Dividend Distribution Tax - Explained

DDT or Dividend Distribution Tax is to be paid by companies who distribute their profits to their shareholders in the form of dividends. The current rate of DDT is 15% (effective rate of 20% once it is grossed up and adjusted with surcharge and education cess). This dividend received is then tax free in the hands of the shareholders.

The reason why DDT exists if that the profits earned by companies must be retained within the company to fund its future operations and growth. However, many investors invest in high dividend paying companies looking for a regular income source.

What will happen if DDT is reduced in the upcoming budget?

If DDT is reduced in the budget, it will bring a cheer to this class of investors, and bring an overall positive sentiment in the financial markets. Domestic companies might take advantage of this reduction and announce higher dividends in the coming year, thereby increasing liquidity in the hands of the investors. The short-term impact of such an announcement would definitely be positive for the markets.

DDT treatment on equity Mutual Funds. 

Currently equity MFs are exempted from DDT however there are talks about introducing a 10% DDT on Equity Mutual Funds. Remember that Equity MFs are shareholders of the companies in which they invest, and hence when these companies are distributing dividends, they are already after DDT has been paid. Besides, Equity MFs make profits when the value of their units rise due to capital gains, which are also taxed separately. Hence introducing DDT on Equity MF dividends might lead to negative sentiments in the markets and investors might start looking for other options such as growth oriented funds, debt funds or direct equity (where atleast they save on the management fees).

Questions to ponder!

DDT is paid by the enterprise paying the dividends. When a company earns profits and decides to distribute it to its shareholders in the form of dividends, they need to pay DDT on the amount of distribution. There are some discussions on whether this amounts to double taxation, given the dividends are distributed from tax paid profits, will leave it for the readers to ponder.

Although Dividends are tax free in the hands of the receiver (investor), we can assume that they are the ones ultimately bearing the burden of this tax. Had it not been for DDT, the dividends distributed would have been higher by the companies, so who do you think is really paying this DDT?