Dividend Under Dividend

Dividend Under Dividend

Understanding Dividend Under Dividend in Indian Income Tax

Dividend income is generally taxed in the hands of the recipient. However, a unique situation arises when a dividend is distributed from a company that itself received a dividend. This is commonly referred to as “dividend under dividend” and has specific implications under the Income Tax Act, 1961 of India. This article aims to clarify the tax treatment of such income.

What Constitutes “Dividend Under Dividend”?

A dividend under dividend occurs when a company (Company B) receives a dividend from another company (Company A) and subsequently distributes this dividend income (or a portion of it) to its own shareholders. The crucial point is that the dividend received by Company B is not treated as business income but as dividend income. When Company B distributes this dividend income to its shareholders, the distributed amount constitutes a “dividend under dividend” from the perspective of the ultimate shareholder.

Tax Treatment of Dividend Received by Company B

The dividend received by Company B (the intermediary company) is taxed in its hands. The Income Tax Act provides for an exemption on a portion of the dividend income received by a domestic company. However, this exemption isn’t absolute and depends on several factors:

  • Domestic Company: The exemption applies primarily to dividends received by a domestic company. Foreign companies generally do not enjoy the same level of exemption.
  • Rate of Exemption: The rate of exemption under Section 10(34) of the Income Tax Act, 1961 is currently 100%. This implies that no tax is payable on the dividend received by the domestic Company B. This exemption is subject to change depending on the provisions in the Finance Act of the relevant assessment year. Therefore, it’s crucial to refer to the latest amendments.
  • Deduction of Tax at Source (TDS): While the dividend might be exempt in the hands of Company B, TDS is still deducted at the source by Company A (the company distributing the dividend) at the prescribed rate. This TDS can be claimed as a refund by Company B.

Tax Treatment of “Dividend Under Dividend” in the Hands of the Ultimate Shareholder

The crucial aspect is the taxation of the dividend distributed by Company B (the dividend under dividend) to its shareholders (the ultimate recipients). This dividend is treated as income in the hands of the shareholder. The taxability depends on several factors:

  • Taxation as Dividend Income: The amount received by the ultimate shareholder is generally taxed as dividend income under the head “Income from Other Sources.”
  • Applicable Tax Rates: The tax rate on dividend income varies according to the individual shareholder’s income slab and the total income for that financial year. There is a specific tax rate applicable to dividends in the income tax slabs. There is no separate tax slab for dividend income.
  • Tax Deducted at Source (TDS): Company B is required to deduct TDS on the dividend distributed to its shareholders. The rate of TDS on dividend income depends on the total dividend income received.
  • Exemption Under Section 10(34): The original exemption enjoyed by Company B does not extend to the ultimate shareholder. The shareholder’s tax liability is determined based on the dividend amount received, irrespective of how it was earned by the intermediary company.

Difference between Dividend and Dividend Under Dividend: A Simplified Explanation

To illustrate the difference:

Scenario 1: Direct Dividend

  • Company A pays a dividend directly to Mr. X (a shareholder).
  • Mr. X pays tax on this dividend income according to his applicable income tax slab.

Scenario 2: Dividend Under Dividend

  • Company A pays a dividend to Company B (in which Mr. X holds shares).
  • Company B pays a dividend to Mr. X (from the dividend it received from Company A).
  • Mr. X pays tax on this dividend income according to his applicable income tax slab. Although Company B received an exemption, Mr. X does not get this benefit. The taxability is determined separately for Mr. X.

In both scenarios, the ultimate recipient (Mr. X) pays tax on the dividend. The only difference is the intermediary step in the second scenario, which doesn’t alter the tax implication for the ultimate shareholder.

Illustrative Example

Let’s assume Company A distributes a dividend of ₹10,00,000 to Company B. Company B then distributes ₹8,00,000 as a dividend to its shareholders.

  • Company B: Company B, being a domestic company, benefits from the exemption under Section 10(34) and pays no tax on the dividend received from Company A. However, TDS was deducted at source by Company A. Company B can claim a refund for the TDS deducted.
  • Ultimate Shareholder (Mr. X): Mr. X receives ₹8,00,000 as dividend from Company B. This amount is included in Mr. X’s income under the head “Income from Other Sources.” He pays tax on this dividend according to his applicable tax slab and TDS is deducted by Company B.

The tax treatment of “dividend under dividend” is primarily governed by the following sections of the Income Tax Act, 1961:

  • Section 2(22)(e): This section defines “dividend” comprehensively, encompassing the scenario of dividend distribution from income already received as a dividend.
  • Section 10(34): This section provides the exemption for dividends received by domestic companies, crucial for understanding the tax position of the intermediary company (Company B in our example).
  • Section 115BBDA: This section deals with the tax on dividend income in the hands of the recipient.
  • Section 194: This section outlines the provisions for TDS on dividends.

It is essential to note that the interpretation and application of these sections may be subject to judicial pronouncements and interpretations from the Income Tax Department.

Implications and Considerations

  • Double Taxation Avoidance: While there’s no double taxation of the dividend itself, it’s important to understand that the dividend is taxed at each level—once in the hands of the intermediary company (though currently exempted for domestic companies) and again in the hands of the ultimate shareholder.
  • Compliance with TDS: Both the intermediary company and the distributing company are legally obligated to comply with TDS requirements. Failure to comply can lead to penalties and interest charges.
  • Record Keeping: Meticulous record-keeping of dividend transactions is crucial for accurate tax calculation and compliance.

Conclusion

The taxation of “dividend under dividend” under Indian Income Tax law can appear complex. However, by understanding the different stages of dividend distribution and the relevant legal provisions, both companies and individual shareholders can ensure compliance and accurate tax reporting. While the intermediary company may benefit from a (currently 100%) tax exemption on the dividends it receives, this exemption does not extend to the ultimate shareholder. The ultimate recipient is solely responsible for the tax implications on the amount received, regardless of the intermediary’s tax status. It is always advisable to seek professional tax advice for complex scenarios to ensure accurate compliance with the prevailing tax regulations.

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