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Does Dividend Distribution Tax amount to Double Taxation

Written by: Devika Singh - 3rd year student from Army Institute of Law, presently pursuing 5yr B.A, Mohali
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Dividend Distribution Tax is one of the biggest concerns and burdens of corporate world in India. Many may be eyeing the budget 2008-09 for a relief but, there are no hints dropped by the government of any escape from it. Taxing dividends on the hands of the companies have been highly criticized by them by using the concept of double taxation as a shield. As many believe that its implementation will lead to the same. It has been argued that it is wrong to tax same income twice. But the present question is that, do we see the profit earned by companies as of same nature of income earned by the dividend holders? While analysing the present scenario, if we look at the tax provisions prevailing in India, its corporate tax sums up to 40% which is quite high as compared to the other countries.

Corporate India today pays firstly, 33.6% Corporate Tax on its profits, 3 to 4% points on Fringe Benefit Tax. In addition, they pay another 3% points as surcharge and educational cess, and finally, the lowered depreciation rates, thrust an additional tax of 1 to 2% points. It is much higher than India’s competitor China’s corporate tax which sums up to 30% that too on profits earned over 40 lakhs. However, in India it applies to profits earned above 2.5 lakhs. India’s corporate tax can also be considered high even when it comes in comparison to what is applicable in other countries where it varies from 18-28% . One on the main components of corporate tax is Dividend Distribution Tax (DDT). DDT is a tax which is further levied on companies which is another 15%.

But the legal question which arises here is not whether the shareholders are getting justified share of their profit but whether taxing the profits of the company twice by the hands of the company, will amount to double taxation?

Position in India
In India, the dividend distribution tax was first introduced by the Finance Act of 1997, was accepted by the then FM, Yashwant Sinha, while presenting the Finance Bill for 2002-03. Before that, dividends were taxed in the hands of the recipient as any other income. This tax was again abolished in the year 2002. The budget for the financial year 2002-2003 proposed the removal of dividend distribution tax bringing back the regime of dividends being taxed in the hands of the recipients and the Finance Act 2002 implemented the proposal for dividends distributed since 1 April 2002. But presently, the new dividend distribution tax rate for companies was higher at 12.5%, and was increased with effect from 1 April 2007 to 15%.

Position in the United States of America

U.S.A has removed the dividend tax both from the companies and the recipients. Looking at the past situation in the USA, in 2003 president George W. Bush proposed to eliminate the US dividend tax further stating that “double taxation is bad for an economy” and it is fair to Tax Company’s profit, it is not fair to do double taxation by taxing shareholders on the same profit. Here, small dividend holders are exempted from dividend distribution tax. Dividends received by low income individuals were taxed at a five percent rate until December 31, 2007 and will become fully untaxed in 2008. These provisions are set to expire on January 1, 2011. This way the government can keep a check on the income of the rich and exempt the small shareholders as well.

Position in England

Even in England there are two different Income Tax rates on dividends. The rate you pay depends on whether your overall taxable income (after allowances) falls within or above the basic rate Income Tax limit, varying from 10- 32.5%.

Arguments against DDT

The argument extended by most of the corporate houses is that, it leads to double taxation. Dividend is nothing but distribution of profit of the companies. It is after paying income-tax on the profits earned by the companies, that the profit is distributed among shareholders. Dividend distribution tax is further levied on the profits distributed to the shareholders of a company.

The profits of a company are supposed to be the income of shareholders. This way they as part owners i.e. the shareholders have already been taxed. Dividend distribution tax thus amounts to double taxation; the fact that the companies in India are already paying high corporate tax on these profits further deteriorates the condition of the shareholders. Here the company is assessed for both the taxes but it’s been upheld in a catena of cases that “the principle of Income Tax Act is to charge the income with tax but in the hands of the same person only once”. The same income cannot be assessed under two different heads. It was upheld in the case of State of U.P vs. Renusagar Power Co. that whenever a corporate entity is abused for an unjust and inequitable purpose the court would not hesitate to lift the corporate veil. Corporate veil is generally lifted when a company tries to evade taxes, but can shareholders and companies be looked down upon as a single entity, when government policy amounts to double taxation and is arbitrary.

Under the current Taxation system, when a subsidiary company pays dividend to its parent company, it pays dividend distribution tax. When the parent company pays dividend to its shareholders, probably utilising all of its dividend receipts, it further pays dividend distribution tax again on the same funds. This leads to double taxation, which should have been resolved by taxing dividend in the hands of the shareholder. The worst hit is the group companies or the chain investment companies, which will be subject to DDT more than once to distribute its profits to the ultimate shareholders. It is important that shareholders get fair returns on their equity holdings in a company. Otherwise they would prefer to choose investing through other alternative means. Presently a shareholder gets around 50% of his share of profits in a company after paying all its taxes.

Moreover, it creates a bias in favour of undistributed profits against distributed profits. India needs to reduce the overall incidence so as to make Indian companies competitive in the international market. DDT encourages retention of profits in the hands of the company. It severely effects the capital formation and development in a country where capital is scarce and liquidity is one of the essential requirements of an economy. But it is equally important that shareholders get fair return on their equity holdings. Also keeping in mind the present policy of globalisation, high corporate tax and less investment will make Indian companies suffer in the international market.

Arguments in Favour of DDT

The Income Tax department has adopted a different understanding of this subject. It is to be noted that Section 194 of Income Tax Act deals with deduction from shareholders tax and not with deduction on account of company’s own tax, even though it may be taxed on the hands of the company. Bringing up the concept of company having a separate juristic personality than its shareholders makes a distinction between profits earned by the company and income of the shareholders . By saying that the same income cannot be taxed twice is meant that tax is not levied more than once on one passage of the money in the form of one sort of income. Once the profits of a company are transferred to the shareholders it becomes their income and enters a different passage. To take an example, if a man earns 100Rs. and pays it to somebody else for service rendered in a trade or profession by that other person, the sum of 100 enters upon another’s passage , in another form of income that attracts income tax again. Also, although when the assessee is a different person direct taxation may be allowed but where the tax is for altogether different purpose or where the double taxation is indirect rather than direct, there is no scope of invalidating taxation. One of the strongest arguments in the favour of DDT is that it doesn’t let shareholders having huge stakes in the company go off without paying taxes on their incomes. Also, there could be no double taxation if legislature does not enact it.

The present tax policy of taxing dividends on the hands of the company has actually increased the burden on the equity investors in India. It actually goes against the present globalisation policies of India and discourages the shareholders to invest more, further leading to inefficient economic growth. To overcome this conflict of law, it’ll be more justified to introduce tax brackets. A limit for income earned through shareholdings can be prescribed where, a shareholder exceeding this limit may be taxed and the shareholder falling below such limit can be exempted from such tax. In other words, shareholders with a larger shareholding in the company should be taxed at a higher rate on their income. This way the I-T department can keep an easy check on wealthy shareholders and can also control the inequality in the system and on the flip side , it would spare small shareholders whose annual dividend income is comparatively small from paying higher taxes.

[1] Corporate Tax Rates in other countries :- Bulgaria – 19.5%, Canada – 22%, Germany – 25%, Hong Kong – 17.5%, Hungary – 18%, Korea – 27%, Malaysia – 28%, Mauritius – 25%, Nepal – 25%, Norway – 28%, Poland – 19%, Romania – 25%, Singapore – 22%, Sweden – 28%, Taiwan – 25%
[2] Is applicable presently in India by the rate of 15% under Section 194 of The Income Tax Act, 1961
[3] Per Lord Haldane LC, Sugden vs. Leeds 6 TC 211, 253 (HL); State of U.P vs. Raza Buland 118 ITR 50 (SC); Achamma vs. ITC 180 ITR 57;Kamlaker vs. CIT 67 ITR 351,CIT vs. Dalmia 135 ITR 346, 350-51; Cphisalal vs. CIT 248 ITR 506
[4] CIT vs. Surat Cotton 202 ITR 392
[5] AIR 1988 SC 1737
[6] Salomon vs. Salmon & Co., 1897 AC 22
[7] IR vs. Sanderson 8 TC 38,44-45
[8] ITO vs. Radha Krishnan 254 ITR 561 (SC); ITO vs. Atchaiah 218 ITR 239 (SC)
[9] Sir Krishna vs. Tower Area Committee 183 ITR 560 (SC)
[10] Stevens vs. Durban 5 TC 402, 407; ITO vs. Bachhan 60 ITR 57; Laximipat vs. CIT 72 ITR 291, 294(SC); CIT vs. Sidhwa 133 ITR 840; Att. Gen. vs. London County Council 5 TC 242, 260(HL); Re Kamdar 141 ITR 10; cf Sri Krishna vs. Town Area Committee 183 ITR 401 (SC); Ganpatri vs. CIT 138 ITR 294
Kanga Palkhiwala and Vyas, The Law and Practice of Income Tax, Lexis Nexis, 9th Ed., 2004
Taxman 2007

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