Key considerations for U.S. investors on abolition of dividend distribution tax in India
The memorandum to Indian Union Budget 2020-21 (Budget 2020) states that the present-day dividend distribution tax (DDT) was introduced to ease collection of tax at a single point, i.e. the corporate level, but it is “ iniquitous and regressive”. And so, Budget 2020 aims to align with the international practice and reinforce erstwhile provisions to levy tax at the level of investors rather than corporation.
This blog discusses DDT provisions that applies as of today, and what is in store for foreign investors post abolition of DDT as proposed under Budget 2020.
Currently, India is the only country where corporations pay DDT in addition to corporate taxes. DDT is levied at an effective rate of 20.35 percent of the aggregate dividend declared, distributed or paid during a tax year. Investors are exempt to tax on their dividend earnings in India. But foreign investors may still have tax exposures in their home jurisdictions, specifically where India has a tax treaty with such jurisdiction and the treaty does not treat DDT paid by Indian corporation akin to paid by the investor for allowing a tax credit.
Budget 2020 is aiming to align with the international practice by taxing the investors rather than corporations for dividends in India. Albeit, this change would be welcoming for the foreign investors as it eases the process to claim tax credit in their home jurisdictions. But this could result in higher effective tax rates for individual investors, as they would be taxable at progressive tax rates that may further increase with a levy of surcharge and cess in India. It is, therefore, important for global entrepreneurs, specifically high net worth individuals (HNIs), to be aware of their cost of investment in Indian corporations versus their return on equity.
For the purposes of U.S. taxation, while an individual U.S. investor can claim tax credit in the U.S. on dividend earnings from an Indian corporation under the tax treaty between India and the U.S., but a corporate U.S. investor may not be able to do the same. For example, where a U.S. corporation receives dividend from its Indian subsidiary corporation (that has not been elected to be treated as pass through for U.S. tax purposes), a 100 percent deduction is allowed for such dividend. As a result, the tax paid in India adds to the effective tax rate of the global structure, and this may inadvertently reduce the take home share for the U.S. investors.
Accordingly, investment strategies in Indian corporations may need to be thought through keeping in mind the interaction of domestic tax laws between the host and home jurisdiction and its global impact on its investors.
For more information, please contact:
Head of US-India Tax Desk