There had been considerable lobbying in the past from the Chambers of Commerce, Trade Associations, individual high-income taxpayers and various other quarters, generally before the presentation of the budget, for exempting dividend income from Income-Tax. The main ground given was to avoid double taxation.

The argument was that it is wrong to tax the same income twice — once when it is earned by companies in their own assessments, and then to subject such income to tax once again, in the hands of the shareholders, as dividends. In this argument, it was conveniently forgotten that the company and its shareholders are two different legal entities.

This position has been undisputedly accepted by courts in India and abroad, and by jurists such as Lord Halsbury. In India, the separate legal entities of the company and the shareholders has been accepted by the Supreme Court, in the case of Mrs Bacha F. Guzdar vs. CIT (1955) 27 ITR 1, where the court has said that “the company is a juristic person and is distinct from the shareholders….”. There is nothing in the Indian law to warrant the assumption that a shareholder, who buys shares, buys any interest in the property of the company, which is a juristic person, entirely different from the shareholders. Hence, there cannot be any injustice and hardship, if the two separate entities are taxed separately.

DIVIDEND INCOME EXEMPTED

Yet, the lobbying succeeded and dividend income was made tax-free by the Finance Act, 1997, without giving any justification for doing so.

The Finance Minister (FM) merely said, while exempting dividends from tax, in the budget speech, that an area of vigorous debate for many years relates to the issue of tax on dividends, and he wished to end this debate. Hence, he abolished tax on dividends in the hands of the shareholders. Obviously, the undisclosed reason was to end the so-called debate regarding double taxation.

RIGOROUS DOUBLE TAXATION

However, the new scheme ended in the worst form of double taxation by levy of Dividend Distribution Tax (DDT), which is presently levied at16.2250 per cent on the dividends distributed, inclusive of surcharge and education cess. This is imposed on the amount of dividends distributed by companies.

Earlier, the tax on distributed dividends and on corporate incomes was paid by two different entities, but now the tax on distributed dividend is paid by the same entity — the company — firstly, when the income is earned by any company, and again when out of such taxed income, dividend is distributed, which is subjected to tax again.

Thus, double taxation in the existing system is more blatant and the argument given to justify exemption of dividend income on the ground of avoidance of double taxation by imposition of DDT doesn't hold good.

INEQUITY ACCEPTED BY FM

The inequity of the system of taxation in the case of the companies and exempting shareholders from dividend income, as introduced by the Finance Act of 1997, was accepted by the Finance Minister, Mr Yashwant Sinha, while presenting the Finance Bill for 2002-03. He said: “…There is also an inherent inequity in the present system, which allows persons in high-income groups to be taxed at much lower rates than the rates applicable to them. I am now convinced that the existing system must be replaced.

Such income (meaning the dividend income) will henceforth be taxed in the hands of the recipients at the rates applicable to them.” Thus, the old system of taxing the company (on its income) and shareholders (for dividend) incomes was restored. But, the change remained operative for only one year. Mr Sinha's successor, Mr Jaswant Singh, reverted to the old system the following year without assigning any reasons.

SHOULD IT CONTINUE?

The present system of taxation of companies with DDT is prima-facie regressive, as it taxes earned income, such as wages, salary, pensions, income from business / professions, rather rigorously, and exempts unearned income such as dividends. The suggestions are:

Complete exemption for dividend income should be given to the persons with income (including dividend income) in the tax bracket carrying tax rate upto 20 per cent.

Full taxation of dividend income should be provided without any exemption. Simultaneously, DDT should be withdrawn.

Lower rates of taxes and exemptions only make the rich super-rich without affecting growth and development. Hence, tax on dividends and wealth-tax on securities/shares need to be restored.

(The author is a former chairman of CBDT.)

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