One major change which will impact investors post 1st April 2020 is the removal of Dividend Distribution Tax (DDT) for dividends paid out by Indian corporates.

One major change which will impact investors post 1st April 2020 is the removal of Dividend Distribution Tax (DDT) for dividends paid out by Indian corporates.

Current DDT Structure (till March 31, 2020): Companies distributing dividends are required to pay tax at an effective rate of 20.56% directly to the government from distributable dividend. As a result, out of every Rs 100 in distributable dividend, companies had to shell out Rs 20.56 as tax, with only Rs 79.44 left as dividend for shareholders. The dividend paid, however, was tax-free to the investors up to a limit of Rs 10 lakh and post that a concessional rate of 10% was to be payable on dividends received in a financial year.

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New Proposition: The withdrawal of the DDT puts an end to this regime, by requiring all equity investors to treat their dividend receipts as income and pay taxes on it at their applicable slab rates.

A quick snapshot on 1,752 NSE-listed companies for year ending FY2018-19, based on the Capitaline database, showed that merely 938 companies paid dividend last year, totalling about Rs 2 lakh crore.

Now the question arises, whether individual companies will distribute more of their DDT savings or not, that, we think, will depend on their shareholding pattern.

We feel that basis promoter’s shareholding, two categories of companies could possibly see their dividend pay-outs go up significantly — Public Sector Undertakings (PSUs) and Multi-National Corporations (MNCs) (including companies with foreign promoters). For PSUs, the Government of India (their largest shareholder) is not liable to any income tax. Hence, it is likely that PSUs will opt to distribute the DDT savings with the shareholders. Basis the above hypothesis, PSU stocks, some of which are already high-dividend yield, may increase their pay-outs further in the future. Also, given the state of government finance, they are facing tremendous pressure to increase the dividend pay-out.

For multi-national corporations, dividend is the key route to repatriate profits. We feel that they are also likely to raise their dividend pay-outs in the future.

Of the 938 dividend payers last year, there were 58 PSUs and 108 companies with MNCs or foreign companies as holding/parent companies. Despite being less than 18% of the total no. of dividend payers, these two sets of firms contributed nearly 50% of the dividend corpus, with PSUs distributing about Rs 64,500 crore and foreign-owned companies paying Rs 34,000 crore.

How can investors benefit out of it
High net worth individuals having income >10 lakh per annum and who are holding stocks of PSU and MNC companies stand to loose >30% per annum by way of a tax outgo.

Domestic mutual funds/asset managers who enjoy pass-through status and pay no tax can pocket larger dividend incomes from their portfolios, as they will no longer suffer the indirect incidence of the DDT.

Investors having a large equity holdings in PSU/ MNC companies or PMS having exposure to these companies can invest in a similar portfolio (MNC Fund or PSU Fund) and take the advantage of dividend pass through, since MFs are not taxed on the income earned. The benefit will be available to investors who will invest in the growth options of the MNC Fund or PSU Fund.

It makes huge sense for HNIs to switch from holding direct stocks to MF, which apart from giving the benefit of lower taxation will also offer the following benefits:

We recommend to invest in MNC funds, since we believe that the track record of MNC stocks in India is quite consistent. MNC companies are well-run global companies with a time-tested business models and these stocks are also devoid of any corporate governance-related issues.

Though PSU funds also stand to gain from the same, but I am not a big fan of PSU companies. They come with their own problems of operational in-efficiency and excessive government intervention. Moreover, they have been consistently underperforming the market for almost 10 years now.