JULY 14, 2014

By Dhiren Shah & Chintan Shah, Deloitte Haskins & Sells LLP

FINANCE (No.2) Bill, 2014 has proposed certain amendments which has significant impact on various facets of taxes in respect of investments in Indian companies. We have discussed the same in following paragraphs:

1. Grossing up of dividend distribution tax

Current provisions of Section 115-O of the Income-tax Act, 1961 (“the Act”) provides for levy of additional tax on domestic companies in respect of incomes distributed by them in the form of dividend. Such income is not chargeable to tax in the hands of shareholders vide Section 10(34) of the Act. Similarly, Section 115-R of the Act provides for levy of similar tax on income distributed by mutual fund to its investors / unit holders. Income received by the investors is exempt from levy of taxes in view of provisions of Section 10(35) of the Act.

In case of both the aforesaid provisions, the additional income-tax payable was worked out having regard to the amount of income distributed. In other words, the tax was computed having regard to the net amount distributed by the company without any grossing up.

Prior to insertion of Section 115-O and 115-R of the Act by Finance Act, 2003, income by way of dividend and that distributed by mutual funds was taxable in the hands of the shareholders and investors respectively. The tax in hands of shareholders / investors was computed having regard to the gross amount distributed.

Vide Finance Bill, 2014 sub-section (1B) has been proposed to be inserted in Section 115-O of the Act whereby to compute tax on distributed profits, distributed income would be required to be increased by the amount of tax in such a manner that after reduction of the amount of tax from such increased amount, the balance would be equal to the net distributed income. In other words, the tax on dividend would be required to be computed having regard to the grossed up amount. Similar provision has been proposed to be inserted in Section 115R of the Act.

A comparative position of tax to be paid on distributed income by companies pre and post amendment is tabulated hereunder for ease of reference:

From the aforesaid table, it is apparent that the effective tax cost on distribution of dividend by a company is increased from 16.995% to 20.47%.

Amended provisions are applicable with effect from October 1, 2014.

2. Holding Period for determining nature of capital gains – Unlisted shares

Proviso to Section 2(42A) of the Act provides that in respect of certain class of capital assets, even though the holding period is more than 12 months, such asset would be considered as a short-term capital asset. As per the said proviso, a share of a company (whether listed or unlisted) held for more than 12 months was considered as a long-term capital asset. The resultant capital gains / loss on transfer of such share were considered to be long-term capital gains / loss.

Finance Bill, 2014 has proposed that only listed shares would be eligible for the shorter holding period of 12 months to be classified as a long-term capital asset as against any share held in a company which was earlier eligible for shorter holding period. In view of the said proposal, any share of an unlisted company would be classified as a short term capital asset unless it is held for at least for 36 months. Accordingly, in respect of such shares benefit of indexation and lower rate under Section 112 of the Act would be applicable only if such shares are held for more than 36 months.

The impact of the aforesaid amendments needs to be carefully considered and understood while arriving at any decision in respect of investing in shares of companies / liquidating existing investments in order to avoid unexpected tax cost and other consequences. Further, subject amendment is applicable from AY 2015-16 and hence technically would cover the transactions which are already executed from April 1, 2014 till today.