other hand, dividends are taxed under either Income from Other Sources or Income from Business & Profession, depending on the specific circumstances surrounding the investment.

Old vs new 

The dividend received from an Indian company was exempt until 31 March 2020 (FY2019-20). This exemption was due to the company having paid dividend distribution tax (DDT) before distributing the dividend. After the abolition of this rule, Finance Act 2020 introduced the double taxation formula. The government said all dividend received on or after 1 April 2020 is taxable in the hands of the investor/shareholder.

The DDT liability on companies and mutual funds stands withdrawn. Similarly, the tax of 10% on dividend receipts of resident individuals, HUF and firms in excess of Rs.10 lakh (Section 115BBDA) also stands withdrawn.

The Finance Act, 2020 has introduced a provision for Tax Deducted at Source (TDS) on dividend distribution by companies and mutual funds effective 1st April 2020. The standard TDS rate stands at 10% on dividend income exceeding Rs. 5,000 from a company or mutual fund. 

However, in response to the COVID-19 pandemic, the government has temporarily lowered the TDS rate to 7.5% for distributions made between 14th May 2020 and 31st March 2021. Any tax deducted at source can be availed as a credit towards the total tax liability of the taxpayer at the time of filing their Income Tax Return.

How the taxes are calculated

The company pays taxes on its earned profit at a rate of 25.17%, which comprises 22% as the base rate, a 10% surcharge, and a cess of 4%. Following the deduction of taxes, dividends are distributed from the remaining profit amount. Individual resident shareholders are required to pay taxes on the received dividend amount based on their applicable tax slab rates, which stand at 31.2% — a combination of a 30% base rate and a cess of 4%, CA Suresh Surana said in a column. 

For individuals whose taxable income surpasses Rs 10 lakh in the old tax regime or Rs 15 lakh in the new tax regime, the effective marginal tax rate stands at 31.2%. This percentage escalates to 35.88% once the income crosses the threshold of Rs 1 crore. Moreover, when considering the corporate tax rate of 25.17%, the combined effective tax rate adds up to 48.51%.

The Finance Act, 2020 brought about changes in the tax implications for companies regarding dividends. Prior to this act, companies were liable to pay tax at an effective rate of 17.65% on the dividend amount, with dividends being tax-free for shareholders. This resulted in an overall effective tax rate of 38.37%, which was notably lower than the previously set rate of 48.51%.

For partnership firms and limited liability partnerships (LLPs), the current effective tax rate stands at 34.94%, as partners are not subject to additional tax on their profit shares. Conversely, resident individuals or companies face an effective tax rate that is nearly 50%.

Dual taxation, also known as double taxation, poses a significant challenge as it can lead to a substantial reduction in profits available for distribution to shareholders. This, in turn, may influence investment decisions by discouraging companies from paying dividends. Besides, double taxation distorts investment decisions by creating an incentive for companies to retain earnings rather than distributing them to shareholders.

With this, investors may favour capital gains over dividends due to the lower tax implications involved, which can impact the flow of funds into the equity market.

Also, in a globalised economy, countries that impose lower tax burdens on dividends are more likely to attract foreign investment compared to those with higher effective tax rates resulting from double taxation.

Budget expectations

Surana said rationalisation of the tax treatment of dividends is crucial. "There is an imminent need to restrict dividend taxation for resident investors to 15% (excluding surcharge and cess). This can result in an effective tax rate of 19.5% (assuming surcharge of 25% and cess of 4%). Lowering tax rates on dividends for residents can encourage companies to distribute profits while ensuring an adequate revenue stream for the government," he said. 

He added streamlining tax laws and reducing compliance burdens can simplify business operations and boost investor confidence. The Interim Budget 2024, characterised as a vote on account, did not introduce any modifications to the tax system. 

However, there is anticipation that the current government will implement this highly beneficial measure in the forthcoming full budget scheduled for July 2024.