FINANCIAL PLANNING

&

TAX MANAGEMENT
SECTION- 115-O OF THE INDIAN INCOME TAX ACT, 1961

SUBMITTED TO SUBMITTED BY

DR. T.N.RAVI GROUP – 2

FINANCE - B

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INTRODUCTION

India has a well-developed tax structure with clearly demarcated authority between Central
and State Governments and local bodies. Central Government levies taxes on income (except
tax on agricultural income, which the State Governments can levy), customs duties, central
excise and service tax. Value Added Tax (VAT), stamp duty, state excise, land revenue and
profession tax are levied by the State Governments.

Indian taxation system has undergone tremendous reforms during the last decade. The tax
rates have been rationalized and tax laws have been simplified resulting in better compliance,
ease of tax payment and better enforcement. The process of rationalization of tax
administration is ongoing in India.

COMPANY

A domestic company is defined by the Finance Act as an Indian company or any other
company which, in respect of its income liable to income tax for the assessment year, has
made the prescribed arrangements for declaration and payment of dividends within India.

TAX ON DISTRIBUTED PROFITS OF DOMESTIC COMPANIES

Background

The dividend declared by companies was earlier covered by Section 115-O as effect from 1
June 1997 and it remained governed by these sections upto 31 st March 2002. During this
period dividend declared by companies was subjected to tax on distributed profits and
correspondingly the shareholders were allowed exemption under section 10(33).

Thereafter section 115-O was amended and dividend declared during the period 01.4.2002 to
31.3.2003 was not covered by Section 115-O and there was no tax on income distributed by
companies. Correspondingly for this period dividend received by shareholders was also not
exempt under section 10 i.e. it was taxable in the hands of shareholders.

Again with effect from 1.4.2003 section 115-O was made applicable to dividend distributed
by companies on or after 01.04.2003 and correspondingly for Assessment Year 2004-05
onwards the dividend has been made exempted under section 10(34) in the hands of the

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shareholders. This shows that dividend has never been tax-free. Thus, the tax has either been
paid or levied and made payable at the point of distribution by the company and exempted in
the hands of shareholders.

OVERVIEW OF SECTION 115-O

Dividend is taxable in India under section 115-O of the Income tax Act, 1961. Effective rate
of Dividend Distribution tax from 1st April 2007 is 16.995% (15% basic rate + 10%
surcharge + 2% education cess and 1% higher education cess). This tax cannot be avoided on
payment of dividend, even if no income tax is payable by the company on its total income.

Dividends are those distribution of profits which are declared in proportion to share capital
held, (on paid basis) by shareholder on the record date. At relevant times company is made
liable to pay additional tax on dividend distributed and the shareholder is exempted.

Certain payments are made by companies to shareholders who hold substantial interest and in
which public is not substantially interested in the company are deemed as dividend
U/S 2(22)(e), if the company has accumulated surplus. Such payments are in fact in nature of
loans and advances and are generally not in proportion of capital held by shareholders.
Though there is no release of funds in favour of the borrower-shareholder, and therefore, they
are not really dividend. However, these are deemed dividend in hands of shareholders but are
not considered as dividend for the purpose of additional tax payable by the company.
Therefore such deemed dividend is not exempt in hands of shareholders.

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PROVISIONS OF SECTION115-O

Notwithstanding anything contained in any other provision of this Act and subject to
the provisions of this section, in addition to the income-tax chargeable in respect of
the total income of a domestic company for any assessment year, any amount
declared, distributed or paid by such company by way of dividends (whether interim
or otherwise) on or after the 1st day of June, 1997, but on or before the 31st day of
March, 2002, whether out of current or accumulated profits shall be charged to
additional income-tax (hereafter referred to as tax on distributed profits) at the rate of
ten per cent.
Notwithstanding that no income-tax is payable by a domestic company on its total
income computed in accordance with the provisions of this Act, the tax on distributed
profits under sub-section (1) shall be payable by such company.
The principal officer of the domestic company and the company shall be liable to pay
the tax on distributed profits to the credit of the Central Government within fourteen
days from the date of the following*
a. Declaration of dividend
b. Distribution of any dividend
c. Payment of any dividend

*Whichever is earlier

The tax on distributed profits so paid by the company shall be treated as the final
payment of tax in respect of the amount declared, distributed or paid as dividends and
no further credit therefore shall be claimed by the company or by any other person in
respect of the amount of tax so paid.
No deduction under any other provision of this Act shall be allowed to the company or a
shareholder in respect of the amount which has been charged to tax under sub-section
(1) or the tax thereon.
The provisions of this Section applies to a domestic company for any assessment year,
on an amount declared, distributed or paid by such company by way of dividends
(whether interim or otherwise) on or after April 1, 2003.
The said dividend distribution tax is in addition to the income tax chargeable on the
total income of the Company and the same shall be payable @15% and the same shall

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 be increased by Surcharge @10%, and such aggregate of tax and surcharge shall be
further increased by an Education cess @2% and higher education cess 1% .
w.e.f. 1-4-2008 where the domestic company has received any dividend from its
subsidiary company (where its share holding is more than 50% of its nominal capital),
and that such subsidiary has paid dividend distribution tax on dividend declared by it
then the amount of such dividend shall be reduced from the amount of dividend liable
to tax, provided the domestic company itself is not a subsidiary of any other company.
The Section applies to dividend payments made either out of current or accumulated
profits.
In order to avoid cascading effect of tax on dividend distribution, sec 115-O(1A)
provides for set-off of dividend subject to fulfilling of the following conditions:
a. The company shall be a domestic company
b. The domestic company has received dividend from its subsidiary
c. Such dividend is received during the same financial year in which dividend is
paid
d. The subsidiary has paid tax under sec. 115-O on such dividend; and
e. The domestic company is not a subsidiary of any other company

In any case, the same amount of dividend shall not be taken into account for reduction more
than once

The dividend so paid will be eligible for exemption for the shareholders under Section
10(34).

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PAYMENTS OF DIVIDEND BY COMPANIES

Companies can distribute their profit or income including accumulated profit or

income to shareholders in certain manners. Such distribution is called declaration of
dividend. The term dividend has been defined in section 2(22) in an inclusive manner
and it also provides certain payments, which will not be included within the definition
of dividend.
In case of payments which are deemed as dividend i.e. the payments are not in
proportion to the share holding/paid up capital held by different members. The
deemed dividend U/S 2(22)(e) is materially different from other types of dividend-
covered U/S 2(22).

EXEMPTIONS FOR COMPANIES DEVELOPING, OPERATING OR

MAINTAINING SEZ (SPECIAL ECONOMIC ZONE)

No tax on distributed profits shall be chargeable in respect of the total income of an

undertaking or enterprise engaged in developing or developing and operating or developing,
operating and maintaining a Special Economic Zone for any assessment year on any amount
declared, distributed or paid by such Developer or enterprise, by way of dividends (whether
interim or otherwise) on or after the 1st day of April, 2005 out of the current income either in
the hands of the Developer or enterprise or the person receiving such dividend.

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ANALYSIS AND FINDINGS

 ARGUMENTS FOR DDT

The Income Tax department has adopted a different understanding of this subject. It is to be
noted that Section 194 of Income Tax Act deals with deduction from shareholders tax and not
with deduction on account of company’s own tax, even though it may be taxed on the hands
of the company. Bringing up the concept of company having a separate juristic personality
than its shareholders makes a distinction between profits earned by the company and income
of the shareholders. By saying that the same income cannot be taxed twice is meant that tax is
not levied more than once on one passage of the money in the form of one sort of income.
Once the profits of a company are transferred to the shareholders it becomes their income and
enters a different passage.

One of the strongest arguments in the favour of DDT is that it doesn’t let shareholders having
huge stakes in the company go off without paying taxes on their incomes.

 ARGUMENTS AGAINST DDT

The argument extended by most of the corporate houses is that, it leads to double
taxation. Dividend is nothing but distribution of profit of the companies. It is after
paying income-tax on the profits earned by the companies, that the profit is distributed
among shareholders. Dividend distribution tax is further levied on the profits
distributed to the shareholders of a company. The profits of a company are supposed
to be the income of shareholders. This way they as part owners i.e. the shareholders
have already been taxed. Dividend distribution tax thus amounts to double taxation;
the fact that the companies in India are already paying high corporate tax on these
profits further deteriorates the condition of the shareholders.
Under the current Taxation system, when a subsidiary company pays dividend to its
parent company, it pays dividend distribution tax. When the parent company pays
dividend to its shareholders, probably utilising all of its dividend receipts, it further
pays dividend distribution tax again on the same funds. This leads to double taxation,
which should have been resolved by taxing dividend in the hands of the shareholder.
The worst hit is the group companies or the chain investment companies, which will
be subject to DDT more than once to distribute its profits to the ultimate shareholders.

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 DDT encourages retention of profits in the hands of the company. It severely effects
the capital formation and development in a country where capital is scarce and
liquidity is one of the essential requirements of an economy. But it is equally
important that shareholders get fair return on their equity holdings. Also keeping in
mind the present policy of globalisation, high corporate tax and less investment will
make Indian companies suffer in the international market.

SUGGESTIONS

It is suggested that dividend distribution tax should be totally withdrawn to boost

investments in corporate sector. Further, the cascading effect should be eliminated not
just partially by granting the benefit only in case of horizontal structure of holding -
subsidiary but also in case of Vertical structures wherein there will be more than one
step down subsidiary. Multi-tier structures are being very commonly adopted by the
corporate in the new complex and competitive business environment.
The present tax policy of taxing dividends on the hands of the company has actually
increased the burden on the equity investors in India. It actually goes against the
present globalisation policies of India and discourages the shareholders to invest
more, further leading to inefficient economic growth. To overcome this conflict of
law, it’ll be more justified to introduce tax brackets. A limit for income earned
through shareholdings can be prescribed where, a shareholder exceeding this limit
may be taxed and the shareholder falling below such limit can be exempted from such
tax. In other words, shareholders with a larger shareholding in the company should be
taxed at a higher rate on their income. This way the I-T department can keep an easy
check on wealthy shareholders and can also control the inequality in the system and
on the flip side, it would spare small shareholders whose annual dividend income is
comparatively small from paying higher taxes.