Dividend Distribution Tax, ICDS, REITs: Current challenges and budget expectations

(Image: Milind Arvind Ketkar)

The current challenge

Briefly, Dividend Distribution Tax (DDT) is levied on the dividends declared, distributed or paid by the Indian domestic companies at the rate of 15% (plus applicable surcharge and cess) on grossed up basis, resulting in the effective DDT rate of about 20.36%. While, there have been several shifts in the provisions dealing with DDT ever since they were introduced in the Indian Income-tax Laws by Finance Act, 1997, however in the backdrop of how the law on DDT stands as of today, some of its select facets and the challenges posed pursuant to the same are as follows:

- Cascading impact of DDT on two counts:
o Firstly, while under the current law, if a company receives dividend from its subsidiary, further distribution of dividend by the recipient company does not attract DDT, however, the benefit is limited to receipt of dividends from only subsidiary companies in which more half of its nominal value of equity capital is held. Accordingly, there still remains a cascading effect on upstreaming of dividends in structures where holding is diversified.
o Secondly, multi-layered corporate structures, given that the same amount of dividend cannot be taken into account for reduction more than once

- No clarity on whether the surcharge and education cess have to be considered while grossing up the amount of distributable profits

- DDT on SEZ developers and on undertakings engaged in infrastructure development

- Non-availability of credit to the foreign investors in their home country in most cases in respect of DDT levied on Indian corporates

- While dividends is exempt in the hands of shareholders, pursuant to the last year’s budget amendment, now dividends are taxable at 10% in the hands identified class of shareholders, who receive dividend of more than INR 1 million in any financial year (referred as additional dividend tax)

What change is expected this budget

The Government does not seem hint at any changes in the DDT framework. However, talking of the expectations, given the challenges faced and the government’s intent, as articulated at several points, of making India an investment destination, the government may accord a complete pass through status to the dividends which have suffered DDT once irrespective of the tiers in the corporate structures and also remove any limitations with respect to the percentage of equity holding.

That said, it is also expected that the rate of DDT be reduced to 10% in line with the rates in most of the tax treaties entered by India. Also the additional dividend tax could possibly be withdrawn, given the multi-taxation impact it creates.

As an alternative to the above, the government may instead consider replacing DDT with withholding tax on dividends, which besides the above, may also address the issue of availment of credit of tax by the foreign investors.

Needless to say, scoping out SEZ and infra developers from the DDT levy tops the industry agenda.

How it will impact businesses (here, we will discuss only the major sectors that the change/announcement will impact)

While all expectations may not stand converted in this Budget, even if the Budget address the cascading effect on DDT, the positive sentiment will be felt across the board on all sectors, in particular Real Estate given that the multi-tier SPV structures are now permitted under the SEBI regulations.

ICDS

The current challenge:
Much to the annoyance of the industry and the academia, the government had in 2015 decided to introduce the Income Computation & Disclosure Standards (ICDS) or Tax Accounting Standards, in other words.  Having considered the industry view and the recommendation of the Easwar panel, the government back-tracked and deferred the application of the ICDS by a year.
Meanwhile, large listed companies embraced International Financial Reporting Standards (IFRS) based Indian Accounting Standards (Ind-AS).  Several other companies are scheduled to embrace the same over the next couple of years.  The new Ind-AS based on substance and notional fair value adjustments, could materially alter the profits of the business. The necessary question that poses up for consideration therefore is as to how the taxes would be computed thereon, particularly the Minimum Alternate Tax (MAT) which is very closely linked to the book profits.  In fact, there are several adjustments under Ind-AS (debt equity characterization, income deferral, fair value adjustments, etc.) for which the current MAT provisions u/s 115 JB of IT Act do not provide adequate clarity as to the treatment thereof.  Also, while the normal tax computation provisions are not based on the accounting profits, the latter does in fact form the starting basis.

What change is expected this budget

As such, one expects the Finance Ministry to provide a clear convergence road map between the taxation framework (both MAT and normal tax) and the new Ind-AS Accounting guidelines.  The CBDT appointed Lohia Committee report does provide some guiding principles, but falls short of definitive guidelines.  One wonders if the revenue department wants to fall back on the ICDS for tax purposes, hopefully not, but nonetheless a clear policy directive is indeed the need of the hour given that several large corporates have already transitioned to Ind-AS and many more are in the queue. The potential long term solution could be to provide specific tax adjustments (like depreciation, expenses allowed on cash basis, etc. under the current law) in the law itself for all potential Ind-AS deviations so that there is certainty and clarity on how the tax rules work, as was also recommended by the Easwar panel.  This would require a lot of home work and one wonders if the government is indeed ready with it.  We shall know on February 1.

REITs

REIT regulations in India has been into deliberations for quite some time now. Whilst there have been numerous amendments on the tax and regulatory regime governing REITs, India is still to witness its first REIT listing. Industry players expects more liberalisation on the taxation regime to ensure that tax does not impact the overall returns made by the real estate developers / investors.

Key expectations from the Union Budget 2017-18, from an income-tax perspective, are as under:

· Amongst various instruments and interest that real estate developers hold in the Special Purpose Vehicle (‘SPV’) owning real estate project, only swap of shares (held as capital asset) with the units of the REIT is regarded as a tax exempt transaction. This exemption should also be extended to other instruments (viz. debentures, etc.) or partnership interest held in the SPV.
· Swap of asset directly in exchange of the units of the REIT should also be regarded as a tax exempt transaction.
· REIT units should be treated at par with listed equity for 'long term capital asset' characterisation i.e. holding period should be reduced from 36 months to 12 months.
· In addition to the dividend distribution tax exemption granted to the SPV, similar exemption should also be extended to the subsidiary of such SPV.
· In case the SPV has brought forward losses, the same should be eligible for carry forward and set off against future profits post transfer of shares of the SPV into REIT, which lapses under the current regime due to change in majority shareholding.

Industry players hope that the above amendments, if enacted vide Union Budget 2017-18, could facilitate the much needed exits for the real estate developers / existing investors from stabilised assets and also, provide a new investment avenue for retail investors in the growing real estate market in India.

- By Frank D’Souza, Senior Partner – Direct Tax, PwC India, Vishal J Shah, Partner – Direct Tax, PwC India and Bhairav Dalal, Partner – Real Estate Tax, PwC India. Views expressed are personal.

The thoughts and opinions shared here are of the author.