Why scrapping dividend distribution tax (DDT) is important?

We are aware that dividends paid out on equity shares are subjected to dividend distribution tax at 15%. Let us understand why DDT adds a lot of stress.

Nov 01, 2019 10:11 IST India Infoline News Service

Over the last few years there have been persistent demands from the market representatives and the industry bodies to scrap the dividend distribution tax (DDT). Currently, DDT is deducted from equity dividends and from equity mutual fund dividends and the net amount is paid out to the investors. This substantially reduces the net dividend available in the hands of the equity investors and makes equity as an asset class less attractive. It has substantially dented the dividend yield theme. Let us understand why DDT adds a lot of stress.
 
How DDT makes a dent on shareholder earnings?
We are aware that dividends paid out on equity shares are subjected to dividend distribution tax at 15%. But you will be surprised to know that the actual impact of the DDT is much higher than 15%. Here is why. The Income Tax Act stipulates that the DDT must be paid on the grossed up dividend and not the net dividend. That means, when a company pays dividend, the impact of 15% will be on the grossed up amount. In other words, the actual impact of the DDT is not 15% but 17.65% (15% / 0.85). On top of that, there is a 12% surcharge and a 4% cess that is payable. Here is how much DDT will impact the investor.
Dividend Details DDT Impact
Actual rate of DDT charged 15%
Impact of DDT on grossed up basis (15/0.85) – A 17.65%
Add: Surcharge at 12% - B 2.12%
Add: Cess at 4% - C 0.79%
Overall effective rate of DDT (A + B + C) 20.56%
 
The effective DDT on equity dividends is not 15% but 20.56%. In other words, when the company declares gross dividends of Rs100, the shareholder gets only Rs79.44 as the net dividend on hand. That is how steep the impact of the DDT is on shareholders.
 
How DDT makes a dent on the company?
The 20.56% DDT is a hit on the corporates also in 3 different ways.
Firstly, the DDT has to be paid by the company within 14 days of the declaration of the dividend or the payment of the dividend, whichever is earlier. This poses a major cash flow management issue for the company.
Secondly, since dividend is a post-tax appropriation, the tax paid on dividends cannot be shown as an expense in the P&L account. Thus, it becomes a gross cost for the company.


For the same reason, the taxes paid on dividends cannot also be set off against other incomes while filing the tax returns. This makes the effective cost of DDT much higher for the companies.
 
DDT is impacting equity fund performance in a big way
When the DDT was introduced on equities more than 12 years ago, equity mutual funds were consciously kept out of the ambit. However, post April 2018, equity mutual funds were also brought under the ambit of DDT. The CBDT imposed DDT of 10% on dividends distributed by equity funds. However, if you add up the surcharge of 12% and the cess of 4%, the effective DDT works out to 11.648%.  More importantly, this creates a cascading effect for the equity fund holder because there is already a component of DDT that must have been paid out when the company declared the dividend in the first place. This not only impacts equity fund performance but also an individual’s financial plans.
 
DDT is really impacting buyback plans of companies
In the Union Budget 2019 announced in July, it was proposed to tax buybacks at 20%. The intent was to avoid any scope of arbitrage. After the government imposed 10% income tax on dividends above Rs1 million in the hands of shareholders, many companies opted for the buyback route to avoid the DDT and income tax on dividends. The scrapping of the DDT will pave the way for automatic scrapping of buyback tax since the arbitrage will not exist.
 
Scrapping DDT is long overdue. It not only does away with the cascading effect but also avoids the impact of double taxation. Above all, it will pave the way for scrapping buyback tax so that companies can once again revive their quiescent buyback plans post July.

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