Dividend Distribution Tax (DDT)

Written by : Knowledge Centre Team

2024-08-02

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A dividend is something that puts a smile on every investor’s face. Dividend payment reflects a company’s positive cash flow and good financial health. But do you know dividends come with extra baggage? Like any other income, dividend income is not free of taxes.

Dividend Distribution Tax (DDT)was a form of taxation companies used to pay while declaring and distributing dividends. But not anymore. Now the Indian Government wants its citizens to pay up for their dividend income by themselves.

During the Union Budget 2020, our Finance Minister announced the end of DDT with effect from 1st April 2020. Now taxpayers are liable to pay taxes for their dividend income. Before we come to a conclusion on which method is better, let’s explain both the past and the present norms of dividend taxation.

What is Dividend Distribution Tax (DDT)?

Until FY 2019-20, any public or private company based in India had to pay DDT on distributed profits, aka dividends. The rate of which was 15% of the gross dividend amount. That translates to an effective rate of 17.65% on the actual dividend paid before cess and surcharge. After cess and surcharge, the rate stood at 20.56%.

The Dividend Distribution Tax was mandated by Section 115-O of the Income Tax Act, 1961. Introduced on 1st April 2003, it was described in Chapter XII-D under the heading of ‘Special Provisions Relating to Tax on Distributed Profits of Domestic Companies.

DDT had to be paid within 2 weeks of announcement or distribution of dividends. If not paid within 14 days of declaration or credit, whichever is early, the company had to pay a penal interest of 1% each month till they pay.

Let's use an illustration to better grasp this:

Determine the DDT for the Rs. 2 lakhs dividend that was declared:

Determine the grossed-up dividend in step one. This is calculated at 17.65% on Rs. 2 lakhs. Adding the amount to Rs. 2 lakhs results in Rs. 235,300.
Compute the Dividend Distribution Tax (DDT) on the Grossed Up Dividend at 15%, which comes to Rs 35,295. As a result, the DDT on Rs 2 lakhs will be Rs 35,295.

Key Pointers to Note about DDT

Under the Wealth Tax Act, 1957, the following persons are liable to pay dividend distribution tax:

1. A company which has declared, distributed or paid any dividend on or after the 1st day of April 1957.

2. A mutual fund specified under Section 10(23D) of the Income-tax Act, 1961 which has declared, distributed or paid any dividend on or after the 1st day of October 2002.

You should note the following key points about the Dividend Distribution Tax:

Despite the existence of DDT, if one beneficiary’s total dividend income was more than ₹10 lakhs, he had to pay 10% of it in taxes
DDT didn’t carry any deduction or tax credit for the company’s income tax liability. It was over and above of corporate tax paid by a company
If an Indian company received dividends from its foreign subsidiary, it was taxed at a concessional rate under Section 115 BBD
If the dividend is paid on behalf of the New Pension Scheme (NPS), no DDT applies to it
DDT rate for debt mutual funds was 25%, while for equity-focused MF, it was 10%, as introduced in Budget 2018
Dividend Distribution Tax is levied at the rate of 15% on dividends distributed by a domestic company and mutual fund
The tax is payable by the company or mutual fund and is not borne by the shareholders

Dividend Distribution Tax is not levied on the following dividend payments:

By foreign companies
To shareholders who are not residents of India
To shareholders who are resident in India but not liable to tax in India
Distributed by a company to its shareholders who are taxable in India but are not resident in India
To shareholders who are not taxable in India and are not resident in India.

New Provisions of Dividend Taxation

The Finance Act, 2020, introduced in Budget 2020, shifted the dividend tax payment liability from businesses to individual investors. Now your dividend income will be taxed at your income tax slab rate. That means if you fall in the 30% bracket, your dividend income will also be taxed at 30%, irrespective of the total amount.

This new arrangement of dividend taxation imposes a TDS deduction for dividends paid more than ₹5,000. This TDS will be deducted at 10% of the total dividend payment amount. This deduction will be available as a tax credit during IT return filing. You can also submit Form 15G/15H to companies for not deducting any TDS if your total annual income is lower than the tax exemption limit.

Key Pointers to Note About the New Dividend Tax

For non-resident Indians, TDS for dividends of domestic companies will be deducted at 20% subject to the Double Taxation Avoidance Agreement (DTAA)
You could claim up to 20% of total dividend income as a deduction on dividend tax by showing interest expense if you bought the stocks by taking up a loan
If your total dividend tax liability is greater than ₹10,000 a year, you need to pay advance tax
Dividends of foreign companies are also taxable and will be taxed according to the tax slab under the head of ‘Income from Other Sources’
Foreign company dividends that are taxed outside of India will get the benefit of double taxation relief. You can claim relief u/S 91 if no DTAA exists with the country of origin

Everything, to be precise. With the abolition of DDT, the tax payment liability is now in the hands of shareholders, which was earlier in the hands of companies paying dividends. Now instead of the curtailed dividend, you’ll receive the full dividend amount credited to your bank if no TDS is deducted.

All the DDT liability of mutual funds is also withdrawn with the introduction of the Finance Act, 2020. Even the 10% tax on dividend receipts over 10 lakhs for individuals, HUFs and Firms also stands cancelled.

Old or New - Which One is Better for Investors?

It depends on which tax slab you fall. Like many other income tax norms, the low-income group will benefit from the new dividend taxation norms. In contrast, the high earners will be churning out more than before. Let’s explain this with a couple of examples.

Scenario 1: If your yearly income is ₹2,40,000 and you received a total dividend of ₹5,000 then under the old system, your effective dividend credit would have been around ₹3,972. But in the new system, you’ll receive the full ₹5,000 in your account.

Scenario 2: If your yearly income is ₹24,00,000 and you received a total dividend of ₹5000, then under the new system, you are left with around ₹3,350. This is less than ₹3,972, which you would have got according to the old taxation rules.

As you can see, people in the exemption and 10% bracket will be benefited from the new rules of dividend taxation, while people in the highest tax bracket have to pay more than their previous tax liability.

Investments for Tax-Free Dividends

If you are investing in direct equity stocks for dividend income, as per the new provisions, almost every penny is taxable. However, using the following portfolio investments you can avoid paying taxes on the dividend or other incomes from the stocks:

ULIPs for Tax-Free Income and Growth

The ULIP is a combination of insurance and investment. This plan is a great option for those who wish to invest in the stock markets and want life insurance protection.

It is best suited for long-term investment goals like retirement, a child’s higher education, etc. ULIPs offer various benefits to policyholders.
A ULIP plan allows the investor to avail of the tax benefit on the premium paid up to Rs. 1.5 lakh under Section 80C of the Income Tax Act, 1961.
The returns on the investment are completely tax-free under Section 10(10D) of the Income Tax Act, 1961, subject to certain conditions.
The investor can avail of the benefit of a life insurance cover with the ULIP plan.
The ULIP plan offers the facility of partial withdrawal after five policy years.

ULIPs offer multiple fund choices for you to select from and you can invest in a blue-chip equity fund to gain dividend income. Your partial withdrawals after five years are completely tax-free. So, no tax is to be paid on the income of the equity fund.

Equity Mutual Funds

Whether equity mutual funds gain value through dividends or selling stocks, Tax Laws will treat your portfolio gain as a capital gain. Long-term capital gain of up to Rs 1 lakh is exempt from tax every year.

Thus, you can invest in mutual funds investing in blue chip or dividend-paying stocks and enjoy a withdrawal of tax-free capital gains up to Rs 1 lakh every year.

Diversification is one of the basic principles of investment safety. Applying it to your income-generating investments will help you build a stable income. Dividends are also a mode of passive income which works for you even while you sleep.

Disclaimer: This article is issued in the general public interest and meant for general information purposes only. Readers are advised to exercise their caution and not to rely on the contents of the article as conclusive in nature. Readers should research further or consult an expert in this regard.

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