Why the dividend distribution tax is a burden

Image: Ajay Verma / Reuters

Dividend distribution tax (‘DDT’) has probably been a favourite levy of finance ministers because of the ease of levying the tax. It shifts the incidence of tax from the recipient to the payer, negates treaty benefit and is agnostic to slab rates for individual tax payers.

The current challenges:

· Over a period of time, it has proved to be a tax burden. The effective rate of DDT is currently close to 20 percent. This raises the effective tax rate of corporates to a prohibitive level.

· There is no credit mechanism for foreign shareholders in whose hands dividends are taxable in their home countries.  Also, the cascading effect of this tax has been dealt with only partially by the existing law.

· By ignoring slab rates for individual tax payers, it favours individuals in a higher tax bracket as compared to those in a lower tax bracket.

· As if all this does not sound bad enough, the litigation on account of expenses incurred for earning this supposed tax-free income is one more issue that continuous to irk investors.

What change is expected this budget:

· While one could wish for a total abolishment of any tax on dividends, at a practical level, the finance minister could be expected to ring in changes in the rate and manner of collection.

· To start with, the government can be expected to revert to a dividend withholding tax instead of tax paid by the corporates.

· This will help small tax payers, and also allow for treaty relief where intended. In any case, the rate of DDT can be rationalised to 10 percent which is a more acceptable rate internationally as well.

· Budget 2016 can be expected to clarify that REITS and SEZs are exempt from DDT or tax on dividends. A specific exemption from tax can be expected for the infrastructure sector as well.

The impact:

· These changes will provide a much needed booster to investments in the infrastructure sector. Exemption to REITs should encourage greater inflow of capital to the real estate sector. There should be an increase in foreign investments in general which help development of all the industry sectors.

- By Frank D’Souza, Partner – Direct Tax, PwC India. The opinions expressed are his own.