The Finance Bill, 2020 in Budget 2020-21 seeks to withdraw the dividend distribution tax (DDT) payable by the company. It has reverted to the classical system of taxing dividends in the hands of the shareholders. 

Background of the issue:

  • Increment in dividend payouts: With India registering substantial growth between 1997 and 2020, corporate performances also registered progress and dividend pay-outs increased. 
  • The income tax payer came under the radar of the IT department. This development made tracking of the shareholder much easier. 
  • The withdrawal of DDT came as a relief to the corporate sector which has wanted DDT to be removed and the effective corporate tax rate in India to be reduced. 
  • Corporates are also required to conserve cash for further growth. This largely prompted the government to revert to the classical system for taxing dividends.

About Dividend Distribution Tax

  • A company, when earning profits, pays a sum out of those profits to the stockholders, known as a dividend. The tax levied on the dividend payments is termed as Dividend Distribution Tax.
  • Any shareholder in a company is entitled to the dividend as a return on investment. Dividend covers various elements of payouts from a company and seeks to tax those at some stage. 
  • As a concept, ‘dividend’ has been in existence since the inception of the Income Tax Act. 

Three methods of taxing dividend and their background in India

1.Classical system-

  • The classical system was in vogue till 1997-98. 
  • According to this system, the dividend was taxable in the hands of the shareholder, subject to the then available deduction under Section 80L for a maximum of ₹12,000. 
  • This was a progressive system.

2.The simplistic system or DDT regime-

  • The Finance Act of 1997 analyzed the merits and demerits of the classical system and embarked on the route of the simplistic system of taxing dividends in the hands of the distributing company. 
  • In the process, shareholders were spared the burden of offering dividends as tax in their hands
  • The DDT system replaced the classical system from 1997-98. 
  • The rate of DDT started at about 10% and climbed to 20.56%. 
  • The advantage of DDT was that tracking of dividends in the hands of the company became easier and collecting the tax on dividend was a painless process. 
  • The main drawback was that the treaty agreements with countries like the U.S. did not permit the set-off of the DDT paid against the tax liability of the shareholder. 
  • DDT was simple but inequitable since it made no distinction between a low taxpayer and a high taxpayer.

3.The imputation system-

  • The dividend is taxed in the hands of the shareholders but they are also allowed a set-off of a portion of the corporate tax discharged by the company. 
  • The imputation credit resembles an underlying tax credit granted to non-residents under certain treaties entered into by India. 
  • While there are complexities in that system, it mitigates the hardships caused by the double taxation impact of dividend distribution.

What was the earlier mechanism to levy DDT? 

  • DDT was deducted at the time of the company distributing dividends, which means that it was taxable at source, not at the hands of receiving shareholders.
  • Currently, companies are required to pay DDT on the dividend paid to its shareholders at the rate of 15% plus applicable surcharge and cess in addition to the tax payable by the company on its profits.
  • But, an additional tax was imposed on the shareholder, who in a financial year, received over Rs. 10 lakh in dividend income.


  • High-net-worth individual:
    • The recent move has created ripples since high-net-worth individuals never expected a full tax in their hands, which is being sought to be achieved by the proposal.
    • The main contention of the high-net-worth individual is that while the classical system is acceptable as a concept, the maximum tax rate is an unexpected extra burden.
  • Foreign shareholders being taxed at a much lower rate than the Indian counterpart: Shareholders in other countries with a protective treaty regime can receive dividends attracting tax rates as low as 5%. 
  • Issue of the maximum tax rate:
    • Any decision to declare a dividend is analyzed from the standpoint of the company and the standpoint of the entity receiving the dividends. 
    • As long as dividends were received tax-free, the structure was irrelevant. 
    • But with the current proposal, even family trusts can be taxed at the maximum rate. 
    • This blow is bound to force companies to revisit their strategy of paying dividends.


  • Indian promoter groups control a majority of shareholding in Indian companies. 
  • For them, wealth is largely represented by the value of shares and the dividends received over a period of time. 
  • These have been passed on to successive generations. 
  • These shares can be held by individuals, HUFs, family companies, or family trusts

Probable implications of the move:

On Equity Market

  • It may increase the attractiveness of the Indian Equity Market.
  • It may provide relief to a large class of investors.
    • Especially those investors who are liable to pay tax less than the rate of DDT, if the dividend income is included in their income.
    • In the case of foreign investors too, the non-availability of credit of DDT resulted in a reduction of the rate of return on equity capital for them.
  • It may result in making India an attractive destination for the purpose of Foreign Direct Investments.
    • India ceases to be an outlier as currently, no other country in the world has a DDT regime.

On Tax Structure

  • The proposal for deduction of the dividend received by holding company from its subsidiary will remove the effects of Tax Cascading. The matter assumes significance since corporates currently pay tax on their profits and any tax on the distribution of post-tax profits amounts to double taxation. 
  • The tax on dividends is a triple levy. The Dividend basically means the distribution of a company's after-tax profits.

Tax on dividends: Triple levy

The tax paid by a company is the first level. DDT is the second level. The recently-introduced Super Rich Dividend Tax — the 10% tax on anyone who earns dividend income of Rs 10 lakh or above — is the third.

On Tax Compliance

  • However, there is speculation that taxing the dividend in the hands of the shareholder would compromise the objective of improved compliance.

On Revenue Receipts

  • The removal of DDT will lead to estimated annual revenue forgone of Rs. 25,000 crore. However, it is being argued any loss whatsoever in revenue gets offset by the tax that shareholders pay.

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Image Source: Financial Express