Section 80M Inter-Corporate Dividend Deduction: The Cascading Tax Problem the Finance Act 2020 Left Unresolved

Introduction

When the Finance Act 2020 abolished the Dividend Distribution Tax (DDT) under Section 115-O of the Income Tax Act, 1961, India shifted from a company-level tax to the classical shareholder-level dividend taxation model.[1] At the core of this transition, Section 80M was reintroduced to prevent double taxation of inter-corporate dividends across multi-tier corporate structures. Despite its intent, Section 80M continues to face structural gaps, interpretive uncertainties, and unresolved cascading tax issues. This article explores how Section 80M dividend deduction works, the regulatory framework, key case law, and the ongoing challenges in corporate dividend taxation.

Historical Background: From Classical Taxation to DDT and Back

India’s approach to taxing dividends has been anything but linear. Prior to 1997, dividends were taxed in the hands of shareholders under the classical system — straightforward in principle but administratively cumbersome given the difficulty of tracking income across a dispersed shareholder base. The Finance Act, 1997 introduced Section 115-O, which imposed a Dividend Distribution Tax on domestic companies at the point of distribution, making dividends entirely exempt in shareholders’ hands under Section 10(34) [2]. Section 115-O charged an additional income-tax at 15% on any amount declared, distributed, or paid by way of dividend — eventually rising to an effective rate of 20.56% inclusive of surcharge and cess.

The original Section 80M — which allowed deductions for inter-corporate dividends — was made redundant under the DDT regime and was formally omitted by the Finance Act, 2003. DDT had its own internal mechanism to prevent cascading taxation: under Section 115-O(1A), a holding company was allowed to reduce the DDT base by the amount of dividend received from a subsidiary company, provided that subsidiary had already paid DDT on that same dividend [1]. This created a partial shield against layered taxation within holding-subsidiary structures, though it was limited only to the immediate holding-subsidiary relationship and did not travel up a multi-tier pyramid.

The Finance Act 2020 scrapped this entire architecture. With effect from April 1, 2020, dividends declared, distributed, or paid by domestic companies became entirely exempt from DDT. Section 10(34), which exempted dividend income in shareholders’ hands, was simultaneously withdrawn. Section 115BBDA — which imposed a 10% tax on dividend income exceeding ₹10 lakh in the hands of resident individuals — became redundant and was also withdrawn. Dividends were now fully taxable in the hands of recipients at their applicable slab rates or corporate tax rates [2]. And Section 80M was re-inserted to ensure that the same dividend income did not get taxed at every tier of a corporate pyramid.

Statutory Framework: What Section 80M Actually Says

Section 80M, inserted after Section 80LA by the Finance Act, 2020, with effect from Assessment Year 2021-22, reads materially as follows [3]:

“Where the gross total income of a domestic company in any previous year includes any income by way of dividends from any other domestic company or a foreign company or a business trust, there shall, in accordance with and subject to the provisions of this section, be allowed in computing the total income of such domestic company, a deduction of an amount equal to so much of the amount of income by way of dividends from such other domestic company or foreign company or business trust as does not exceed the amount of dividend distributed by it on or before the due date.”

The Explanation further clarifies: “For the purposes of this section, the expression ‘due date’ means the date one month prior to the date for furnishing the return of income under sub-section (1) of section 139.”

Sub-section (2) of Section 80M bars double-dipping: where a deduction has been allowed in any previous year in respect of dividend distributed, no deduction shall be allowed again in respect of the same amount in any other previous year [3]. This ensures that a single distribution event does not generate deductions across multiple assessment years.

Section 80M falls under Chapter VI-A of the Income Tax Act, 1961 — the chapter dealing with deductions from gross total income. This placement is significant because Section 80A(2) imposes a ceiling: the aggregate amount of deductions under Chapter VI-A cannot exceed the Gross Total Income of the assessee. Consequently, where a domestic company has a negative or nil Gross Total Income, no deduction under Section 80M is available even if substantial dividends have been distributed to shareholders — a limitation that has drawn considerable criticism from practitioners [4].

The Regulatory Architecture Around Section 80M

Section 80M does not operate in isolation. It interacts with a web of provisions that collectively determine the final tax incidence on inter-corporate dividends. Section 194 of the Income Tax Act was simultaneously amended by the Finance Act 2020 to require the payer company to withhold tax at 10% on dividends distributed to shareholders where the amount exceeds ₹5,000 [1]. This TDS mechanism replaces the administrative convenience that DDT offered, though at the cost of a considerably greater compliance burden across all distributing companies.

For dividends received by a domestic company from a foreign company in which the Indian company holds 26% or more equity shareholding, Section 115BBD provides for a concessional tax rate of 15% on a gross basis without allowing deduction for any expenditure. Section 80M deduction is, however, available even against such income — an amendment made at the final stage of the Finance Act 2020, expanding the provision beyond the original Finance Bill 2020’s scope, which had restricted the deduction only to dividends from domestic companies [2]. This expansion was necessary because the Finance Bill 2020 proposal had created a fresh anomaly: a domestic company receiving foreign dividend would have been taxed on it without any relief upon distribution, effectively replicating the very cascading effect that Section 80M was meant to cure.

Under Section 14A read with Rule 8D of the Income Tax Rules, 1962, the tax department retains the power to disallow expenditure incurred in relation to earning dividend income. The interaction between Section 14A and Section 80M — specifically, whether the deduction under Section 80M is to be computed against gross dividend income or net dividend income after applicable disallowances — is a contested area that the statute does not definitively resolve [4].

The Cascading Problem: What Remains Unresolved

The central failure of the Finance Act 2020’s treatment of Section 80M lies in what the provision does not address. The deduction mechanism is conditional: a domestic company can only claim the deduction if it has actually distributed dividends to its own shareholders on or before one month prior to the due date of filing its return of income. The Act makes clear that mere declaration is insufficient — actual distribution must have occurred [3]. This creates a structural trap for holding companies that receive dividend income in a particular financial year but, for legitimate business or treasury reasons, do not distribute that income within the prescribed window. In such a scenario, the same stream of income is taxed at the subsidiary level at the applicable corporate rate, then again at the holding company level with no Section 80M relief, and once more in the hands of the ultimate shareholders. The cascading effect reasserts itself the moment the timing condition is not met [8].

The problem is compounded in multi-tier structures. In a holding pyramid of A → B → C → D, at each intermediate tier, the deduction under Section 80M requires that tier’s company to have distributed dividends before the prescribed date. If any intermediate company fails to meet this condition, not only does that company lose the deduction, but the cascading effect reverberates upward through the entire chain. No provision in Section 80M or elsewhere in the Act addresses this cascading failure within pyramidal corporate groups — a structural gap that was flagged during analysis of the Finance Bill 2020 but left unaddressed [2].

The omission of Section 80AA is another silent but serious problem. The original Section 80M, prior to its removal in 2003, operated alongside Section 80AA which specifically clarified that the deduction was to be computed with reference to net dividend income — not gross. When Section 80M was re-inserted in 2020, Section 80AA was not restored. The resulting statutory silence has generated interpretive uncertainty that practitioners have struggled to resolve: the deduction potentially takes on very different values depending on which computation base applies, and neither CBDT nor the courts have definitively answered the question [4].

Constitutional Validity and the DDT Legacy: Key Case Law

The constitutional underpinning of the DDT regime — which Section 80M was designed to succeed — was conclusively settled by the Supreme Court of India in Union of India & Ors. v. M/s. Tata Tea Co. Ltd. & Ors. [AIR 2017 SC 4856]. The Supreme Court, upholding the constitutional validity of Section 115-O under Entry 82 of List I of the Seventh Schedule to the Constitution of India, held that once a dividend is declared and distributed to shareholders, it loses the character of the source income from which it was derived. Rejecting the contention that DDT could not be levied on dividends derived from agricultural income — a state subject — the Court applied the doctrine of pith and substance and held that the additional income-tax under Section 115-O was squarely within Parliament’s legislative competence [5]. This ruling is foundational to any understanding of dividend taxation in India because it resolved, definitively, that Parliament can levy tax on distributed dividends irrespective of the nature of the underlying source income — a principle that equally supports the legitimacy of the current classical model.

At the tribunal level, significant clarification emerged from the ITAT Kolkata in Purnasons Pvt. Ltd. v. ITO, which examined whether the deduction under Section 80M is available where dividends are distributed within the due date prescribed by the section. The Tribunal ruled in favour of the assessee, allowing the Section 80M deduction on dividends distributed before the statutory deadline [6]. Separately, the Delhi High Court, in proceedings arising out of a Section 80M disallowance, held that the disallowance of deductions to the extent of dividends distributed to shareholders was unsustainable in law and directed deletion of the addition — a decision that reinforces the taxpayer-friendly reading of the provision in cases of actual, timely distribution [6].

The question of deemed dividends under Section 2(22)(e) has also entered the debate. The Finance Bill 2020 Memorandum states explicitly that Section 80M was inserted to remove the cascading effect. A restricted interpretation that excludes deemed dividends from the ambit of Section 80M would defeat this legislative purpose. A Calcutta High Court decision under the pre-2003 Section 80M had held that the assessee was entitled to relief in respect of dividends received on reduction of company capital — pointing toward a broad reading of the term “dividend” [7]. Whether this reasoning extends to deemed dividends under the re-inserted provision remains contested and is almost certainly headed for further litigation.

TDS Obligations and Compliance Burden Post-Finance Act 2020

One of the practical consequences of the transition from DDT to the classical system is the dramatically increased compliance burden on distributing companies. Under the DDT regime, the company paid DDT as a single aggregate tax; there was no need to separately identify each shareholder’s tax residency or treaty status. Post Finance Act 2020, Section 194 requires TDS at 10% for resident shareholders on dividend exceeding ₹5,000, while for non-resident shareholders, Section 195 applies with the actual rate determined by the applicable Double Taxation Avoidance Agreement [2].

For non-resident shareholders, the transition was arguably a net positive in one important respect: DDT was a tax levied on the company, not on them personally, and therefore non-residents could not claim credit for it in their home jurisdiction in the absence of enabling treaty language. As Cyril Amarchand Mangaldas noted, under the DDT regime, non-resident shareholders were not able to claim foreign tax credit for DDT paid by the Indian company, whereas post-2020, TDS directly withheld on their dividend income makes it creditable under applicable DTAAs [9]. But this benefit came alongside an unacknowledged burden for high-income resident shareholders, whose effective marginal rate on dividend income can now reach 42.74% inclusive of surcharge — far exceeding what they bore collectively under the DDT era.

What the Finance Act 2020 Left Open

The statute provides no carry-forward mechanism for unclaimed Section 80M deductions. If a company cannot claim the deduction in Assessment Year 2021-22 because it did not distribute dividends before the prescribed date, the question of whether it may claim that deduction in the next year — in relation to distributions made then — has no definitive statutory answer. A plain reading of the provision arguably permits it: sub-section (2) only bars re-claim of deductions already allowed, not deductions never availed. But this interpretation is contested and likely to generate prolonged assessment disputes [4].

The Finance Act 2020 also failed to restore Section 80AA alongside Section 80M. Until the gross-versus-net computation question is settled by either amendment or authoritative judicial pronouncement, assessees and assessing officers will operate from opposing positions, and the resultant disputes will take years to work their way through the appellate machinery. The parliamentary intent — clearly reflected in the Finance Minister’s Budget Speech of 2020 — was that inter-corporate dividend taxation should not be punitive or duplicative. The legislative execution, however, left enough gaps that achieving this intent now depends on interpretive goodwill that tax administration historically has not reliably extended.

Conclusion

Section 80M, as re-inserted by the Finance Act 2020, represents a genuine attempt to prevent cascading dividend taxation in the post-DDT framework. Its last-minute extension to include foreign dividends and business trust distributions reflects some legislative responsiveness to structural deficiencies in the Finance Bill 2020 proposal. However, the provision as it stands carries forward a set of unresolved tensions: the strict timing condition for distribution, the absence of a carry-forward mechanism for unclaimed deductions, the unresolved gross-versus-net computation question, the gap left by the deletion of Section 80AA, the cascading exposure in multi-tier holding structures, and the open question of deemed dividends. These are not academic concerns — they are live issues affecting the tax liability of some of India’s largest corporate groups. Section 80M partially cures the problem it was designed to address. In doing so, it leaves the harder cases precisely where they were.

References

[1] ClearTax, Section 80M of the Income Tax Act – Inter-Corporate Dividends — https://cleartax.in/s/section-80m

[2] Cyril Amarchand Mangaldas, Abolition of Dividend Distribution Tax: A New Paradigm for Equity Investments (April 2020) — https://corporate.cyrilamarchandblogs.com/2020/04/abolition-of-dividend-distribution-tax-a-new-paradigm-for-equity-investments/

[3] AAP Tax Law, Section 80M of Income Tax Act – Deduction in Respect of Certain Inter-Corporate Dividends — https://www.aaptaxlaw.com/income-tax-act/section-80-m-income-tax-act-deduction-in-respect-of-certain-inter-corporate-dividends-sec-80m-of-income-tax-act-1961.html

[4] Lakshmikumaran & Sridharan Attorneys, Dissecting Section 80M of the Income Tax Act – The Known and the Unknown — https://www.lakshmisri.com/insights/articles/dissecting-section-80m-of-the-income-tax-act-the-known-and-the-unknown/

[5] ITAT Online, Union of India & Ors. v. Tata Tea Co. Ltd. (Supreme Court, September 2017) — https://itatonline.org/archives/uoi-vs-tata-tea-co-ltd-supreme-court-s-115-o-dividend-distribution-tax-entire-law-on-the-constitutional-validity-of-dividend-distribution-tax-ddt-under-article-246-of-the-constitution-read-with-en/

[6] Tax Guru, Section 80M Deduction Allowed for Dividend ‘Distributed’ on or Before Due Date – Purnasons Pvt. Ltd. v. ITO (ITAT Kolkata, June 2024) — https://taxguru.in/income-tax/section-80m-deduction-allowed-dividend-distributed-due-date.html

[7] Mondaq, The Conundrum of Deeming Provisions – Whether Deduction Under Section 80M is Available in Case of Deemed Dividend (June 2020) — https://www.mondaq.com/india/shareholders/952666/the-conundrum-of-deeming-provisions-whether-deduction-under-section-80m-is-available-in-case-of-deemed-dividend-untested-waters

[8] Tax Guru, Section 80M – Deduction – Inter-Corporate Dividends (July 2020) — https://taxguru.in/income-tax/section-80m-deduction-inter-corporate-dividends.html

[9] Cyril Amarchand Mangaldas, Dividend Distribution Tax Abolishment: Something Lost in Translation (February 2020) — https://tax.cyrilamarchandblogs.com/2020/02/dividend-distribution-tax-abolishment-heres-something-lost-in-translation/