ACCOUNTING OF DIVIDEND DISTRIBUTION TAX

Started as “Accounting Standards” in
August, 2001. Dolphy Dsouza was the first contributor and had at that time
“agreed to write a series of eight articles on AS 16 to AS 23”. However, till
date – to the joy of the readers – continues as the sole contributor giving the
most important aspects of accounting standards. The feature got a suffix to its
name in July, 2002 – gap in GAAPs – and was called “Accounting Standards: Gap
in GAAPs”. Since the arrival of Ind AS it is renamed as at present.

This monthly feature carries
clarifications, commentary, comparison, and seeks to clarify about accounting
concepts and practices. The author says, “Accounting was never a debated topic
in India as much as tax is. Hopefully, my feature has a small hand in bringing
accounting to the centre stage” He shared another secret benefit: “People know
me because they have seen an unusual name in the BCA Journal for the last 18
years.  I once even got a hefty hotel
discount, as the hotel owner was a CA and an avid reader of the BCAJ!”

ACCOUNTING OF DIVIDEND DISTRIBUTION TAX

Prior to 1^st June, 1997,
companies used to pay dividend to their shareholders after withholding tax at
prescribed rates. The shareholders were allowed to use tax deducted by the
company against tax payable on their own income. Collection of tax from
individual shareholders in this manner was cumbersome and involved a lot of
paper work. To make dividend taxation more efficient, the government introduced
the concept of dividend distribution tax (DDT). Key provisions related to DDT
are given below:

(a) Under DDT, each company distributing dividend
needs to pay DDT at stated rate to the government. Consequently, dividend
income will be tax free in the hands of shareholders.

(b) DDT is payable even if no income-tax is payable
on the total income, e.g., a company that is exempt from tax on its entire
income will still pay DDT.

(c) DDT is payable within fourteen
days from the date of (i) declaration of any dividend, (ii) distribution of any
dividend, or (iii) payment of any dividend, whichever is earliest.

(d) DDT paid by a company in this manner is treated
as the final payment of tax in respect of dividend and no further credit
therefore can be claimed either by the company or by the recipient of dividend.
However, dividend received is tax free in the hand of all recipients (both
Indian/ foreign).

(e) Only dividend received from domestic companies
is exempt in the hands of recipient. Dividend received from overseas companies
which do not pay DDT is taxable in the hands of recipient, except for the
impact of double tax relief treaties, if any.

(f)  No DDT is required to be paid by the ultimate
parent on distribution of profits arising from dividend income earned by it
from its subsidiaries. However, no such exemption is available for dividend
income earned from investment in associates/ joint ventures or other companies.
Also, no exemption is available to a parent which is subsidiary of another
company.

DDT accounting under Ind AS 12 involves
certain issues. The most important issue is that for the entity paying
dividend, whether DDT is an income-tax covered within the scope of Ind AS 12?
Will DDT be an equity adjustment or a P&L charge or this is an accounting policy
choice?

Consider that in the structure below,
company B distributes dividend to its equity shareholders, i.e., company A and
pays DDT thereon.

For DDT accounting in SFS and CFS of B, one
may consider paragraphs 52A/ 52B and 65A of Ind AS 12.

“52A     In
some jurisdictions, income taxes are payable at a higher or lower rate if part
or all of the net profit or retained earnings is paid out as a dividend to
shareholders of the entity. In some other jurisdictions, income taxes may be
refundable or payable if part or all of the net profit or retained earnings is
paid out as a dividend to shareholders of the entity. In these circumstances,
current and deferred tax assets and liabilities are measured at the tax rate
applicable to undistributed profits.

52B      In
the circumstances described in paragraph 52A, the income tax consequences of
dividends are recognised when a liability to pay the dividend is recognised.
The income tax consequences of dividends are more directly linked to past
transactions or events than to distributions to owners. Therefore, the income
tax consequences of dividends are recognised in profit or loss for the period
as required by paragraph 58 except to the extent that the income tax
consequences of dividends arise from the circumstances described in paragraph
58(a) and (b).”

“65A.    When
an entity pays dividends to its shareholders, it may be required to pay a
portion of the dividends to taxation authorities on behalf of shareholders. In
many jurisdictions, this amount is referred to as a withholding tax. Such an
amount paid or payable to taxation authorities is charged to equity as a part
of the dividends.”

One may argue that DDT is in substance a
portion of dividend paid to taxation authorities on behalf of shareholders. The
government’s objective for introduction of DDT was not to levy differential tax
on profits distributed by a company. Rather, its intention is to make tax
collection process on dividends more efficient. DDT is payable only if
dividends are distributed to shareholders and its introduction was coupled with
abolition of tax payable on dividend. DDT in substance does not adjust the
corporate tax rate, and is a payment to equity holders in their capacity as
equity holders. This aspect is also recognised in the IASB framework. Thus, DDT
is not in the nature of income-taxes under paragraphs 52A and 52B. Rather, it
is covered under paragraph 65A. Hence, in the SFS and CFS of company B, the DDT
charge will be to equity. The Accounting Standards Board (ASB) of the ICAI has
issued a FAQ regarding DDT accounting. The FAQ confirms this position with
regard to accounting SFS and CFS of company B. However, this position is very
contentious globally and there is a strong argument to treat DDT as an
additional tax in substance. Therefore, though there is no difference in the
Ind AS and IFRS standard on DDT, the practice applied in India may be different
from the practice applied globally.

In the SFS of the company receiving
dividend, i.e., company  A, net dividend
received is recognised as income. In CFS of company A, there is no dividend
distribution to an outsider. Rather, funds are being transferred from one
entity to another within the same group, resulting in DDT pay-out to an entity
(tax authority) outside the group. Hence, in the CFS of company A, DDT cannot
be treated as equity adjustment; rather, it is charged to profit or loss.

If company B as well as company A pay
dividend in the same year, company B will pay DDT on dividend distributed.
Under the income-tax laws, DDT paid by company B is allowed as set off against
the DDT liability of company A, resulting in reduction of company A’s DDT
liability to this extent. In this scenario, an issue arises how should the
company A treat DDT paid by company B in its CFS?

One view is that DDT paid relates to company
B’s dividend. From a group perspective, for transferring cash from one entity
to another, cash/tax was paid to the tax authorities. Hence, it should be
charged to P&L in company A’s CFS. The other view is that due to offset mechanism,
no DDT in substance was paid on dividend distributed by company B. Rather,
company A has paid DDT on its dividend distribution to its shareholders. Hence,
DDT should be charged to equity in company A’s CFS to the extent of offset
available.

The ITFG has clarified that second view
should be followed. Under this view, the following table explains the amount to
be charged to P&L and to equity in company A’s CFS:

The above is a simple example where both
parent and subsidiary pay dividends concurrently.  It may so happen that a subsidiary has
distributable profits, but will distribute those, beyond the current financial
year.  In such a case, in parent’s CFS, a
DTL should be recognised at the reporting date in respect of DDT payable on
dividend expected to be distributed by the subsidiary in near future. Absent
offset benefit, the corresponding amount is charged as expense to P&L.
However, there is no direct requirement related to recognition of asset toward
offset available.

Considering the above, the ITFG (Bulletin 9)
has stated that at the reporting date, the parent in its CFS will recognise DTL
in respect of DDT payable on dividend to be distributed by subsidiary. The
corresponding amount is charged to P&L. In the next reporting period, on
payment of dividend by both entities and realisation of offset, the parent will
credit P&L and debit the amount to equity. Effectively, the ITFG views
require DDT on expected distribution to be charged to P&L in the first
reporting period which will be reversed in the immediate next period. The
authors believe that the ITFG view does not reflect substance of the
arrangement. Moreover, such an approach will create an unwarranted volatility
in P&L for two reporting periods which should be avoided. The standard
requires creation of a DTA if there is a tax planning opportunity in place. If
the parent company has a strategy in place to distribute dividends to its
shareholders out of the dividends it receives from its subsidiaries, within the
same year, then it will be able to save on the DDT. Consequently, corresponding
to the DTL, an equivalent DTA should also be recognised in the first reporting
period. We recommend that ITFG may reconsider its views on the matter.

ITFG (Bulletin 18) has subsequently changed
its position and clarified that accounting treatment of DDT credit depends on
whether or not it is probable that the parent will be able to utilise the same
for set off against its liability to pay DDT. This assessment can be made only
by considering the particular facts and circumstances of each case including
the parent’s policy regarding dividends, historical record of payment of
dividends by the parent, availability of distributable profit and cash,
etc.  The revised ITFG position is a step
in the right direction.

In light of the ITFG 18, a few important
questions and clarifications are given below: