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T.C.A. Ramanujam

T. C. A. Ramanujam looks at who will benefit from the proposals on dividend distribution

THE Finance Bill, 2003 comes in the wake of the radical recommendations of the Kelkar Task Force, which include a complete revamp of the Income-Tax Act, removing exemptions and deductions, paving the way for a tax neutral regime, and imposing an almost flat tax rate.

The Kelkar panel had also suggested a reduction of corporate tax rate, for both domestic and the foreign companies, and realigning depreciation rates so as to ensure uniformity between the rates prescribed under both the tax and company laws. The corporate sector, though, did not seem to favour these suggestions. If implemented, these would have definitely simplified the code and avoided intricate disputes about the calculation of book profits for levying MAT.

The Kelkar panel had projected Rs 10,000 crore in revenue by revamping the corporate tax structure. It is unfortunate that this advice of the eminent Harvard economist fell on deaf ears. MAT will continue to torment assessing officers (AOs) and the corporate houses.

Ninety-two clauses in the Finance Bill relate to amendments to the I-T Act at various levels. The most significant of the amendments relates to the taxation of dividends. But there seems to be not end to debate on double taxation of dividends. In 1996, the then Finance Minister had declared that he would end the debate by exempting all dividends from taxation. His successor thought that revenue was being lost by this measure. He levied a tax on distributed profits, first at 10 per cent and then at 20 per cent the next year. Last year, dividend was again brought to tax.

While Mr Jaswant Singh has chosen to exempt dividend from taxation, there will be a 12.5 per cent levy on profits distributed as dividends. This arrangement, however, is only for one year. One never knows if this will continue next year. There was an eminent jurist who repeatedly stressed that a stable fiscal policy is to a nation what a stable family is to an individual. Who cares?

Corporate houses are already looking at ways to avoid the 12.5 per cent dividend distribution tax (DDT). Buy back the shares or issue bonus shares. Do not distribute dividend. The small shareholder may be of the view that accumulated profits would lead to appreciation in their share value.

In exempting dividend from taxation, the Finance Minister is emulating the US President, Mr George W. Bush, who made a similar proposal to the Congress. The exemption is deceptive. The small shareholder will no doubt be happy to receive tax-free dividends, and the paperwork involved would be reduced. The measure, however should be a boon to captains of industry who, as promoters, receive lakhs of rupees as dividends.

Last year, the top 100 dividend-paying companies distributed Rs 14,000 crore. The dividend tax, at the maximum rate, worked out to Rs 4,400 crore in the hands of the shareholder. The dividend distribution tax in the hands of the company will be Rs 1,750 crore. It has been estimated that the weighted average promoter holding in Indian companies is over 50 per cent. They are the biggest beneficiaries of this change in the law, not the individual shareholder. Who cares for equity in taxation, anyway?

Is there any rationale for pegging the tax on distributed profits at 12.5 per cent? This rate has oscillated between 0, 10, 20 and 12.5 per cent in the past five years. The Finance Bill itself says that these are short-term measures. Will there be a switchover to dividend tax next year? Will Section 115-O be withdrawn? Who knows? Double taxation continues even now with DDT.

The Finance Minister has declared that he has an open mind on this issue and the DDT may be completely withdrawn or modified when the Finance Bill is taken up for discussion in Parliament.

Dr Kelkar had proposed exemption of dividend without suggesting DDT. Mr Jaswant Singh has adopted a policy of pick and chose. The Task Force had specifically mentioned, in para 5.93 of its Report, that there should be no tax on distribution of dividends by a company. However under option two, even while insisting on no tax on the dividends in the hands of shareholders, the Kelkar panel had recommended levy of DDT at the rate of 15 per cent on dividends distributed in 2003-04, 7.5 per cent in 2004-05 and nil in 2005-06.

Commenting on similar proposals in the Bush tax plan, a business weekly notes thus: "Perhaps the most important element in the Bush plan is the elimination of the personal tax on dividends. The general idea is that taxes on profits are already paid at the corporate level, so levies on dividends at the personal level constitute double taxation of these profits. Corporations react to the double taxation in several ways.

First, instead of paying dividends, they retain earnings and use accumulated earning to make stock repurchases. These practices, in essence, convert dividends into capital gains, which are taxed at low effective rates.

A downside to this tax-spurred corporate financial strategy is less transparency and weakened stockholder control over management-important concerns these days."

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