An example of how the new system would impact tax cost is shown in Table 1. The effect on investor-shareholder is shown in Table 2. While the tax withheld would be available as a credit for the recipient, the DDT paid under the existing system cannot be claimed as a tax credit in most cases.

Recipient shareholder

Unlike the pre-Section 115O regime, dividend received after March 31, 2002, would not be eligible for any deduction under Section 80L. Any expense incurred for earning the dividend, say, interest on loan borrowed for investment in shares, can be claimed as tax deductible — Section 14A would not be applicable any more to dividend income.

Tax withholding

As per the existing provisions, where the shareholder (individual) estimates his total income to be nil, then he may submit a declaration in the prescribed form, based on which the company would not deduct any tax at source. For this, Section 197A is proposed to be amended. So, tax withholding cannot be averted where the dividend received/receivable during a fiscal exceeded Rs 50,000; however, after claiming the expense, the total income may be less than Rs 50,000.

Any distribution from April 1, 2002 to May 31, 2002, though taxable in the hands of the recipient, would not be liable for tax deduction at source. But if the companies manage to declare and distribute dividend before March 31, 2002, with SEBI relaxing its rigid stand (on certain procedural compliance), then the new system would be effectively operative only in fiscal 2003-04. There being no requirement to withhold tax during these two months would then be purely academic.

For a resident recipient, the withholding rate would be 10 per cent (plus surcharge) and for non-residents the rate would be as per the relevant DTAA read in conjunction with the Act. The rates under the DTAA are normally in the 5-15 per cent range. The rate mentioned under the I-T Act for non-residents is 20 per cent for NRIs and 40 per cent for others. Needless to say, the rate mentioned under the DTAA, being more favourable (in most cases), would be adopted. But in case dividend is payable to an investor, being a resident of a country with whom there is no DTAA, then the rates prescribed under the Indian law become relevant.

As per Section 115A of the I-T Act (as proposed to be amended), dividend and income from the UTI and MFs are taxable only at 20 per cent for a non-resident (corporate and others). There is an apparent and continuing anomaly between withholding rate (40 per cent) and rate of taxability (20 per cent). It is important to note that the tax rate (Section 115A) is prescribed in the I-T Act, whereas the withholding tax rates are specified in the Finance Act. The question is whether the rates prescribed in the Finance Act override those in the I-T Act and require compliance despite being in excess of the final rate of tax liability.

The Finance Act, 1994 amended Section 115A to include non-resident non-corporates within the ambit of flat-rate taxation bringing them on a par with foreign companies which were already so taxed in respect of dividend and certain other income. According to Circular 684 of June 10, 1994, to bring some rationality in taxability across non-residents, the non-corporate non-residents hitherto taxed at rates prescribed in the annual Finance Act on net basis (net of expenses) would, henceforth, be taxed at the flat rate on gross receipts.

This explanation could lead to the conclusion that the rate prescribed under the I-T Act would override those prescribed in the Finance Act. This means there could be a good basis to deduct only 20 per cent on dividend as against 40 per cent mentioned in the Finance Bill, 2002. Another argument to support this is that Section 195 requires tax deduction at rates in force. When the income is taxable only at 20 per cent, the withholding cannot be required to be made at any higher rate.

UTI and MFs

The issue here is: If a non-corporate recipient has income only from such source, whether the basic exemption (Rs 50,000) as provided in the annual Finance Act be claimed so that only such income in excess of this amount would be liable to tax at 10 per cent. Based on the explanation contained in circular 684 (discussed above), it may not be possible to claim the basic exemption, as this exemption forms part of the rates contained in the annual Finance Bill, 2002.

Therefore, the proposals could lead to the view that even where the total income of an assessee of, say, Rs 40,000, is from the open-ended equity-oriented fund of the UTI (a mutual fund), the assessee would have to remit tax at 10 per cent on the same.

Another instance of the tax rate being prescribed is in Section 112. This section explicitly contains a proviso which enables the claim of basic exemption against capital gain. The explicit absence of such an enabling provision under the proposed Section 115BBB could further support the contention of a flat rate. A specific clarification in this regard may be useful.

Another issue is the co-existence of the proposed Section 115BBB and the already existing Section 115A. While the former relates to any assessee, the latter pertains to only non-residents. But Section 115A includes in its ambit income received in respect of units of an MF or the UTI.

For income from open-ended equity-oriented fund, one could also probably apply Section 115BBB on the basis that the same is specific to that source; thankfully, the same is favourable to the assessee.

Pass-through mechanism

Under this, the retained dividend would be taxable in the hands of the company-shareholder. The proposed section, as it reads now, does not allow pass-through facility to dividend distribution out of income from the UTI and MFs.

However, the Finance Ministry has clarified that the pass-through status would be available to a domestic company earning dividend from the UTI and MFs as well. One hopes this clarification finds a place in the statute book.

Also, pass-through is not available for computing MAT under Section 115JB.

Thus, it is a "some win, some lose game" — the winners are foreign investors and those who have heavily borrowed to make investments, and the losers are small investors and corporate promoters.

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