Address the anomalies post DDT abolition

Address the anomalies post DDT abolition

Up to March 31, 2020, a domestic company in India was liable to pay dividend distribution tax (DDT) on the distribution of dividend to its shareholders. As dividend was subjected to DDT in the hands of the company, shareholders were exempt from paying tax on such dividend income. However, if the dividend received by a shareholder during the year exceeded ₹10 lakh, the excess amount was chargeable to tax at 10 per cent under Section 115BBDA.

The Centre abolished the concept of DDT in Budget 2020, and adopted the traditional system of taxation wherein dividend declared, distributed or paid on or after April 1, 2020, will be taxable in the hands of the shareholders. Other consequential amendments were also made under various provisions of the Income Tax Act including in Section 194, (regarding deduction of tax at source). However, in our opinion, some provisions have been left unamended. We have highlighted these provisions below.

For instance, it is necessary to provide relaxation from the levy of interest under Section 234C if the shortfall in payment of advance tax is attributable to wrong estimation or under-estimation of the dividend income. Further, the relevant provisions of the I-T Act should be amended to avoid the timeless controversy of taxability of dividend under the relevant head of income, ie, business/profession or other sources.

Advance tax rules

Advance tax is a scheme wherein an assessee has to estimate her income and tax liability thereon. The tax so estimated is required to be paid in instalments during the financial year itself. Thus, an assessee is required to pay tax as she earns.

If an assessee defaults or makes short payment of advance tax instalments then she is liable to pay interest under Section 234C. However, interest under Section 234C is not charged in respect of incomes which are uncertain and difficult to estimate. For instance, interest is not charged if the assessee fails or under-estimates the amount of capital gains or income from gambling activities.

Up to Assessment Year 2020-21, the relaxation from charging of interest under Section 234C was provided in respect of dividend chargeable to tax under Section 115BBDA as well. After the abolition of DDT, Section 115BBDA would be of no relevance as the entire amount of dividend shall now be taxable in the hands of the shareholder as per the normal provisions of the I-T Act. Thus, it is recommended that Section 234C should be amended to provide relaxation from the levy of interest if the shortfall in payment of advance tax is attributable to wrong estimation or under-estimation of the dividend income.

Clarity on income head

With the dividend being chargeable to tax in the hands of shareholders with effect from AY2021-22, the timeless controversy of taxability of dividend under the relevant head of income would come to the fore again.

In the I-T Act, there are five heads of income — Salary, House Property, Business or Profession, Capital Gain, and Other Sources. Income from other sources is a residuary head of income and sweeps in all taxable incomes which fall outside the other four heads of income. The provisions relating to the taxability of residuary income are contained in Section 56.

Clauses (i) to (xi) of Section 56(2) provide for chargeability of various incomes under the head of other sources. Clause (i) explicitly specifies that dividend shall be taxed under the head ‘Income from other sources’. However, for several other items of income specified in Clauses (ia) to (xi), it has been provided such incomes shall be taxable under the head ‘other sources’ only when the same is not chargeable to tax under the head ‘Profits and gains of business or profession’.

For instance, as per clause (id), interest on securities is chargeable to tax under the head ‘other sources’ only when it is not chargeable to income tax under the head ‘Profits and gains of business or profession’. The exclusion of the said phrase from clause (i) suggests that the dividend income can never be taxed as a business income and must always be taxed under the head ‘Income from other sources’.

However, the taxability of dividend income under the head ‘business or profession’ when it is connected to the business carried on by assessee (for example, dividend received in respect of shares held as stock-in-trade) has always been a matter of turf war.

The Delhi High Court in the case of CIT vs Excellent Commercial Enterprises & Investments Ltd [2005] 147 Taxman 558 (Delhi) held that where shares are held by the assessee as a stock-in-trade, it could not be said that the dividend income would fall as an income from other sources as contemplated under Section 56. The Supreme Court in the case of Brooke Bond & Co Ltd v CIT [1986] 28 Taxman 426 (SC) held that the nature of the dividend income must be determined having regard to the true nature and character of the income.

Thus, it is recommended that akin to other clauses, dividend income should be taxable under the head ‘Income from other sources’ only if it is not chargeable to income tax under the head ‘Profits and gains of business or profession’.

Wadhwa is DGM at Taxmann, a research and advisory firm. Mittal is a Consultant at Taxmann

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