Economy Watch Abolish ‘Dividend Distribution Tax’ for growth
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Economy Watch Abolish ‘Dividend Distribution Tax’ for growth

Archive Manager by WEB DESK
May 9, 2010, 12:00 am IST
in General
Jeay Sindh Freedom Movement chairman Sohail Abro

Jeay Sindh Freedom Movement chairman Sohail Abro

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The memorandum proves that classical system of taxing dividends in the hands of recipients is far superior to Dividend Distribution Tax System. With computerisation of Income Tax system, the TDS system has become easier and is also operating for interest payments. TDS and PAN are useful tools against money laundering and funding of terrorism.

Sequence of events
Since the introduction and abolishing of this system {and even its reintroduction} can be done only through Budget (Finance Bill), the references to the same in the decade since its introduction assumes great importance, I am therefore reproducing ad verbatim the references made to this system under caption “direct taxes” by various Finance Ministers in their budget speeches as under:

Budget Speech of Shri P. Chidambaram February 28, 1998 (Budget 1998-99)

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Income Tax
Para 90 of the speech

” The rate will be 10 per cent in the first slab of Rs. 40,000 to Rs. 60,000, and 20 per cent in the slab of Rs. 60,000 to Rs. 1,50,000 and 30 per cent for all income above Rs. 1,50,000.

Voluntary Disclosure Scheme
I have considered various options. And I believe that the time is opportune to introduce a Voluntary Disclosure Scheme. The date of commencement of the scheme will be notified separately, but the scheme will end on December 31, 1997.

Corporate Tax and Dividend Tax
Turning to corporate taxes, I had in my last budget reduced the rate of surcharge from 15 per cent to 7.5 per cent and had expressed the hope that I would take a similar step in my next budget. I propose to abolish the balance surcharge on companies.

Corporates should be encouraged to undertake new investments. Hence, I propose to reduce the tax rate applicable to both domestic and foreign companies.

The rate for domestic companies will now be 35 per cent and for foreign companies 48 per cent. The reduction in the corporate rates, apart from better compliance, should impart an added momentum to the growth process, create multiplier beneficial effects all around and also attract greater foreign investment.

Dividend Tax
Another area of vigorous debate over many years relates to the issue of tax on dividends. I wish to end this debate. Hence, I propose to abolish tax on dividends in the hands of the shareholder.

Some companies distribute exorbitant dividends. Ideally, they should retain bulk of their profits and plough them into fresh investments. I intend to reward companies who invest in future growth. Hence, I propose to levy a tax on distributed profits at the moderate rate of 10 per cent on the amount so distributed. This tax shall be incidence on the company and shall not be passed on the shareholder.”

The Planning Commission had appointed an “Advisory Group on Tax Policy and Tax Administration Reform for the Tenth Plan”.

The Group had submitted its interim report in December 2000 for enabling the Hon. Finance Minister to incorporate their recommendations in the Budget (Finance Bill) if he so desired. I am reproducing the relevant recommendation from the interim report:

“It is recommended that the prevailing 20 per cent dividend tax be abolished. Instead, the MAT should be reconstituted as a tax equal to the aggregate of 0.75 per cent of adjusted net worth at the end of the year plus 10 per cent of the dividend distributed. It would allow carry forward for set-off against future tax liability in excess of the MAT as provided in Section 115JAA.”

The Group submitted its final report in June 2001. I am reproducing the relevant extracts from the report dealing with income tax on corporate sector, the basic arguments-both for and against-in respect of the “double taxation” of dividend income and problems of the administration of income and capital gains tax etc., since the same give a very good insight of all problems involved. I believe it will also enlighten all involved in appreciating the reasons why the Group had made recommendation for abolishing Dividend Distribution Tax System. I may add that the Group had also pointed out that most successful and resourceful corporate bodies use expertise to become “zero tax” companies eliminating income tax on their profits. The Group has suggested adding an element related to dividend payment in the calculation of MAT (Minimum Alternative Tax).

In most countries with income taxation, corporate entities are subject to tax on their profits and, in addition, dividends are taxed in the hands of shareholders (subject to exemption upto a point). The base of the corporate income tax, however, is commonly the accounting profits derived with reference to historical costs. Certain modifications are also often made by law to accounting profits to provide incentives for activities considered important for social and economic policies or to provide relief from inflation as well as to curb misuse of the corporate form to reduce personal tax liability.

Under a system of general income taxation, whether companies should be taxed independently as separate entitles has been the subject matter of prolonged debate among tax economists. One view is that since corporations are not persons, strictly speaking, there is no case in equity for taxing the profits of companies as such. The tax should be levied only on the owners, that is, the equity holders, by attributing the profits of the companies to the shareholders. Such a system, however, can operate smoothly only if all profits are distributed every year among the shareholders.

“We recommend that the corporate tax rate should, under no circumstances, exceed the maximum marginal tax liability under the personal income tax (inclusive of surcharge). Accordingly, the existing corporate tax rate should be lowered to 30 per cent in line with the recommendation made under the personal income tax. This will also make the rate internationally more comparable.

We also recommend the abolition of the distribution tax on dividends in view of our recommendation on MAT on companies in the following Sections and the empirical analysis of the effective rate of corporate tax liability. The Finance Bill, 2001, proposes to roll back the rate of distribution tax to 10 per cent, which comprises a right step forward. But it falls short of comprehensive reform that the Group suggests in restructuring the MAT, of which the dividend tax reform would comprise a part.

At present, the tax rate on foreign companies is 48 per cent. Traditionally, this rate has been kept at 10-percentage point higher than the tax rate for domestic companies. This differential is maintained to recoup the potential loss on account of the non-declaration of dividends in India by foreign companies. Since we have proposed the abolition of dividend distribution tax, there will be no further justification for maintaining the differential. Accordingly, we also recommend that the tax rate for foreign companies be reduced to the level recommended for domestic companies i.e. to the level of 30 per cent.”

Some basic considerations as I see them
Before offering my comments on the sequence of speeches of various Finance Ministers, I wish to emphasise that I accept that as per Constitution and legal system that we have given to ourselves, every democratically elected Government has authority to propose and amend laws by tabling appropriate proposals in the Parliament and getting them passed by majority and approval of Hon. President. But the Constitution and the conventions followed require the Government to state clearly the objective of the proposal, its impact and provide answers to the points raised in debate by Members of the Parliament (and in reality even by citizens in various mass media).

I also wish to emphasise that I do not subscribe to the oft-repeated concept that share market reflects the status of economy or share prices are affected by rates of dividend or price to earning ratios. If it were true, it would be impossible to justify not only the daily price fluctuations in the market but also rises and declines even in average prices over the last 12 months. The highly traded and high priced shares belonging to “A” group shares have much lower yield in terms of dividend even at lowest traded price compared to yield on Government securities. Even before introduction of futures and options trading, shares of various companies were tradable commodities. Their use for raising short term funds, through systems like buy back arrangement, meeting working capital requirement through banks, mutual funds etc, and most importantly the inflow and outflow of short term funds from foreign institutional investors have been deciding the share market prices especially of the floating shares of group A companies. The real “investors” had (God be thanked) not rushed to sell shares because the price was high or to purchase because the price was low. If all or even majority of the shareholders of say ABB, Siemens, Crompton Greaves or L & T decide to sell all their shares on any day because of the high price on that day, the prices will tumble because there would be no funds available to pay for the same. The prices of “commodity” called these “shares” follow simple supply and demand law, speculative maneuvers of traders, the so-called market sentiments and no other consideration. I am fully aware and admit that share market, the market players, the brokers, the merchant bankers, the mutual funds all play very important role in the economy and development and also as a channel to collect / attract funds for new investments. But it is the value-adding sector, which gives strength to basic investment climate. The share market cashes on the same. There is no value addition in share market.

(The write is a B.E.(Elect) (Hons), M.I.E. Dr.-Ing. Dresden, Germany Retired : Secretary -General & Executive Director, IEEMA. Director (India), International Copper Association Formerly: Faculty Member, Elect. Engg. Dept. I. I. T. Powai, Mumbai.)

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