One major area which needs rationalisation in Union Budget 2025 is the taxation of dividends for resident shareholders. Resident shareholders are those who are considered resident individuals as per income tax laws, basically, those living and residing in India. While the abolition of the Dividend Distribution Tax (DDT) in FY 2020-21 was a step towards aligning with global best practices, the current framework has led to double taxation of dividends. This double taxation disproportionately impacts resident shareholders, discourages equity investments, and creates disparities between resident and non-resident investors.
How individual shareholders are paying double tax on dividends
The Dividend Distribution Tax (DDT) was first introduced in the Budget 1997 as a means to simplify the taxation of dividends. Over time, it underwent several modifications before being abolished in 2020, transferring the tax burden directly to shareholders in a bid to improve transparency and align with international practices.
After the abolition of the Dividend Distribution Tax (DDT) w.e.f. FY 2020-21, now dividends are taxed in the hands of resident individual shareholders as per the income tax slabs applicable to them. For these taxpayers whose net taxable income exceeds Rs 10 lakhs in the old tax regime or Rs 15 lakhs in the new tax regime, the effective marginal tax rate is 31.2%, which progressively increases to 35.88% where taxable income exceeds Rs. 1 crore (irrespective of the tax regime). This coupled with the corporate tax rate of 25.17%, results in an effective cumulative tax of 48.51%.
This happens because firstly, the company pays tax on the profit earned at 25.17% (22% plus 10% surcharge plus cess 4%). Thereafter, the dividends are declared from the profit amount left after tax. On the dividend amount received by the individual shareholders, tax is again levied at the income tax slab rates applicable to them, say at 31.2% (30% plus cess at 4%).
How NRIs pay lower tax on dividends from Indian companies
On the other hand, the effective tax rate paid by non-resident shareholders is substantially lower. As per income tax laws, non-residents are liable to pay a flat tax on dividends at 20%, which coupled with a cess of 4%, results in an effective tax rate of 20.8%. A surcharge is applicable if net taxable income (including dividends) exceeds Rs 50 lakh in a financial year. This flat 20% tax rate gets further reduced by Double Tax Avoidance Agreements (DTAA) to 5%-15% in most cases. However, in comparison, resident taxpayers with incomes in the highest tax bracket of 30% pay tax at 31.2% (including cess at 4% excluding surcharge).
Example of how much more tax resident individual shareholders pay on dividends as compared to NR shareholders To understand this, here is an example. Suppose a company earns a profit of Rs 100. On this profit, a tax of Rs 25.17 is paid by the company which leaves Rs 74.83 for dividend distribution. On the dividend received by shareholders, those at the highest tax slab will pay tax at 31.2% (30% plus 4% cess), if the taxable income exceeds Rs 10 lakh in the old tax regime or Rs 15 lakh in the new tax regime. This double taxation leads to an effective tax rate of 48.51% as follows:
| Figures in Rs. | |||||
| Description | Amount | Tax Rate (%) – RI | Tax Amount (RI) | Tax Rate (%) – NR | Tax amount (NR) |
| Profit of the company and corporate tax | 100 | 25.17% | 25.17 | 25.17% | 25.17 |
| Dividends (100-25.17) | 74.83 | 31.2% | 23.34 | 20.80% | 15.56 (74.83 * 20.8%) |
| Total tax | 48.51 | 40.73 | |||
| RI – Resident Indian NR – Non-Resident | |||||
In the case of partnership firms and Limited Liability Partnership (LLP), the present effective tax rate is 34.94% since there is no further tax on the partners on their share of profit. Only in the case of resident individuals or companies, the effective tax rate is the highest and almost equivalent to 50%.
Such a high tax rate not only discourages dividend distribution but also impacts the overall attractiveness of equity investments in India, potentially driving investors towards alternatives with lower tax implications.
Issues arising from double taxation of dividends
Such dual taxation can result in a significant portion of a company’s profits being eroded before they reach the investors.
Further, the current system of double taxation of dividends presents several issues:
Economic Efficiency: Double taxation distorts investment decisions of individual investors as it incentivizes companies to retain earnings rather than distribute them as dividends.
Decline in Investment: Investors may prefer capital gains over dividends due to lower tax implications, affecting the flow of funds into the equity market.
Complexity: Compliance with multiple layers of taxation increases administrative burden and compliance costs for companies and investors alike.
Impact on Retail Investors and SMEs: Retail investors, particularly those reliant on dividend income for regular cash flow, bear a disproportionately higher tax burden under the current regime. Similarly, SMEs, which often distribute dividends to maintain shareholder confidence, face challenges in retaining capital for growth due to the high effective tax rate.
International Competitiveness: In countries like the United States, qualified dividends are taxed at preferential rates ranging from 0% to 20%, depending on income levels. The UK provides a tax-free dividend allowance, while developing nations like Indonesia and Thailand impose a 10% dividend tax rate. Vietnam levies tax at the rate of 5% on dividends.
Lower income tax rates for taxing dividends
To address the aforementioned challenges, rationalisation of the tax treatment of dividends is crucial. There is an imminent need for restricting tax on dividends for resident investors to 15% (excluding surcharge and cess) which can result in a maximum effective tax rate of 17.94% for investors whose income falls in the surcharge bracket. (assuming surcharge of 15% and cess of 4%). For taxpayers to whom the surcharge is not applicable, the effective tax rate would be 15.6% (15% plus cess at 4%).
Rationalising dividend taxation for resident shareholders could lead to an increase in retail investor participation in the equity markets and a significant boost to dividend-paying companies’ valuations.
Lowering tax rates on dividends for residents can encourage companies to distribute profits while still ensuring an adequate revenue stream for the government. Further, streamlining tax laws and reducing compliance burdens aligns with the government’s vision of fostering a business-friendly environment under initiatives like Make in India and Ease of Doing Business and improve investor sentiment. It is hoped that the government will consider this highly beneficial measure in the forthcoming Union Budget, scheduled to be presented on 1st February 2025.
