Monday, April 3, 2017




Why are dividends exempt from taxation?

According to the Companies Act, since dividends are technically a share in the profit received by the investor for investing share capital in the company, he should enjoy such income only from profits after taxes. Therefore, by the same logic, if the investor is asked to include dividend income as a part of his total individual income for taxation, it would amount to "taxing an already taxed income", or "double taxation". Thus, dividend income from domestic companies was made exempt from taxation. This is more or less a globally embraced concept. But are they REALLY? The other side of the smoke screen. However, this is just one side of the smoke screen. On the other side is the concept of dividend distribution tax (DDT). Section 115-O of the Income Tax Act states: "In addition to the income-tax chargeable in respect of the total income of a domestic company for any assessment year, any amount declared, distributed or paid by such company by way of dividends shall be charged to additional income-tax at the rate of 15 per cent." Thus, even though dividend is not taxable in the hands of the shareholder, it has not exactly escaped double taxation. While it's only fair that a company should be free to distribute its profits after income tax amongst its members, as per the provisions of Section 115-O, it cannot do so unless it has paid an additional tax called the Dividend Distribution Tax (DDT) at the rate of 15 per cent. Consequently, the net dividend distributed is less by that much. The DDT was introduced with the Finance Bill, 1997, and justified in the Memorandum to the Finance Bill, 2003, as: "It has been argued that it is easier to collect tax at a single point, i.e., from the company, rather than compel the company to compute the tax deductible in the hands of the shareholder." The double taxation effect that is caused by the DDT has not been clearly rationalised till date.


Besides, the dividend received from non-domestic or foreign companies is taxable in the hand of the shareholder separately. With the unfortunate existence of DDT almost globally (known as just "Dividend Tax" in most countries), the recipients of dividends from foreign companies undergo a worse fate "triple taxation". First, the foreign company pays Income Tax or Revenue Tax on operating profits to the government of its country. Then it again pays Dividend Tax (same as Indian DDT) to its government. Finally, when the investor in India receives his "doubly taxed" dividend, he has to again pay Income Tax, as tax received from non-domestic companies is not exempt under the Income Tax Act. To add to this jarring irrationality, in some countries like China, while Chinese citizens in Mainland China are victim to the cruelty of a Dividend Tax as high as 50 per cent, Chinese citizens in Hong Kong completely escape tax liability!


Some other countries such as Canada and Australia have, however, worked out a tax credit system on dividend tax which can be studied and implemented, mutatis mutandis. Additionally, bilateral tax exemption agreements should be considered with stock exchanges such as London Stock Exchange or NYSE where there is a lot of mutual interest in terms of investments. –

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