DR.

RAM MANOHAR LOHIYA

NATIONAL LAW UNIVERSITY

2017-18

Final Draft

Income Tax

Problem faced by the companies while dealing

with Dividend Distribution Tax.

Under Guidance of: Submitted by

Mr. Bhanu Pratap Srijan Jha (143)

Associate Professor (Law) Enrol. No- 140101145

Dr. Ram Manohar Lohiya VIIth Semester

National Law University,
Section- ‘B’
Lucknow
 ACKNOWLEGDEMENT

 
 
A research project of such great scope and precision could never have been possible without
great co-operation from all sides. Contributions of various people have resulted in this effort.
Firstly, I would like to thank God for the knowledge he has bestowed upon me.

I would also like to take this opportunity to thank Bhanu Pratap Sir without whose valuable
support and guidance, this project would have been impossible. I would like to thank the
library staff for having put up with my persistent queries and having helped me out with the
voluminous materials needed for this project. I would also like to thank my seniors for having
guided me and culminate this acknowledgement by thanking my friends for having kept the
flame of competition burning, which spurred me on through the days.

-sd

Srijan Jha

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 Table Of Contents
ACKNOWLEGDEMENT.........................................................................................................2

Table Of Contents......................................................................................................................3

Introduction............................................................................................................................4

Dividend Direct Tax and its recognization for the companies...............................................5

question of double taxation....................................................................................................5

Position in India..................................................................................................................6

Position in England.............................................................................................................7

Arguments against DDT.....................................................................................................7

Arguments in Favor of DDT...............................................................................................8

DIrect Tax Code and the History behind it............................................................................8

Nitty Gritties Of Dividend Direct Tax Under The Heads Of Direct Tax Code, 2010...........9

DIVIDEND INCOME:.....................................................................................................11

DIVIDEND DISTRIBUTION TAX:................................................................................11

PAYMENT OF TAX:.......................................................................................................11

FAILURE TO PAY TAX:................................................................................................12

MANDATORY PAYMENT:...........................................................................................12

Conclusion............................................................................................................................13

BIBLIOGRAPHY................................................................................................................14

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 INTRODUCTION

As goes the topic of the project “Problem faced by the companies while dealing with
Dividend Distribution Tax”, the very first part of the introduction would encompass the scope
of a corporate entity in paying taxes. As is the definition of the ones who are liable to pay
income tax, even a company or a corporate structure would qualify for being counted as
‘persons’ who can be taxed. Now comes the question of income on which they are liable to
pay the taxes. For this we need to go into the realm of Section 5 and 6, and a reading of the
same provides us an understanding that a lot of incomes would qualify as ‘taxable income’.
Yet constricting ourselves to the discipline just mentioned, we shall henceforth look into the
scope and problems that arise out of Dividend Distribution Tax.

In India the Dividend Distribution Tax was first introduced in the financial year of 2002-03
by virtue of acceptance of Finance Act, 1997 by Yashwant Sinha, while presenting the
Annual Budget in 2002-2003. The tax is implied on the corporations and not the ones
receiving the same. Hence in the bigger picture the problem is of double taxation, as an
argument against the same says that it is a tax levied on sharing the profits with the
shareholders, after having already paid the income tax on profits. Conjoined to the same is
the question that whether it qualifies for being referred under the head of ‘income tax’ if it is
charged after the payment of income tax. The project would seek to answer and discuss these
questions.

This aspect has only been mentioned once before the Supreme Court of India in the case of
Nokia v. Additional CIT1 , and the Supreme Court rather decided on points that was
circumscribing the point of dividend distribution tax. Courts have taken a stance to not go
into the reality of accounting and realising the DDT, because usually it does not provide any
particular read on law, or there is no new point of law that comes to the surface by looking
into this aspect. Similar happened in the case of CIT v. Associated Cement Company2.

1
(2015) 13 SCC 729.
2
2015 SCC OnLine Bom 7487.

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 DIVIDEND DIRECT TAX AND ITS RECOGNIZATION FOR THE
COMPANIES

The word “Dividend” has origin from the Latin word “Dividendum”. It means a thing to be
divided. Dividend means the portion of the profit received by the shareholders from the
company’s net profit, which is legally available for distribution among the members.
Therefore, dividend is a return on the share capital subscribed for and paid to its shareholders
by a company. Dividend defined under section 2(35) of the Companies Act, 2013, includes
any interim dividend.

As per Section 2(35) of Companies Act, 2013 defines the term as including any interim
dividend.

 Dividend is basically the share of profit distributed among shareholders.

 Ordinary meaning of dividend is a share of profits, whether at a fixed rate or
otherwise, allocated to holders of shares in a company.
 Dividend can be paid on Equity or preference shares both.
 The word “Dividend” has origin from the Latin word “Dividendum”. It means a
thing to be divided.

Dividend can be paid out of Followings mentioned below: Section- 123 (1)(a)

 Profit of the current year after providing of the depreciation; or

 Profit of the previous financial year or years after providing for depreciation for
previous years; or
 Out of the money provided by Central or State Government for payment of dividend
in pursuance of guarantee given by that, if any.

It’s not mandatory to transfer some amount into reserve before declaring dividend amount.
Earlier in Companies Act, 1956 it was Compulsory to transfer the amount in reserve while
declaration of dividend. But the same is on the discretion of the Company in Companies Act,
2013.

QUESTION OF DOUBLE TAXATION

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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%.

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 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.

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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 Favor 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.

DIRECT TAX CODE AND THE HISTORY BEHIND IT

The Direct Taxes Code (DTC) is an attempt by the Government of India (GOI) to simplify
the direct tax laws in India. DTC will revise, consolidate and simplify the structure of direct
tax laws in India into a single legislation. The DTC, when implemented will replace the
Income-tax Act, 1961 (ITA), and other direct tax legislations like the Wealth Tax Act, 1957.

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The first draft bill of DTC was released by GOI for public comments along with a discussion
paper on 12 August 2009 (DTC 2009) and based on the feedback from various stakeholders,
a Revised Discussion Paper (RDP) was released in 2010. DTC 2010 was introduced in the
Indian Parliament in August 2010 and a Standing Committee on Finance (SCF) was
specifically formed for the purpose which, after having a broad-based consultation with
various stakeholders, submitted its report to the Indian Parliament on 9 March 2012.

Recent action: As a follow-up on this initiative and as stated by the Finance Minister (FM) in
his Interim Budget Speech in February 2014, after taking into account the recommendations
of the SCF, a “revised” version of DTC (DTC 2013) has been released on 31 March 2014.

The DTC 2013 proposes to introduce:

1. General Anti Avoidance Rules (GAAR),

2. Taxation of Controlled Foreign Companies (CFC),
3. Place of Effective Management (POEM) rule as a test to determine residency and tax
indirect transfer of Indian assets.

Also contains expanded source rules for taxation of royalty, fees for technical services (FTS)
and interest.

Further certain novel provisions are also included such as additional tax levy on certain
persons having high net worth such as dividend tax levy on dividend income earned by
resident shareholders in excess of INR10 million. It also proposes a tax rate of 35% for
individuals/HUFs where the total income exceeds INR100 million.

NITTY GRITTIES OF DIVIDEND DIRECT TAX UNDER THE HEADS OF

DIRECT TAX CODE, 2010

Sec.314 (81) (1) of the Direct Taxes Code provides that the term 'dividend distributed or paid
by a company includes-

a) any distribution by a company of accumulated profits, whether capitalized or not, if

such distribution entails the release by the company its shareholders of all or any part
of the assets of the company;
b) any distribution to its shareholders by a company of debentures or debenture-stock, or
deposit certificates in any form, whether with or without interest, and any distribution

9
 to shareholders of its preference shares by way of bonus, to the extent to which the
company possesses accumulated profits, whether capitalized or not;
c) any distribution made to the shareholders (other than the shareholders not entitled in
the event of liquidation to participate in the surplus asses) of a company on its
liquidation, to the extent to which the distribution is attributable to the accumulated
profits of the company immediately before its liquidation, whether capitalized or not;
d) any distribution to its shareholders (other than shareholders not entitled in the event of
liquidation to participate in the surplus assets) by a company on the reduction of its
capital, to the extent to which the company possesses accumulated profits, whether
such accumulated profits have been capitalized or not; and
e) any payment by a closely-held company, to the extent of accumulated profits, if such
payment is-
 by way of advance or loan to a shareholder being the beneficial owner of
equity shares holding not less than 10% of the voting power; or
 by way of advance or loan to any Hindu undivided family, or a firm, or an
association of persons, or a body of individuals, or a company in which such
shareholder is a member or a partner or a shareholders, and in which he has a
substantial interest; or
 to any person on behalf, or for the individual benefit, of such shareholder

Sec. 314(81)(2) provides that the dividend distributed by a company does not include-

 any advance or loan made to a shareholder or the said concern by a company in the
ordinary course of its business, where the lending of money is a substantial part of
the business of the company;
 any divided paid by a company which is set off by the company against the whole
or any part of any sum previously paid by it and treated as a dividend within the
meaning of Sec.314(81)(1)(e) to the extent to which it is set off;
 any payment made by a company on purchase of its own shares from a shareholder
in accordance with the provisions of Section 77A of the Companies Act, 1956; and
 any distribution of shares pursuance to a demerger by the resulting company to the
shareholders of the demerged company (whether or not there is a reduction of
capital in the demerged company).

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 DIVIDEND INCOME:
Sec. 7 of the Direct Taxes Code provides that for the purpose of inclusion in the total income
of an assessee any dividend declared, distributed or paid by a company within the meaning of
item (a) or item (b) or item (c) or item (d) or item (e) of sub clause (1) of Section 314 shall be
deemed to be the income of the financial year in which it is so declared, distributed or paid as
the case may be. Any interim dividend shall be deemed to be the income of the financial year
in which the amount of such dividend is unconditionally made available by the company to
the member who is entitled to it.

DIVIDEND DISTRIBUTION TAX:

Sec. 314 (82) defines 'dividend distribution tax' as the tax chargeable under Section 109.
Dividend distribution tax is dealt with in Chapter VII of Part B of Direct Taxes Code. Sec.
109 provides that every domestic company shall be liable to pay tax on any amount of
dividend declared, distributed or paid, whether interim or otherwise, to its shareholders,
whether out of current or accumulated profits. The said amount shall be reduced by the
amount of dividend if any received by the domestic company during the financial year if such
dividend is received from its subsidiary and the subsidiary has paid tax under this section on
such dividend. A company shall be a subsidiary of another company if such other company
holds more than fifty per cent of nominal value of the equity share capital of the company.
The term 'dividend' for the purpose of this section shall not include any payment referred to
in item (e) of sub clause (1) of clause (81) of Section 314.

The tax rate is 15% on the amount of dividend declared, distributed or paid by a domestic
company.

PAYMENT OF TAX:
The domestic company or the principal officer of such company responsible for making
payment of the dividend, as the case may be, shall be liable to pay the tax on dividend to the
credit of the Central Government within a period of fourteen days from the date of
declaration, distribution or payment of such dividend, whichever is earliest. It is to be noted
that no deduction under any other provision of this Code shall be allowed to the domestic
company or a shareholder in respect of the dividend charged to tax or the tax thereon. The
Code further provides that the tax on dividend so paid by the domestic company shall be
treated as the final payment of tax in respect of the dividend declared, distributed or paid and

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no further credit shall be claimed by the domestic company or by any other person in respect
of the tax so paid.

FAILURE TO PAY TAX:

If the tax payment has not been made in accordance with this provision, then the domestic
company or the principal officer of such company shall be deemed to be an assesse in default
in respect of the tax payable by it or him and the provisions of this Code relating to the
collection and recovery of tax shall apply.

If the tax is not paid within the stipulated period either wholly or partly then simple interest is
liable to be paid @ 1% for every month on the amount of such tax for the period beginning
on the date immediately after the last date on which such tax was payable and ending with the
date on which the tax is actually paid.

A condition came in front of the Delhi High Court, where the Hon’ble Court could clearly see
that one of the parties was trying to evade the payment of DDT, and the Court decided
against him.3

MANDATORY PAYMENT:
Notwithstanding that no income tax is payable by a domestic company on its total income
computed in accordance with the provisions of Part A of the Code, the tax on dividend
declared, distributed or paid under this section shall be payable by the company.

3
Controls and Switchgear Contractors Limited v. Deputy CIT 2014 SCC OnLine Del 3180.

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 CONCLUSION

India has often favoured transaction taxes as the solution to difficult questions of income tax
design. For example, we replaced our dividend withholding system with a dividend
distribution tax (“DDT”) in 19971 to resolve the issue that “the procedure for tax collection is
cumbersome and involves a lot of paper work”.4

The research questions that are involved in the making of this project can be enumerated as
follows:

1. Whether Dividend Distribution Tax qualifies as an Income Tax?

2. Whether Dividend Distribution Tax qualifies as Double Taxation or is it protected
under S.194 of Income Tax Act?

The first question is to be answered in negative. However, dividend distribution tax does
qualify as another direct tax, just like the income tax and hence the provisions that have been
provided are of utmost importance.

The second question of double taxation or not can be answered. 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 globalization 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.

4
Explanatory Notes to the dividend tax provisions introduced by Finance Act, 2007, available at
http://indiabudget.nic.in/ub1997-98.mem/MEM2.HTM (Last visited on Sept 17, 2017).

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 BIBLIOGRAPHY

The following sources were used in making of this project:

 Taxmann manual on Income tax

 Direct Taxes Code available at
https://www.taxmanagementindia.com/visitor/acts_rules_provisions.asp?ID=432
 Constitution of India by V. N. Shukla (relating to the aspects of Double Taxation)
 Vinod Singhania on Income Tax, published by Taxmann
 www.scconline.com
 www.taxmann.com
 DIRECT TAX LAWS : Deemed Dividend under Income-tax Act, by T.R. Nagrajan
[2011] 20 CPT 74
 DIVIDEND INCOME NO LONGER A SWEET EXEMPTED PIE, by Shripal
Lakdawala, Madhavi Jajoo and Shefali Gantara [2016] 67 taxmann.com 18
 THE INDIAN EQUALISATION LEVY: INELEGANT BUT NOT UNEXPECTED,
by Shreya Rao 2016 NLS Bus L Rev 25
 DIVIDEND DISTRIBUTION TAX UNDER DIRECT TAXES CODE, by M.M.
Govindrajan, available at
https://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=1021

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