The abolition of the Dividend Distribution Tax (DDT) regime fundamentally changed the taxation of dividends in India. With the introduction of the classical system of dividend taxation from Assessment Year (A.Y.) 2021-22 onwards, dividends are now taxed directly in the hands of shareholders.
While domestic corporate groups received relief through Section 80M of the Income Tax Act, Indian companies earning dividends from foreign subsidiaries continue to face a significant tax and compliance burden. The absence of Section 80M relief for foreign dividends creates an imbalance that impacts Indian multinational groups and leads to economic double taxation.
Under the earlier DDT regime, companies distributing dividends paid tax before the dividend reached shareholders. This system was replaced with the classical taxation model, where dividends are taxed in the hands of the recipient shareholder.
Current Tax Treatment of Dividends
Under the present framework:
Accordingly, when an Indian holding company receives dividends from a foreign subsidiary, the income becomes taxable in India at normal corporate tax rates, such as:
Section 80M was introduced to prevent cascading taxation of dividends within a domestic corporate structure.
Purpose of Section 80M
The provision allows a domestic company to claim deduction for dividends received from another domestic company if the recipient company further distributes dividends to its shareholders before the due date of filing its return of income.
The objective is straightforward:
A significant issue arises because Section 80M applies only to dividends received from domestic companies.
Dividends received from foreign subsidiaries do not qualify for this deduction.
This creates a clear disparity between domestic and foreign investments.
Scenario 1 – Domestic Subsidiary
An Indian parent company receives a dividend of ₹100 crore from its Indian subsidiary and redistributes ₹80 crore to its shareholders.
Under Section 80M:
Scenario 2 – Foreign Subsidiary
An Indian parent company receives ₹100 crore from a foreign subsidiary and redistributes the entire amount to shareholders.
Since Section 80M is unavailable:
This leads to economic double taxation, because:
To mitigate double taxation, Indian tax law provides Foreign Tax Credit under Sections 90 and 91.
Section 90 – DTAA Relief
Where India has a Double Taxation Avoidance Agreement (DTAA) with the foreign country, the Indian company may claim credit for:
Section 91 – Non-Treaty Relief
If no DTAA exists, unilateral tax relief may still be available for taxes paid abroad, subject to Indian tax limitations.
Although FTC provides relief, the mechanism is highly technical and compliance-intensive.
1. Complex Computation of Underlying Tax
Calculating the underlying tax credit is complex. It requires determining the portion of the foreign subsidiary’s tax that is attributable to the profits out of which the dividend was paid. The formula is: (Dividend Paid / Post-Tax Profit of Foreign Sub) * Total Tax Paid by Foreign Sub.
2. Country-wise FTC Restriction
FTC is calculated separately for each jurisdiction.
Excess credit from one country cannot be adjusted against tax payable on income from another country.
3. Timing Mismatches
Foreign taxes and Indian taxation may arise in different financial years, creating practical difficulties in claiming credits.
4. Documentation Burden
The taxpayer must maintain:
Failure to comply procedurally may result in denial of FTC.
Facts
An Indian company taxed at 25% receives dividend from its wholly owned US subsidiary.
Details
Step 1 – Dividend Income
Approximate dividend income in India:
Step 2 – Indian Tax Liability
Tax at 25%:
8.3 crore×25%=2.075 crore8.3\ \text{crore} \times 25\% = 2.075\ \text{crore}
Indian tax payable:
Underlying Tax Credit
Approximate credit:
However, FTC cannot exceed Indian tax payable on such income.
Withholding Tax Credit
Approximate credit:
Although the total foreign taxes exceed the Indian tax liability, FTC is restricted to the Indian tax amount.
Therefore:
The present framework creates an uneven playing field between domestic and foreign investments.
Key Concerns
While FTC avoids absolute double taxation, it does not provide the seamless pass-through mechanism available for domestic dividends.
The current regime raises important policy concerns for India’s outbound investment ecosystem.
Possible reforms may include:
Such reforms would align India with several global tax systems that provide more efficient treatment for foreign subsidiary profits.
For A.Y. 2025-26, dividends received from foreign subsidiaries remain fully taxable in India without the benefit of Section 80M deduction. Although Foreign Tax Credit mechanisms offer partial relief, the compliance process is complex and often results in stranded credits.
Indian companies with global operations must therefore carefully plan dividend repatriation strategies, maintain robust FTC documentation, and evaluate treaty benefits to optimize tax efficiency.
Until legislative reforms address the Section 80M exclusion for foreign dividends, Indian multinational groups will continue to face structural disadvantages in cross-border profit repatriation.
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