Dividend Under Dividend: A Comprehensive Guide to Indian Income Tax Implications

Understanding the tax implications of dividends, especially when dividends are distributed from the income derived from other dividends, can be complex under the Indian Income Tax Act, 1961. This article aims to clarify the treatment of "Dividend under Dividend" for tax purposes in India.

What is a Dividend under Dividend?

A "Dividend under Dividend" refers to a situation where a company (Company B) receives dividends from another company (Company A), and subsequently, Company B distributes these received dividends as dividends to its own shareholders. The crucial aspect here is that the income distributed as a dividend by Company B is derived from the dividends it received from Company A. This creates a layering of dividend distribution, hence the term "Dividend under Dividend."

Tax Implications for Company B (Recipient Company):

Company B, the recipient of dividends from Company A, enjoys a significant tax advantage. Section 10(34) of the Income Tax Act exempts dividends received from domestic companies from tax in the hands of the recipient company. This means that Company B does not pay any tax on the dividends it receives from Company A. This exemption, however, is subject to certain conditions:

Domestic Company: The dividend must be received from a domestic company. Dividends from foreign companies are not eligible for this exemption.
Taxation at Source: While Company B is exempt from tax on the received dividends, the payer company (Company A) is required to deduct tax at source (TDS) under Section 194 of the Income Tax Act. The rate of TDS depends on several factors, including the shareholding pattern of Company B in Company A. This TDS is treated as an advance tax payment for Company B and is eventually adjusted against its tax liability, if any.

Tax Implications for Shareholders of Company B:

The dividends received by the shareholders of Company B (i.e., the "Dividend under Dividend") are subject to tax in their hands. The taxability of these dividends depends on the status of the shareholder:

Individual Shareholders: For individual shareholders, the dividend received is taxable under the head "Income from Other Sources". A dividend distribution tax (DDT) was abolished in Budget 2020, so now dividends are taxable in the hands of the recipient (individual shareholder). This means the entire amount of dividend received is included in their total income and taxed according to their applicable tax slab rate. No separate deduction or exemption is available specifically for "Dividend under Dividend". However, the individual shareholder can claim deductions and rebates as per the provisions of the Income Tax Act, which may influence their overall tax liability.
Hindu Undivided Family (HUF) Shareholders: Similar to individual shareholders, HUFs are also taxed on the dividend income received under the head "Income from Other Sources". The tax rate applicable will depend on the total income of the HUF.
Corporate Shareholders: Corporate shareholders are also taxed on dividend income under the head "Income from Other Sources." However, they may be able to claim certain deductions and exemptions depending on their specific circumstances. It's crucial to note that the tax treatment for corporate shareholders may differ from that of individual shareholders, and seeking professional advice may be beneficial in specific situations.
Foreign Institutional Investors (FIIs) and Foreign Portfolio Investors (FPIs): The taxability of dividends for FIIs and FPIs is governed by the relevant Double Taxation Avoidance Agreements (DTAAs) between India and the investor's country of residence. These agreements can provide for reduced tax rates or exemptions, varying from case to case.

Tax Treatment of Inter-Corporate Dividends:

When a corporate shareholder receives dividends, the tax treatment might be different depending on the nature of the relationship between the companies. Section 80M of the Income Tax Act provides for a deduction in the computation of total income for dividends received by a domestic company from other domestic companies. The deduction is 80% of the dividend income. However, the benefit of this deduction is subject to certain conditions and limitations. This is distinct from the exemption under Section 10(34) discussed earlier, which applies at the recipient company level before calculating total income. The interplay between these two provisions requires careful examination on a case-by-case basis.

Avoiding Double Taxation:

The structure of "Dividend under Dividend" inherently raises concerns about potential double taxation. While the recipient company (Company B) is exempt from tax on the initial dividend received, the shareholders of Company B are taxed on the subsequent dividend received. This is, however, a standard feature of the Indian tax system, where income is taxed in the hands of the recipient. The abolition of DDT in 2020 further reinforced this principle by removing the layer of taxation at the company level.

Practical Implications and Considerations:

Tax Planning: Understanding the tax implications of "Dividend under Dividend" is critical for effective tax planning. Companies should consider the overall tax implications for both the recipient company and its shareholders while designing dividend distribution policies.
Professional Advice: Due to the complexities involved, it is highly recommended to seek professional advice from a qualified tax consultant or chartered accountant. They can help navigate the intricacies of the Income Tax Act and ensure compliance with relevant regulations.
Maintaining Records: Meticulous record-keeping is essential to demonstrate compliance with tax laws. Companies should maintain detailed records of all dividend transactions, including TDS certificates and other relevant documentation.
Changes in Tax Laws: It is crucial to remain updated on any amendments or changes to the Income Tax Act, as these can impact the tax treatment of dividends.

Conclusion:

The tax implications of "Dividend under Dividend" are complex and require careful consideration. While the recipient company benefits from the exemption under Section 10(34), the shareholders are taxed on the dividend income they receive. The absence of DDT simplifies the structure, but the shareholders' tax liability must be carefully considered. Professional tax advice is strongly recommended to ensure accurate compliance with Indian income tax regulations and effective tax planning. This article provides a comprehensive overview, but specific situations may necessitate a more tailored approach guided by legal and tax professionals. The information provided herein is for general guidance only and should not be substituted for professional advice.