Every domestic company is liable to pay a Dividend Distribution Tax @15% on the amount declared, distributed or paid by such company by way of dividends. The effective rate of tax works out to16.995%. The proposed Direct-tax Code also contains similar provision. The only exception is when the dividend is received by a domestic company from its subsidiary.

Dividends are generally paid by the companies out of their post tax profits. Thus, the dividend-paying company first pays income tax on its profits and then pays dividend out of the balance profits. The dividend received by the shareholder is out of profits which have already suffered tax. Therefore, if the person receiving dividend is again liable to pay income tax, it virtually amounts to double taxation of the same income.

Therefore, in many countries either there is no tax on dividend income or such income is taxed at concessional rates. In India, section 10(34) of the Income-tax Act exempts any income in the hands of the recipient (including foreign company) by way of dividends on which Dividend Distribution Tax (DDT) has been paid under section 115-O.

It will be recalled that the DDT was introduced as a measure for easier collection of tax rather than as an additional burden of tax on the shareholders receiving dividend. The memorandum explaining finance bill 2003, stated that it has been argued that it is easier to collect tax at a single point, i.e., from the company rather than compel the company to compute the tax deductible in the hands of the shareholder.

The levy of additional income tax which effectively reduces the quantum of dividend to be declared by the domestic company direct hits the foreign investors because the said additional Income-tax does not qualify for the underlying tax credit in the investors home country. The reason is simple. The said additional income tax is paid by the Indian domestic company (not by the shareholder). The credit for tax will be available only for the taxes which are paid in India by the shareholder himself.

It is therefore, advisable that a suitable amendment be made in the Income-tax Act to ensure that non-resident shareholders become entitled to tax credit for the additional income tax paid by the Indian domestic company.

The government should consider that levying DDT at flat rate of 15% is unreasonably high particularly for small investors. An individual does not pay income tax up to an income of Rs 1,60,000/-(Rs 1,90,000 in case of women) and pays tax @ of 10% over and above the income of Rs 1,60,000 and Rs 1,90,000 respectively upto an income of Rs 5,00,000/- But, even such persons indirectly bear the burden of tax in the shape of DDT @ 16.995% (the effective rate after surcharge and education cess). In this manner, DDT is a disincentive for low income investors.

In view of the above it is felt that DDT needs to be withdrawn particularly for the following reasons:

# The DDT effectively results in double taxation of the same income. It can hardly be called an equitable legislation. Therefore, continuing with DDT goes against the declared objective of the new Direct Taxes Code.

# DDT indirectly results in taxing the dividend income @ of 16.995%. The small investors or low income group assessees are saddled with the liability of the tax on dividend income @ 16.995% while their other income is taxed at a lower figure. Thus, the advantage of exemption of dividend income is enjoyed by higher income group assesses rather than by lower income group assesses.

# DDT is not allowed as a tax credit to the foreign investors against their dividend income in their home country primarily because DDT is paid by the dividend paying company instead of directly by the foreign shareholders. Therefore, DDT is a strong disincentive for equity investment by the foreigners in India.