income tax
The Union Budget 2022, announced by the Finance Minister, emphasizes strengthening India's resilience and enhancing its digital capabilities. Among the various amendments proposed in the Finance Bill is a significant change aimed at increasing tax revenue: the withdrawal of the concessional tax regime for foreign dividends.
Under Section 115BBD of the Income Tax Act, 1961 (‘the Act’), Indian companies receiving dividends from specified foreign companies—where they hold 26% or more of the nominal value of equity shares—formerly benefited from a concessional tax rate of 15%. This rate aligned with the previous Dividend Distribution Tax (DDT) imposed under Section 115-O of the Act.
The Finance Act, 2020, abolished the DDT and introduced a classical taxation system, wherein dividends are now taxed in the hands of shareholders at applicable rates, plus surcharge and cess.
To create parity in tax treatment for dividends received by Indian companies from specified foreign companies compared to those received from Indian companies, the provisions of Section 115BBD are set to be discontinued starting from the assessment year 2023-24.
The Foreign Exchange Outbound Investment regulations permit Limited Liability Partnerships (LLPs) and partnership firms to invest overseas. Consequently, there was an expectation for a similar 15% concessional tax rate on foreign dividends for these entities. However, the Government appears to have aimed to restrict avenues for tax benefits, aligning with broader fiscal objectives.
With the proposed amendment, dividends from foreign companies will now be taxed at the standard corporate tax rate, affecting Indian companies that hold 26% or more equity in overseas firms. Corporate tax rates vary from 15% to 30% (plus surcharge and cess), depending on company classification.
As Indian companies or startups pursue global expansion, they may need to reconsider their group structures and tax returns. This amendment could influence outbound investment strategies, potentially prompting businesses with significant foreign operations to relocate to jurisdictions with lower or zero dividend tax rates, or those offering participation exemptions under specific conditions. Thus, the removal of the concessional tax rate on foreign dividends becomes a crucial consideration in outbound investments.
Additionally, this withdrawal may dissuade the repatriation of profits back to India, possibly affecting the nation's foreign exchange inflow.
Despite the challenges presented by this amendment, a notable advantage may arise: the ability to claim deductions for expenses incurred in earning foreign dividends. Previous provisions under Section 115BBD taxed on a gross basis, disallowing expense deductions. Under the new structure, companies can deduct relevant expenses such as collection charges and loan interest when dividends are treated as business income.
Conversely, if dividends are taxable under ‘Income From Other Sources,’ the taxpayer can only deduct interest expenses incurred for earning the dividend, limited to 20% of the total dividend income.
Companies utilizing deductions under Section 80M may not experience a significant impact from this amendment, as it may maintain the current amount of deductions claimed. This means that the tax cost related to repatriating funds back into India may remain unaffected when dividends received by Indian companies are subsequently distributed to shareholders before the tax return filing deadline.
In summary, while the proposed amendment may lead to increased tax costs for Indian companies receiving foreign dividends, it establishes greater uniformity in the taxation of dividend income. Stakeholders should assess how these changes will influence their financial strategies and compliance moving forward.