By SR Patnaik, Bipluv Jhingan
Indian Union Budget 2021-22: One of the significant changes introduced by the Finance Act, 2020 was the abolishment of the Dividend Distribution Tax (“DDT”) and reinstating the classical system of taxing dividends, where the shareholder is liable to pay tax on the dividend income. This change had a major impact on the taxation of unitholders of Real Estate Investment Trusts and Infrastructure Investment Trusts (collectively referred to as “Business Trusts”), which derive a significant chunk of their returns from dividends earned by the Business Trusts. Subsequently, the relevant stakeholders made various representations to the Finance Minister to clarify the newly introduced provisions to ensure that the new system of taxing dividend is not very onerous for the Business Trust and investors.
Before the Finance Bill, 2020 was enacted, the Finance Minister provided certain relaxations to address the concerns of the Business Trust industry. Though the majority of the concerns of the Business Trust industry seem to have been addressed in the second set of revisions, we are trying to revisit some of these changes and analyze their efficacy through this article.
Under the erstwhile regime, dividend distributed by a domestic company was subject to DDT, in the hands of the company, at an effective rate of 20.56%. Such dividends were generally exempt in the hands of all shareholders, including non-resident unitholders in the Business Trusts in India, though they may have been taxed in the home jurisdiction of a non-resident unitholder. Further, as per erstwhile regime, dividend distributed by a special purpose vehicle (“SPV”), in which a Business Trust held the entire share capital other than as required to be held by the Government or any regulatory authority, was exempt from DDT. The dividend received by business trusts from their SPVs was then distributed to the unitholders without any further tax being levied on it.
Pursuant to the passage of Finance Act, 2020, dividend income is now directly subject to tax in the hands of the shareholders, at the applicable rate and the SPV is required to withhold tax on the same. However, a Business Trust is still exempt from tax on dividend income from an SPV provided the business trust holds controlling interest or such percentage holding, as may be prescribed. Even though the dividend income is exempt in the hands of Business Trusts, no specific exemption has been granted to the SPVs from withholding tax while distributing post tax profits to a business trust. Though it is possible for the Business Trust to obtain a nil withholding tax certificate, the Finance Minister may also incorporate appropriate carve outs in the withholding tax provisions to rationalise these provisions and to reduce unnecessary hassle of obtaining nil withholding certificates from the tax authorities time and again.
Additionally, the erstwhile regime did not exempt a multi-level structure (i.e. where the business trust holds shares in the SPV through an intermediary holding company) from the applicability of DDT. Accordingly, the dividend paid by an SPV to its holding company was subject to DDT. However, holding companies could claim exemption from DDT provided the entire share capital of the holding company was held by a Business Trust.
It is pertinent to note that Finance Act, 2020 has reintroduced section 80-M in the Income-tax Act. This section provides for a deduction for dividends received by one domestic company from another domestic company, limited to the amount of dividend received from the investee company if the shareholder company pays dividend before the specified due date i.e. one month prior to the return filing date. Accordingly, under the current regime SPVs are not required to pay any tax on dividend distributed and the holding company can claim the deduction from such dividend income to the extent of dividends distributed by it before the specified date.
Under the current provisions the SPV would also be required to withhold tax at the rate of 10% on the dividends distributed by it to the holding company. Further, relevant SEBI regulations governing the Business Trust require holding companies to distribute 100% of their income from SPVs. Thus, considering that the actual money received by the holding company from the SPV, after deduction of tax at source, would be 90% of the income earned by it from SPV, certain holding company may face cash flow issues in complying with regulatory requirement of distributing 100% income, which consequently will prevent such holding companies from claiming 100% deductions of the dividends earned from the SPVs. Though this issue may not arise in situations where the holding companies have sufficient cash to meet the distribution requirements, this issue is more likely to arise in newly established Business Trust structures. Thus, Budget 2021 should provide for suitable amendments to address this issue and rationalise of the current taxation provisions.
With the Finance Minister promising a post pandemic budget ‘unlike anything in the past 100 years’, one must not lose sight of the fact that rationalising existing provisions, as discussed above, and providing certainty to taxpayers may go a long way in promoting investments in the post pandemic world.
(SR Patnaik is Partner & Head – Taxation; and Bipluv Jhingan, Senior Associate, Cyril Amarchand Mangaldas. Views are the authors’ own.)