The Union Budget of India for 2020–2021 presented by the Finance Minister Nirmala Sitharaman on 1 February 2020 has abolished the Dividend Distribution Tax (DDT) and replaced it with a dividend tax on the shareholders. The measure could hurt HNWIs the most.
Starting 1 April 2020, the current effective DDT rate of 20.56% imposed on Indian companies (according to the dividend paid to their investors) will be replaced with a tax on the dividends held by shareholders, at a rate according to the shareholder’s income bracket.
Small tax payers stand to benefit as their effective rate of tax is much lower than the DDT rate of 20.56%. “Whilst this may put more cash in the hands of shareholders, the abolition of DDT, unfortunately, may not be favourable to all investors,” Kunal Savani, director in tax and private client practice at Indian law firm Cyril Amarchand Mangaldas told Asian Private Banker.
“For HNWIs, the applicable effective tax rates vary from 34.32% to as much as 42.74% for the ‘super-rich’. Hence, such dividend-receiving investors would be paying a much more significant amount in income tax, as compared to the current DDT of 20.56%. This may discourage companies paying out cash to investors.”
Among all new measures suggested in the budget, Savani said the abolition of DDT will affect HNWIs the most, because of the negative impact on private discretionary trusts which will be liable to pay the maximum marginal tax rate of 42.74% on any dividend income received by such trusts.
As private discretionary trusts are often utilized by wealthy Indians to consolidate their wealth and structure their shareholdings, he suggests that owners of these structures review and consider restructuring to defend against this additional levy of the tax on dividend income.
Foreign investors gain
For non-residents, the budget suggests a withholding tax of 20%. As many jurisdictions impose a 10% dividend tax, foreign investors from a tax jurisdiction that has signed a Double Taxation Avoidance Agreement (“DTAA”) with India will be able to enjoy the benefit of the applicable DTAA while claiming the tax paid in India as credit in their home countries.
“Under the new regime, non-resident investors will be able to take advantage of the lower tax rates specified in the DTAAs. In addition, they will be entitled to claim credit for the withholding tax paid in India, against the tax payable in the country of their residence,” said Savani. Considering that the majority of India’s DTAAs provide a beneficial rate of 10% for taxing dividends, the return on equity is likely to increase for non-resident investors, he adds.
“Having said this, it may be relevant to note that the beneficial rate under the DTAA is generally restricted to the ‘beneficial owner’ of the dividends.”
Redefining non-resident Indians
Apart from abolishing the DDT, the Indian government has changed the definition of non-resident Indian (NRI). A circular issued by the Indian Finance Ministry states that an Indian citizen or a person of Indian origin (PIO) outside India will lose their NRI status if they reside in India for 120 days at a stretch, instead of the current 182-day stipulation. This means that an Indian expat will be liable to pay taxes in India, unless he or she stays out of country for 240 days.
Even so, there is a major difference in tax liability between the two possible resident statuses. Individuals who qualify as a resident not ordinarily resident (RNOR) pay tax only on the income earned in India. They need not pay any tax in India on their foreign income. Individuals who qualify as an ordinary resident (OR) are required to disclose their overseas assets in their India tax return and will be taxed in India on their global income (income earned in India as well as income earned outside India). The new budget has widened the definition of RNORs, applying it to any individual who has been a non-resident for seven out of past 10 financial years.
On the other hand, those who can maintain their NRI status but are not paying taxes in any other jurisdiction, will now have to pay taxes on income earned in India, or income derived from an Indian business or profession.
A new clause inserted in the tax rules reads: “An individual being a citizen of India shall be deemed to be resident in India in any previous year if he is not liable to tax in any other country by reason of his domicile or residence.”
“This amendment seeks to widen the tax bracket and curb Indian citizens and PIOs to evade tax liability by taking the advantage of existing tax provisions and not paying tax in any country,” said Savani.
The budget also contains a tax amnesty measure. The India government is offering a one-time opportunity for taxpayers to settle any outstanding tax disputes by paying their tax liabilities without interest and penalty. Such measure similar to the tax amnesty scheme delivered by Malaysia, Indonesia and the Philippines over the past few years.