Inter-corporate dividends: New tax law grants 100 percent exemption to group cos

The Tax Laws (Second Amendment) Ordinance 2019 has granted 100 percent exemption from tax on inter-corporate dividends to entities entitled to group relief, retrospectively from July 1, 2019.

In this regard, the government has amended Income Tax Ordinance 2001 through Tax Laws (Second Amendment) Ordinance 2019.

According to an explanation of a chartered accountant, clause (103C) of Part I of Second Schedule to ITI was inserted vide Finance Supplementary (Second Amendment) Act, 2019 with effective from July 1, 2019. The clause provided exemption to dividend income derived by a company, if the recipient of the dividend is eligible for group relief. The exemption to dividend was provided in proportion of shareholding by the parent company in the subsidy company. The ordinance has now exempted 100% of the dividend received by parent from subsidy irrespective of its shareholding in the subsidy, he added.

Another CA firm explained the reduction in tax liability on inter-corporate dividends Clause (103C) of Part I of the Second Schedule pursuant to the provisions of clause (103A) of Part I of the Second Schedule, saying any income derived from inter-corporate dividends was exempt for group companies entitled to group taxation under section 59AA or group relief under section 59B.

The Finance Act, 2015 then added a condition, that such exemption would only be available if the consolidated return of the group had been filed. Subsequently, the Finance Act, 2016 excluded entities entitled to group relief under section 59B from the exemption entirely. The above amendments created significant hardship for corporate and industrial groups by adding multiple layers of taxation on dividends issued by group entities. This resulted in corporate structures becoming inefficient due to multiple taxation of the same income, on mere distribution within the group, even though no value addition was taking place. This also led to substantial litigation from various groups.

The Finance Supplementary (Second Amendment) Act, 2019 addressed this issue by inserting a new clause (103C) in Part I of the Second Schedule which provided exemption to dividend income derived by a company, if the recipient has availed group relief under section 59B, computed according to the following formula: AxB/C where A is the amount of dividend, B is the shareholding of the company receiving the dividend in the company distributing the dividends, and C is the total ordinary share capital of the company distributing the dividend. It is imperative to appreciate that while the original provisions of clause (103A) had provided an outright exemption from tax on inter-corporate dividends to entities entitled to group relief, the newly inserted clause provided relief only in the circumstances where the recipient of the dividend has availed group relief, i.e. loss has actually been surrendered between the two entities and even then, only to the extent of the shareholding that the parent entity has in its subsidiary.

Subsequently, the Finance Act, 2019 addressed the hardship of the corporate taxpayers and extended the exemption to a company which is eligible for group relief under Section 59B of the Ordinance instead of only those who actually availed the scheme of group relief. The Second Amendment Ordinance has now omitted the formula mentioned for calculating relief in respect of inter-corporate dividend for entities eligible for group relief; hence restoring the original position i.e. a 100% outright exemption from tax on inter-corporate dividends to entities entitled to group relief, the CA firm added.